-----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, Bazkt3S3F42p259pcG3kWU97YoPhxJMsH/a78vw7VAYR76DG9TI3pOZXAGWcfdqp kLSgKLwThAuVshBzySn26w== 0000898430-97-005247.txt : 19971212 0000898430-97-005247.hdr.sgml : 19971212 ACCESSION NUMBER: 0000898430-97-005247 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 23 FILED AS OF DATE: 19971211 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HEADLANDS MORTGAGE CO CENTRAL INDEX KEY: 0001046207 STANDARD INDUSTRIAL CLASSIFICATION: MORTGAGE BANKERS & LOAN CORRESPONDENTS [6162] IRS NUMBER: 942851992 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-38267 FILM NUMBER: 97736043 BUSINESS ADDRESS: STREET 1: 700 LARKSPUR LANDING CIRCLE STE 250 CITY: LARKSPUR STATE: CA ZIP: 94939 BUSINESS PHONE: 4154616790 MAIL ADDRESS: STREET 1: 700 LARKSPUR LANDIND CIRCLE STE 250 CITY: LARKSPUR STATE: CA ZIP: 94939 S-1/A 1 AMENDMENT NO. 1 TO THE S-1 FOR HEADLANDS MORTGAGE AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 11, 1997 REGISTRATION NO. 333-38267 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ---------------- HEADLANDS MORTGAGE COMPANY (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 6162 94-2851992 (STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER JURISDICTION OF INDUSTRIAL IDENTIFICATION NO.) INCORPORATION OR CLASSIFICATION CODE ORGANIZATION) NUMBER) ---------------- 1100 LARKSPUR LANDING CIRCLE, SUITE 101 LARKSPUR, CALIFORNIA 94939 (415) 461-6790 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICE) ---------------- PETER T. PAUL PRESIDENT HEADLANDS MORTGAGE COMPANY 1100 LARKSPUR LANDING CIRCLE, SUITE 101 LARKSPUR, CALIFORNIA 94939 (415) 461-6790 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) COPIES TO: PHILLIP R. POLLOCK, ESQ. PETER T. HEALY, ESQ. TOBIN & TOBIN O'MELVENY & MYERS LLP ONE MONTGOMERY STREET, 15TH FLOOR 275 BATTERY STREET, 26TH FLOOR SAN FRANCISCO, CALIFORNIA 94104 SAN FRANCISCO, CALIFORNIA 94111 (415) 433-1400 (415) 984-8833 ---------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as practicable after this Registration Statement becomes effective. 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, as amended (the "Securities Act"), check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities 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. [_] ---------------- 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 THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. ================================================================================ ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A + +REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + +OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + +BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR + +THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE + +SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE + +UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF + +ANY STATE. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED DECEMBER 11, 1997 8,000,000 SHARES HEADLANDS MORTGAGE COMPANY COMMON STOCK Of the 8,000,000 shares of common stock (the "Common Stock") offered hereby (the "Offering"), 4,500,000 shares are being sold by Headlands Mortgage Company (the "Company" or "Headlands") and 3,500,000 shares are being sold by certain non-executive and non-employee shareholders of the Company (the "Selling Shareholders"). The Company will not receive any of the net proceeds from the sale of Common Stock by the Selling Shareholders. In addition, from the Company's net proceeds approximately $18.8 million of previously earned and undistributed taxable income will be paid to existing stockholders in connection with the termination of the Company's S corporation status and approximately $10.5 million will be used to repay certain notes and accrued interest due to current stockholders. Prior to the Offering, there has been no public market for the Common Stock of the Company. It is currently estimated that the initial public offering price will be between $14.00 and $16.00 per share of Common Stock. See "Underwriting" for a discussion of the factors to be considered in determining the initial public offering price. Application has been made to have the shares of Common Stock approved for quotation on the Nasdaq National Market under the symbol "HDLD." Investors purchasing shares in the Offering will be subject to immediate substantial dilution of $10.10 per share in net tangible book value. SEE "RISK FACTORS" COMMENCING ON PAGE 10 FOR A DISCUSSION OF MATERIAL RISKS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY. ----------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Proceeds to Price to Underwriting Proceeds to Selling Public Discount (1) Company (2) Stockholders - -------------------------------------------------------------------------------- Per Share....................... $ $ $ $ Total (3)....................... $ $ $ $
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (1) For information regarding indemnification of the Underwriters, see "Underwriting." (2) Before deducting expenses of the Offering estimated at $800,000, payable by the Company. (3) The Company has granted the Underwriters a 30-day option to purchase up to 1,200,000 additional shares of Common Stock on the same terms and conditions as set forth above, solely to cover overallotments, if any. If such options are exercised in full, the total Price to Public will be $ , Underwriting Discount will be $ , and Proceeds to Company will be $ . The shares of Common Stock are offered by the Underwriters named herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. It is expected that delivery of the certificates representing such shares will be made against payment therefor at the offices of NationsBanc Montgomery Securities, Inc. on or about , 1997. NationsBanc Montgomery Securities, Inc. BT Alex. Brown UBS Securities , 1997 ---------------- CERTAIN INFORMATION CONTAINED IN THIS PROSPECTUS CONSTITUTES "FORWARD- LOOKING STATEMENTS" WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "WILL," "EXPECT," "ANTICIPATE," "BELIEVE," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. THE STATEMENTS IN "RISK FACTORS" CONSTITUTE CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS, INCLUDING CERTAIN RISKS AND UNCERTAINTIES, WITH RESPECT TO SUCH FORWARD-LOOKING STATEMENTS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS. ---------------- CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING PURCHASES OF THE COMMON STOCK TO STABILIZE ITS MARKET PRICE, PURCHASES OF THE COMMON STOCK TO COVER SOME OR ALL OF A SHORT POSITION IN THE COMMON STOCK MAINTAINED BY THE UNDERWRITERS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." [MAP OF HEADLANDS OFFICE LOCATIONS] MAP OF UNITED STATES. MARKINGS INDICATE BRANCH OFFICE LOCATIONS AND SALES OFFICES. LARGE MARKING INDICATES HEADQUARTERS IN LARKSPUR, CALIFORNIA PROSPECTUS SUMMARY The following summary does not purport to be complete and is qualified in its entirety by the more detailed information and the consolidated financial statements and related notes appearing elsewhere in this Prospectus. In addition to the other information in this Prospectus, the factors set forth under "Risk Factors" below should be considered carefully in evaluating an investment in the Common Stock offered hereby. Unless otherwise indicated, all information in this Prospectus (i) assumes that the Underwriters' over- allotment option will not be exercised and (ii) reflects a 14,000-for-1 stock split to be effected immediately prior to the Offering. See Note 18 to the Consolidated Financial Statements. OVERVIEW Headlands Mortgage Company (the "Company" or "Headlands") is a specialty mortgage banking company in the business of originating, selling, securitizing and servicing mortgage loans secured by one- to four-family residences. The Company was incorporated in California and commenced its mortgage banking business in 1986. As a specialty mortgage lender, the Company's strategy is to focus on specialized mortgage loan products for primarily high credit quality borrowers. The Company generally places an emphasis on credit scores obtained from three major credit bureaus to evaluate the credit quality of borrowers. The Company considers "high credit quality borrowers" to be those whose credit scores equal or exceed levels required for the sale or exchange of their mortgage loans through Fannie Mae or Freddie Mac. The specialized mortgage loans targeted by the Company provide a relatively greater "spread" (i.e., greater interest and other income to the originator relative to the costs associated with funding and selling the mortgage loans) compared to other mortgage loans that present a similar credit risk. The Company believes that its wholesale lending channel (which generates a majority of its total originations), supported by its correspondent and retail lending channels, provides an efficient and responsive origination system for the types of mortgage loans it seeks to originate. The Company seeks the most efficient method of execution for sales of its mortgage loans and in recent years has increasingly utilized securitization in addition to traditional whole loan sales. The Company's business objective is to increase mortgage loan originations through geographic expansion and by providing a diversified range of mortgage loan products through its wholesale, correspondent and retail lending channels. During the year ended December 31, 1996, the Company originated $2.3 billion of residential mortgage loans, 77% in California and 23% in other states. During the nine months ended September 30, 1997, the Company originated $2.5 billion of residential mortgage loans, 74% in California and 26% in other states. According to National Mortgage News (October 6, 1997), for the six months ended June 30, 1997 the Company was ranked as the second largest wholesale originator in the United States that is not publicly owned or affiliated with a public company, and ranked 14th among all wholesale originators. As of September 30, 1997, the Company's mortgage loan servicing portfolio totaled $4.0 billion of mortgage loan principal balances. The Company is led by President Peter T. Paul, the founder and major shareholder of the Company. Mr. Paul has 25 years of experience in the residential mortgage industry. Mr. Paul and the Chief Financial Officer of the Company have worked together since 1987, and various other members of the executive management team have worked together for more than six years. See "Management--Directors and Executive Officers." BUSINESS STRATEGY MORTGAGE LOAN ORIGINATION Mortgage Loan Product Development. An important element of the Company's mortgage loan origination strategy is to provide a variety of mortgage loan products that are designed to respond to consumer needs and competitive factors and be readily saleable at prices that will generate the Company's targeted rate of return. The Company seeks mortgage loan products with relatively greater "spreads" compared to other mortgage loan products that present a similar credit risk and chooses not to rely on discount pricing to increase mortgage loan origination volume. This approach generally focuses the Company's development process on mortgage loans that 3 fail to satisfy one or more of the standardized criteria (other than credit quality of the borrower) required for sale or exchange through one of the national government-sponsored mortgage entities such as Fannie Mae or Freddie Mac ("Agencies") or one of the national privately-sponsored mortgage conduits. To date, the Company has tailored its loan products primarily for high credit quality borrowers as described above. The Company's secondary marketing department identifies a variety of new mortgage loan products that it believes will respond to consumer needs and that in many cases are not being widely offered by competitors. Such new mortgage loan products may be created by the Company itself or may be introduced by a competitor and identified by the Company as attractive for origination. The Company generally requires that all of its mortgage loan products be readily saleable through the Company's securitization programs or to secondary market investors. The Company presently has under development and review a variety of mortgage loan products that it expects to promote in 1998. Among the products that the Company intends to launch on a pilot basis is a mortgage loan for high credit quality borrowers that permits a higher loan-to-value ratio than is permitted in mortgage loans currently being originated by the Company. Another product to be introduced is a mortgage loan that is designed primarily for lower credit quality borrowers which will require more extensive mortgage insurance than is required on the Company's other loan products. All new mortgage loan products introduced by the Company are carefully pre-tested in the market over a period of time to assess both marketability to consumers and performance of the mortgage loan product as an investment for secondary market investors. Current Mortgage Loan Products. The Company presently offers a broad range of mortgage loan products in order to provide maximum flexibility to borrowers and third-party mortgage brokers and other entities through which it originates mortgage loans (the "Mortgage Sources"). The Company's current mortgage loan products can be categorized as follows: . Agency Mortgage Loans. These mortgage loans satisfy the underwriting criteria for sale or exchange through one of the Agencies. . Non-agency Mortgage Loans. These mortgage loans fail to satisfy the criteria to be Agency mortgage loans for one or more reasons. Certain of these mortgage loans ("Jumbos") generally meet the Agency criteria but exceed the maximum loan size (currently $214,600 for single-family, one- unit mortgage loans in the continental United States). Jumbos are generally eligible for sale to one of the national privately-sponsored mortgage conduits. Certain other non-agency mortgage loans may fail to satisfy other elements of the Agency underwriting criteria, such as those relating to documentation, employment history, income verification, loan-to-value ratios, qualifying ratios or required borrower net worth. Beginning in 1995, the Company began to emphasize the origination of mortgage loans which failed to satisfy one or more of the Agency and national conduit underwriting criteria but which, from a credit risk standpoint (as determined primarily by credit score), presented a comparable risk profile. The Company refers to this category of mortgage loans generally as "Alternative A" mortgage loans. The Company focuses on an applicant's credit score, in conjunction with other factors, in underwriting its Alternative A mortgage loans. While some Alternative A mortgage loans exceed the maximum loan size eligible for sale through one of the Agencies, many have principal balances within the Agency limits. . Home Equity Mortgage Loans. Home equity mortgage loans are generally secured by second liens on the related property. Home equity mortgage loans can take the form of a home equity line of credit ("HELOC") or a closed-end loan. Both types of home equity mortgage loans are designed primarily for high credit quality borrowers and are underwritten according to the Company's criteria for second-lien mortgage loans. Home equity mortgage loans are originated in some instances in conjunction with the Company's origination of a first-lien mortgage loan on the related property. 4 . Other Mortgage Loans. This category consists of mortgage loans for borrowers who have impaired or limited credit profiles or higher debt-to- income ratios than would be acceptable for sale of such mortgage loans to one of the Agencies. Such mortgage loans may also fail to satisfy the Agency underwriting criteria in other ways. The Company categorizes these mortgage loans as "A-" or "B" loans and believes they would generally be considered "subprime" mortgage loans in the secondary mortgage market. The Company does not originate mortgage loans that it would categorize as "C" or "D" loans. In 1994, the Company originated a substantial volume of non-agency mortgage loans in the form of Jumbos which it sold to national mortgage conduits and other private investors. In 1995, the Company's volume of Jumbo originations declined with the general decrease nationwide in the origination volume of residential mortgage loans and the general increase in competition that reduced the spread available for this mortgage loan product. The increase in originations of non-agency mortgage loans and home equity mortgage loans in 1996 reflects the Company's successful development of its Alternative A mortgage loan products and its HELOC and closed-end second-lien products and the commencement of the Company's securitization programs for such mortgage loan products. The following table summarizes the Company's originations of the above categories of mortgage loans:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------- ---------------------- 1994 1995 1996 1996 1997 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Agency Mortgage Loans Number of mortgage loans................ 4,978 4,546 7,093 5,852 3,815 Volume of mortgage loans................ $ 643,770 $ 562,778 $ 885,050 $ 734,114 $ 475,473 Percent of total volume................. 26.71% 41.51% 38.75% 44.66% 18.81% Non-agency Mortgage Loans Number of mortgage loans................ 8,212 4,380 6,068 3,994 8,759 Volume of mortgage loans................ $1,736,830 $ 695,253 $1,137,572 $ 747,922 $1,625,080 Percent of total volume................. 72.06% 51.29% 49.81% 45.50% 64.31% Home Equity Mortgage Loans Number of mortgage loans................ 262 1,767 5,482 3,443 8,359 Volume of mortgage loans................ $ 12,110 $ 72,580 $ 234,308 $ 141,467 $ 400,782 Percent of total volume................. 0.50% 5.35% 10.26% 8.60% 15.86% Other Mortgage Loans Number of mortgage loans................ 137 214 250 174 221 Volume of mortgage loans................ $ 17,690 $ 24,993 $ 26,910 $ 20,346 $ 25,825 Percent of total volume................. 0.73% 1.84% 1.18% 1.24% 1.02% Total Mortgage Loans Number of mortgage loans................ 13,589 10,907 18,893 13,463 21,154 Volume of mortgage loans................ $2,410,400 $1,355,604 $2,283,840 $1,643,849 $2,527,160 Average principal balance............... $ 177 $ 124 $ 121 $ 122 $ 119
Mortgage Loan Origination Channels. The Company originates mortgage loans through its wholesale, correspondent and retail lending channels. Wholesale Lending. The Company's wholesale lending channel, established in 1986, obtains its mortgage loan volume through a network of approximately 5,060 independent mortgage brokers approved by the Company (of which approximately 4,420 submitted mortgage loans in 1996). Mortgage brokers are qualified to participate in the Company's wholesale program after a formal application process, administered by the Company's Quality Assurance Department. The responsibilities of the Quality Assurance Department include the review of licensing, financial statements and resumes of key personnel and credit and reference investigations to determine the history, reputation and general lending expertise of the applicant. Approved mortgage brokers are monitored by the Company's wholesale account executive staff and the broker management division within the Quality Assurance Department. The Company underwrites each mortgage loan application obtained from its mortgage brokers and funds those mortgage loans which meet the Company's underwriting criteria. 5 The Company believes that its wholesale lending channel is well-suited to originate the types of mortgage loans that the Company seeks to originate. The wholesale lending channel permits the Company to respond quickly to changes in market conditions and consumer preferences. The Company can move quickly to introduce a new mortgage loan product by disseminating it throughout the broker network. By revising the terms on which it will fund mortgage loans submitted by its mortgage brokers, the Company may also move quickly to increase the level of origination of certain mortgage loan products or to decrease originations of other mortgage loan products that, due to market or other changes, may no longer meet the Company's targeted rate of return or other origination objectives. The Company believes that its flexibility would be reduced if it maintained a large retail branch system with the attendant fixed investment and overhead costs. The wholesale lending channel also permits the Company to obtain non- agency and other types of mortgage loans from mortgage brokers that generally only originate Agency mortgage loans. The Company builds its relationship with those mortgage brokers by providing access to specialized mortgage loan products. Correspondent Lending. The correspondent lending program is designed to allow the Company to acquire closed mortgage loans on terms similar to those it acquires on a wholesale basis from its mortgage brokers. The correspondent benefits by gaining access to the Company's broad range of innovative mortgage loan products. The correspondent lending program is designed to provide attractive mortgage loan products for small- to medium- sized mortgage companies, banks and thrifts located throughout the U.S. which may have limited access to the capital markets. Retail Lending. The retail channel, through a centralized operation, markets to existing and new customers. The Company markets to existing customers through inserts in the monthly mortgage statements, letters targeted to a specific group (i.e., borrowers with interest rates above a designated level) and outbound customer service calls. New customers are sought through national direct mail campaigns, regional radio advertising and telemarketing. New customers are also sought through several "affinity marketing" programs directed at trade groups and associations and other entities. MORTGAGE LOAN SALES As a mortgage banker, the Company originates all of its mortgage loans with the intent of selling such loans. A primary component of the Company's business strategy is to seek the most efficient method of selling its mortgage loans. In recent years, the Company has developed the capacity to access the capital markets by securitizing its mortgage loans in addition to selling them in whole loan sale transactions. The Company evaluates the sale of each mortgage loan type and compares prices available for each alternative method of sale, given current market conditions at the time and the risk characteristics of the mortgage loan type to determine which method of sale to utilize. The following table shows the method of sale for the Company's mortgage loans for the periods indicated:
NINE MONTHS YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30, -------------------------------- --------------------- 1994 1995 1996 1996 1997 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Mortgage loans sold through securitization......... $ 295,290 $ -- $ 597,965 $ 175,923 $1,442,468 Whole loan sales........ 2,502,396 1,330,484 1,532,119 1,323,468 1,031,351 ---------- ---------- ---------- ---------- ---------- Total................. $2,797,686 $1,330,484 $2,130,084 $1,499,391 $2,473,819 ========== ========== ========== ========== ==========
Securitization. In the second half of 1996, the Company began to securitize substantially all of its non-agency mortgage loans and home equity mortgage loans. Securitization is the process of pooling mortgage loans 6 and issuing securities such as mortgage pass-throughs or collateralized mortgage bonds or notes. The Company uses the cash generated from these transactions to fund originations of its mortgage loan products and to repay borrowings under its warehouse facilities. The Company believes that its ability to access the capital markets through securitization is important to its overall business strategy in several ways. Securitization is a very efficient method of selling the Company's non-agency and home equity mortgage loans. Under the non-agency mortgage loan securitization program, the Company generally sells the more senior classes of the securities produced by the securitization for cash and retains one or more of the subordinated classes. Such securities are carried on the balance sheet at their estimated fair market value (based on market prices for similar securities) under the line item "retained interests in securitizations." Due to the relatively high credit quality of the mortgage loans in these securitizations, the amount of subordinated securities taken back by the Company represents a relatively small percentage (generally less than 2%) of the total principal of the mortgage loans securitized. In addition, the market value of the classes of securities sold generally permits the Company to receive cash in an amount equal to or greater than its cost of funding the mortgage loans. As a result, the securitization of the Company's non-agency mortgage loans to date has not required a substantial amount of the Company's available cash. In the future, the Company may elect to retain additional classes of securities in such securitizations, which would require additional funds. Under the home equity mortgage loan securitization program, the Company generally sells the home equity mortgage loan securities for cash and a retained trust interest that represents (i) an interest (which is subordinated to payment on the securities sold) in the principal of the mortgage loans securitized (the "Principal Amount") and (ii) the right to the excess of future expected interest payments to be received on the mortgage loans securitized over the future interest payments required to be made on the securities sold (the "Interest-only Residual"). The estimated values of the Principal Amount and the Interest-only Residual are shown on the balance sheet under the line item "retained interests in securitizations." The securitizations of the Company's home equity mortgage loans generate negative cash flow compared to the cost of the mortgage loans securitized. The Company to date has elected to mitigate the extent of negative cash flow by selling a portion of the Interest- only Residual in connection with the home equity mortgage loan securitizations. In the future the Company may elect to retain the full amount of the Interest- only Residual in order to receive the future cash flows generated thereby. In such event, the negative cash flow at the time of effecting the securitization would be increased. Securitization also supports the Company's wholesale origination channel by increasing its flexibility in competing for non-agency mortgage loans. The parameters of mortgage loan characteristics that may be included in a pool to be securitized are generally broader than would be the case if the pool were to be sold in a traditional whole loan sale to a financial institution. Mortgage loan characteristics in securitizations are subject to the requirements of the rating agencies and of any third-party credit enhancer that may be involved, such as a monoline insurance company. The Company believes, however, that these requirements generally provide more flexibility in originating mortgage loans than would be the case under a traditional whole loan sale method. This additional flexibility enables the Company to compete more aggressively for mortgage loans and provide better service to its Mortgage Sources. Whole Loan Sales and Exchanges. Sales of mortgage loans and exchanges of mortgage loans for securities are conducted by the Company's Secondary Marketing Department. The Company's whole loan sales and exchanges of mortgage loans are generally made without recourse to the Company. The Company sells or exchanges substantially all of its Agency mortgage loans through normal secondary channels. The Company also generally sells its closed-end home equity mortgage loans in whole loan sales rather than in the home equity mortgage loan securitization program when the price received from whole loan sales is more attractive to the Company. From time to time the Company sells qualifying Jumbos to one of the privately-sponsored national mortgage conduit programs; such Jumbos are also included at times in the Company's non-agency mortgage loan 7 securitization program along with the Alternative A mortgage loans. The Company sells substantially all of its other mortgage loans (i.e., subprime mortgage loans) on a whole loan basis (servicing released) in order to avoid the credit risk associated with such mortgage loans. OPERATIONS AND INFORMATION SERVICES The Company's focus on providing premium service to its Mortgage Sources and offering a broad range of conventional and specialized mortgage loan products demands the timely delivery of such mortgage loan products to the branches and the careful monitoring and tracking of the origination of such mortgage loan products through delivery to the ultimate investor. For this reason, the Company places great emphasis on its operations and technology capabilities. The Company uses a mortgage loan origination and administrative computer system that has largely eliminated many of the manual efforts associated with the Company's processing operations. The Information Services Department is dedicated to implementing, supporting and improving the software and hardware technology employed by the Company. The Company believes that its emphasis on operations and technology enables it to be an efficient originator and servicer of both conventional and specialized mortgage loan products. MORTGAGE LOAN SERVICING The Company also engages in mortgage loan servicing, which includes the processing of mortgage loan payments and the administration of mortgage loans. The Company's primary source of servicing rights is mortgage loans it has originated and sold, and for which it has retained the right to service. As of September 30, 1997, the Company's mortgage loan servicing portfolio consisted of approximately 36,985 one- to four-family residential mortgage loans with an aggregate principal balance of $4.0 billion. The Company can realize the value embedded in its mortgage loan servicing portfolio immediately by selling its mortgage loan servicing rights or, alternatively, it can realize the value gradually over the life of the mortgage loan servicing portfolio through the receipt of monthly mortgage loan servicing fees. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview." The Company intends to increase its mortgage loan servicing portfolio over time, although the Company may sell portions of its mortgage loan servicing portfolio on a strategic basis from time to time. The Company believes its Servicing Center, which became fully operational in 1994, has the capacity to substantially increase the number of mortgage loans that it services, thereby allowing the Company to achieve certain economies of scale. See "Business-- Mortgage Loan Servicing--General" and "Business--Mortgage Loan Servicing-- Purchase and Sale of Mortgage Servicing Rights." The delinquency rates (including foreclosures pending) for the Company's mortgage loan servicing portfolio were 1.36%, 2.10% and 1.96% at June 30, 1997, December 31, 1996 and 1995, respectively, as compared to national industry averages for all mortgage loans (including government-insured mortgage loans) of 5.32%, 5.40% and 5.13% at June 30, 1997, December 31, 1996 and 1995, respectively, according to the Mortgage Bankers Association of America (the "MBA"). The Company believes the low delinquency rates for its mortgage loan servicing portfolio are primarily a result of the credit quality of the mortgage loans it originates and the relative age of mortgage loans it services. Higher delinquency rates generally lead to higher servicing costs and reduce the value of the mortgage loan servicing portfolio. TERMINATION OF S CORPORATION STATUS Since inception of operations in 1986, the Company has elected to be treated for federal income tax purposes as an S corporation under Subchapter S of the Internal Revenue Code (the "Code"). On the closing of the Offering, the Company's S corporation status will be terminated and the Company will become fully subject to federal and state income taxes as a C corporation. In connection with the termination of S corporation status, certain payments in respect of previously earned and undistributed taxable income (the "Shareholders Distribution Amount") will be made from the net proceeds of the Offering to the Company's existing shareholders (the "Existing Shareholders") and certain accounting adjustments will be made. See "Risk Factors--Possible Liability Under Tax Indemnification Agreement" and "Termination of S Corporation Status." 8 The principal executive office of the Company is located at 1100 Larkspur Landing Circle, Suite 101, Larkspur, California 94939, and its telephone number is (415) 461-6790. THE OFFERING Common Stock offered by The Company............................ 4,500,000 shares The Selling Shareholders............... 3,500,000 shares Common Stock to be outstanding after the Offering(1)............................. 18,500,000 shares Use of Proceeds.......................... The net proceeds of the Offering will be used (i) to pay the Shareholders Distribution Amount, (ii) to pay the full amount due under the Company's outstanding notes to stockholders, (iii) to support increased mortgage loan origination capacity, (iv) to support securitizations, and (v) for general corporate purposes. Pending such use, the net proceeds may be used to retire warehouse indebtedness or make short-term investments. See "Termination of S Corporation Status" and Notes 10 and 12 to the Consolidated Financial Statements. Proposed Nasdaq National Market Symbol... "HDLD"
- -------- (1) Excludes 518,000 shares of Common Stock issuable upon exercise of stock options granted under the Company's Stock Option Plan (the "Stock Option Plan"). See "Management--Stock Option Plan." RISK FACTORS Prospective investors should carefully consider the information set forth under the caption "Risk Factors" and all other information set forth in this Prospectus before making any investment in the Common Stock. 9 SUMMARY FINANCIAL DATA
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------------------------------- ---------------------- 1992 1993 1994 1995 1996 1996 1997 ---------- ---------- ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA: Revenues: Net gain on sales of mortgage loans........ $ 5,061 $ 26,163 $ 6,131 $ 12,307 $ 25,599 $ 10,816 $ 45,010 Loan administration in- come.................. 6,036 8,027 14,737 13,427 11,120 8,281 7,196 Gain on sale of mort- gage servicing rights................ 10,848 11,438 7,449 8,836 11,083 11,041 9,375 Production fees........ 8,788 14,107 6,044 3,832 5,830 4,442 6,223 Net interest income.... 206 1,797 2,709 1,814 5,624 3,496 8,826 Net unrealized gain in valuation of retained interests in securitization........ -- -- -- -- -- -- 668 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total revenues......... 30,939 61,532 37,070 40,216 59,256 38,076 77,298 Operating expenses: Personnel.............. 16,604 20,363 19,610 15,515 20,545 14,670 20,799 General and administra- tive.................. 6,730 11,220 10,584 10,900 13,458 8,659 10,978 Depreciation and amor- tization.............. 704 1,373 2,965 3,484 2,919 2,245 1,983 Amortization and im- pairment of OMSR...... -- -- -- 958 2,093 635 3,600 Occupancy and rents.... 897 3,341 2,591 2,136 1,941 1,436 1,659 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total operating ex- penses................ 24,935 36,297 35,750 32,993 40,956 27,645 39,019 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Income before taxes.... 6,004 25,235 1,320 7,223 18,300 10,431 38,279 Net income............. $ 5,862 $ 24,667 $ 1,270 $ 6,971 $ 17,660 $ 10,016 $ 36,936 ========== ========== ========== ========== ========== ========== ========== Pro Forma Information: Income before taxes.... $ 6,004 $ 25,235 $ 1,320 $ 7,223 $ 18,300 $ 10,431 $ 38,279 Pro forma income tax- es(1)................. 2,462 10,599 541 3,034 7,686 4,381 16,077 Pro forma net in- come(1)............... 3,542 14,636 779 4,189 10,614 6,050 22,202 Pro forma net income per share(1)(2)....... $ 0.68 $ 1.42 Pro forma weighted av- erage number of shares outstanding(1)(2)..... 15,631 15,631 Supplemental pro forma net income per share(1)(2)(3)........ $ 0.68 $ 1.38 Supplemental pro forma weighted average num- ber of shares out- standing(1)(2)(3)..... 15,923 16,331 OPERATING DATA: Loan Origination Volume (in thousands): Agency................. $1,737,357 $2,317,692 $ 643,770 $ 562,778 $ 885,050 $ 734,114 $ 475,473 Non-agency............. 1,233,585 2,310,237 1,736,830 695,253 1,137,572 747,922 1,625,080 Home equity loans...... 4,976 970 12,110 72,580 234,308 141,467 400,782 Other.................. -- -- 17,690 24,993 26,910 20,346 25,825 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total.................. $2,975,918 $4,628,899 $2,410,400 $1,355,604 $2,283,840 $1,643,849 $2,527,160 ========== ========== ========== ========== ========== ========== ========== Loan Origination Volume (in units): Agency................. 12,637 17,432 4,978 4,546 7,093 5,852 3,815 Non-agency............. 4,690 8,608 8,212 4,380 6,068 3,994 8,759 Home equity loans...... 86 17 262 1,767 5,482 3,443 8,359 Other.................. -- -- 137 214 250 174 221 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total.................. 17,413 26,057 13,589 10,907 18,893 13,463 21,154 Loan servicing portfolio (at end of period)(4).. $2,956,000 $4,283,168 $4,779,411 $4,149,305 $4,386,814 $3,971,822 $4,003,079 Weighted average inter- est rate.............. 7.99% 6.94% 7.10% 7.80% 8.10% 7.95% 8.34% Weighted average matu- rity (months)......... 317 301 299 284 278 272 265 Weighted average serv- ice fee rate.......... 0.27% 0.26% 0.31% 0.29% 0.29% 0.29% 0.28% Total delinquencies in- cluding foreclo- sures(5).............. 3.12% 1.73% 1.81% 1.96% 2.10% 1.87% 1.48% Average mortgage loan size.................. $ 148 $ 162 $ 164 $ 152 $ 128 $ 133 $ 108
10
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------ ----------------- 1992 1993 1994 1995 1996 1996 1997 ------- -------- ------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS) BALANCE SHEET DATA (AT END OF PERIOD): Retained interests in securitizations........ $ -- $ -- $ 768 $ 585 $ 15,128 $ 5,263 $ 32,670 Mortgage loans held for sale, pledged.......... -- 321,536 74,623 97,088 238,172 218,559 262,296 Originated mortgage servicing rights, net(6)................. -- -- -- 7,083 20,276 16,453 25,209 Total assets............ 12,550 349,198 98,730 147,432 288,990 256,654 349,998 Warehouse and other operating debt......... -- 307,566 76,278 91,234 241,343 220,015 254,712 Notes payable to stockholders........... -- -- -- -- 9,670 9,670 9,670 Total liabilities....... 5,315 322,297 79,827 121,558 259,846 235,153 283,918 Total stockholders' equity(7).............. 7,235 26,901 18,904 25,874 29,144 21,501 66,080
- -------- (1) Prior to the closing of the Offering, the Company will be treated as an S corporation for federal and state income tax purposes. See "Termination of S Corporation Status." The pro forma presentation reflects the provision for income taxes as if the Company had always been fully subject to federal and state taxes as a C corporation at the tax rates effective for the periods presented (41% for 1992 and 1994; 42% for 1993, and 1995 through 1997). (2) Pro forma net income per share has been computed by dividing pro forma net income by the pro forma weighted average number of shares outstanding. The pro forma weighted average number of shares includes all options issued below the estimated initial public offering price within one year prior to the filing of the Registration Statement for the initial public offering and is calculated using the treasury stock method. The pro forma weighted average number of shares also includes the effect of the assumed issuance of 1,253,334 shares of Common Stock to generate sufficient cash to pay the Shareholders Distribution Amount of $18.8 million at September 30, 1997. The assumed issuance of Common Stock was based on an assumed price of $15.00, the midpoint of the estimated range of the Offering price. Historical earnings per share is not presented because it is not indicative of the ongoing entity. (3) Supplemental pro forma net income per share reflects further adjustment for the effect of the add back, net of tax, of interest expense recorded since July 1996, the inception of the notes, to be repaid from the proceeds of the Offering. In that calculation, weighted average shares outstanding include the effect of the assumed issuance of 700,000 shares of Common Stock in July 1996 to retire the notes payable to stockholders and related accrued and unpaid interest ($10.5 million at September 30, 1997). (4) The Company's mortgage loan servicing portfolio for the years 1992 and 1993 was subserviced for the Company by another servicing entity. See "Certain Management Transactions and Business Relationships--History of Arrangements with FCMC." (5) Represents the mortgage loan balances past due 30 days or more (including those in foreclosure) as a percentage of the total mortgage loan servicing portfolio. (6) At September 30, 1997, the Company's mortgage loan servicing portfolio totaled $4.0 billion of mortgage loans, including $1.7 billion for which no capitalized balance sheet value has been recorded. (7) Does not give effect to (i) a distribution to the Existing Shareholders of the Shareholders Distribution Amount in the aggregate amount of $18.8 million (calculated as of September 30, 1997), or (ii) the creation of a deferred tax liability in the amount of $18.7 million (calculated as of September 30, 1997) arising in connection with the Company's termination of S corporation status. See "Termination of S Corporation Status," "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operation." 11 RISK FACTORS In addition to the other information contained in this Prospectus, the following risk factors should be carefully considered in evaluating the Company and its business before purchasing any of the Common Stock offered hereby. This Prospectus contains forward-looking statements. Discussions containing such forward-looking statements may be found in the material set forth under "Summary," "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Business" as well as within the Prospectus generally. Actual results could differ materially from those described in the forward-looking statements as a result of the risks and uncertainties set forth below and within the Prospectus generally. The Company cautions the reader, however, that this discussion of risk factors may not be exhaustive. CONTROL OF CERTAIN STOCKHOLDERS Peter T. Paul and his family will beneficially own 45.4% (and will have voting power pursuant to a Voting Trust with respect to 56.8%) of the outstanding shares of Common Stock following the closing of the Offering. Accordingly, Mr. Paul will have effective control of the Company, with the likely ability to approve certain fundamental corporate transactions (including mergers, consolidations and sales of assets) and to elect a majority of the members of the Board of Directors. See "Principal and Selling Shareholders." IMMEDIATE DILUTION TO STOCKHOLDERS PURCHASING IN THE OFFERING The initial public offering price is higher than the net tangible book value per share of Common Stock in the Offering. Investors purchasing shares of Common Stock in the Offering will be subject to immediate dilution of $10.10 per share in net tangible book value. See "Dilution." INTEREST RATE FLUCTUATIONS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS The Company's Mortgage Loan Origination and Sale Business May Be Adversely Affected by Changes in Interest Rates. Changes in interest rates can have a variety of effects on the Company's mortgage loan origination business. The market value of fixed-rate mortgage loans has a greater sensitivity to changes in market interest rates than adjustable-rate mortgage loans. To the extent an interest rate is established for a mortgage loan in process prior to the time such mortgage loan is funded (a "locked pipeline loan"), a gain or loss on the sale of such mortgage loan may result from changes in interest rates during the period between the time the interest rate is established and the time the mortgage loan is committed for sale. In order to hedge this interest rate risk, the Company sells (on a forward basis) a portion of its locked pipeline loans (or an equivalent amount of the mortgage-backed securities into which such mortgage loans may be converted). Since 1992, the Company has utilized Tuttle & Co., an unaffiliated advisory and information services company based in Mill Valley, California, for exposure analysis of its mortgage loan pipeline. The Company determines the number of such forward sales it will make based upon a daily probability analysis as to the principal amount of locked pipeline loans that are likely to be funded by the Company. To the extent that the probability analysis utilized by the Company differs from actual experience, the resultant mismatching of commitments to fund mortgage loans at certain interest rates and forward sales of mortgage loans with certain interest rates may have a material adverse effect on the Company's results of operations. See "Business--Hedging Activities." In addition to the interest rate risk discussed above, the Company's origination of mortgage loans that are ineligible for Agency programs ("non- agency mortgage loans") involves risk to the extent the Company has not obtained investor commitments to purchase such mortgage loans on a forward or current basis at the time interest rates are established for such mortgage loans (whether at mortgage loan funding or prior thereto). Specifically, until such forward purchase commitments are obtained, the Company, in most cases, hedges such non-agency mortgage loans with (i) forward sales of Fannie Mae mortgage-backed securities or (ii) forward whole loan sales. The Company determines which alternative provides the best execution in the secondary market. To the extent movements in the interest rates on such securities do not match the current pricing for non-agency mortgage loans in the secondary market, the Company may recognize gains or losses upon the sale of such mortgage loans. 12 Non-agency, home equity and other non-conforming mortgage loans made up 81.2% of the Company's mortgage loan originations during the nine months ended September 30, 1997 and 61.3% of mortgage loan originations during the year ended December 31, 1996. In addition to the foregoing, the Company's results of operations from its origination of mortgage loans can be adversely affected to the extent rising interest rates decrease the volume of mortgage loan originations and the revenue derived therefrom. The Company's Servicing Operations May Be Adversely Affected by Changes in Interest Rates. The Company's servicing operations are also affected by interest rate levels. As mortgage interest rates fall, an increasing number of borrowers can be expected to refinance and prepay their mortgage loans. Prepayments of mortgage loans serviced by the Company result in termination of the Company's future stream of servicing fees from such mortgage loans. In addition, the Company capitalizes servicing rights on mortgage loans that it originates based upon the net present value of future cash flows. If the rate of prepayment of the related mortgage loans exceeds the rate assumed by the Company, due to a significant reduction in interest rates or otherwise, the value of the mortgage loan servicing portfolio will decrease, which could adversely affect the Company's results of operations. Interest rate changes can also adversely affect the ability of the Company to sell mortgage loan servicing rights to a third party . The Company does not presently hedge its mortgage loan servicing portfolio. FAILURE TO EFFECTIVELY USE LEVERAGE TO FINANCE MORTGAGE LOAN ORIGINATIONS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS Unavailability of Funding Sources May Adversely Affect Results of Operations. The Company funds substantially all of the mortgage loans which it purchases and originates through borrowings under warehouse financing facilities, repurchase agreements and internally generated funds. The Company's borrowings are in turn repaid with the proceeds received by the Company from selling such mortgage loans through securitizations or whole loan sales. The Company is currently and may in the future be dependent upon a few lenders to provide the primary credit facilities for its mortgage loans. In addition, the Company's specialized mortgage loan products are often not familiar to warehouse lenders. As new mortgage loan products are introduced, such lenders must be familiarized with the loans and their marketability before they determine whether such mortgage loans are eligible for financing under the warehouse facilities. Any failure to renew or obtain adequate funding under these facilities, or any substantial reduction in the size of or pricing in the market for the Company's mortgage loans, could have a material adverse effect on the Company's operations. Increased Cost of Borrowing May Adversely Affect Results of Operations. If the return on the mortgage loans originated or acquired by the Company with borrowed funds fails to cover the cost of the borrowing, the Company will experience net interest losses and may experience net losses. In addition, the cost of such borrowings can vary depending upon the lender, the nature and liquidity of the underlying collateral, the movement of interest rates, the availability of financing in the market and other factors. Further, the Company may not be able to achieve the degree of leverage it believes to be optimal, which may cause the Company to be less profitable than it might be otherwise. Changes in Interest Rates May Adversely Affect Results of Operations. Profitability may be directly affected by the levels of and fluctuations in interest rates, which affect the Company's ability to earn a spread between interest received on its mortgage loans and the cost of borrowing. The profitability of the Company is likely to be adversely affected during any period of unexpected or rapid changes in interest rates. For example, a substantial or sustained increase in interest rates could adversely affect the ability of the Company to originate and acquire mortgage loans and could reduce the interest rate differential between newly originated mortgage loans and the Company's cost of borrowing. A significant decline in interest rates could decrease the size of the Company's mortgage loan servicing portfolio by increasing the level of mortgage loan prepayments. While the Company monitors the interest rate environment and generally will earn a positive spread between interest paid on borrowed funds and interest earned on mortgage loans, there can be no assurance that the profitability of the Company would not be adversely affected during any period of changes in interest rates. See "Risk Factors--Negative Effects of Interest Rate Fluctuations." 13 Failure to Refinance Outstanding Borrowings May Adversely Affect Results of Operations. While the Company expects to be able to maintain existing financing arrangements, or to obtain replacement financing as its lending arrangements mature, there can be no assurance that such financing will be obtainable on favorable terms. To the extent that the Company is not successful in maintaining or replacing existing financing, it may have to curtail its mortgage loan production activities, which could have a material adverse effect on the Company's operations. Decline in Market Value of Mortgage Assets and Margin Calls May Adversely Affect Results of Operations. A decline in the market value of the Company's portfolio of mortgage loans may limit the Company's ability to borrow or result in lenders initiating margin calls (i.e., requiring a pledge of cash or additional mortgage loans to re-establish the ratio of the amount of the borrowing to the value of the collateral). The Company could be required to sell mortgage loans under adverse market conditions in order to maintain liquidity. Such sales may be effected by the Company when deemed by it to be necessary in order to preserve the capital base of the Company. If these sales were made at prices lower than the amortized cost of the mortgage loans, the Company would experience losses. A default by the Company under its collateralized borrowings could also result in a liquidation of the collateral, including any cross-collateralized assets, and a resulting loss of the difference between the value of the collateral and the amount borrowed. DEPENDENCE ON SECURITIZATIONS FOR SUCCESSFUL OPERATIONS The Company plans to pool and sell through securitizations substantially all of its non-agency mortgage loans and HELOC home equity mortgage loans and expects that the gain recognized from such securitizations will continue to represent a significant portion of the Company's future revenues and net earnings. Further, the Company is dependent on the cash generated from such securitizations to fund its future originations and repay borrowings under its warehouse facilities. The Company's ability to complete securitizations of its mortgage loans will depend on a number of factors, including conditions in the securities markets generally, conditions in the mortgage-backed securities market specifically, the performance of the Company's previous securitizations or the securitizations of others and the Company's ability to obtain credit enhancement. Adverse changes in the securitization market could impair the Company's ability to sell mortgage loans through securitizations on a favorable or timely basis and could have a material adverse effect upon the Company's results of operations and financial condition. Furthermore, because management of the Company expects that an important component of the Company's income will be gain on sale, the Company's quarterly operating results may fluctuate significantly as a result of the timing and level of securitizations. If securitizations do not close when expected, the Company's results of operations may be materially adversely affected for that period. In addition, in order to gain access to the HELOC securitization market, the Company expects to continue to rely upon credit enhancements provided by one or more monoline insurance carriers to enable it to obtain an AAA/Aaa rating for the senior portion of its mortgage-backed securities. Any substantial increase in the price charged by, or the required level of protection to be provided to, the insurance companies, or any unwillingness of insurance companies to guarantee these senior securities in the Company's mortgage loan pools, could have a material adverse effect upon the Company's results of operations and financial condition. ESTIMATED VALUE OF RETAINED INTERESTS IN SECURITIZATIONS MAY BE REDUCED, ADVERSELY IMPACTING RESULTS OF OPERATIONS The Company derives a substantial portion of its revenue and earnings by recognizing gains on the sale of mortgage loans through securitizations. Securitization is the process of pooling mortgage loans that the Company has originated or purchased and issuing securities backed by such mortgage loan pools. The Company generally sells the more senior classes of the securities for cash and retains one or more of the subordinated classes. In its non- agency mortgage loan securitizations, the retained subordinated classes of securities generally have a stated principal amount and earn a fixed interest rate. Management believes that it has made reasonable estimates of the market value of such retained subordinated classes of securities on its balance sheet, based on market prices for similar securities. If the mortgage loans underlying such retained securities should experience delinquencies or losses at rates greater than anticipated, the value of such securities would have to be written-down with a 14 corresponding charge to income. In its home equity mortgage loan securitizations, the Company retains a trust interest that includes an Interest-Only Residual. To value the Interest-Only Residual for the balance sheet, the Company projects the expected cash flows over the life of such retained interest, using prepayment and default assumptions that market participants would use for similar financial instruments that are subject to prepayment, credit and interest rate risks. The Company then determines the present value of these cash flows using an interest rate which it believes is commensurate with the risks involved. If the Company's actual experience differs materially from the assumptions used in the determination of the present value of such retained interests, future cash flows and results of operations could be adversely affected. The Company could also be required to reduce the fair value of its retained interests on its balance sheet. To the Company's knowledge, there is currently no active market for the sale of these retained interests. No assurance can be given that the retained interests could be sold at their stated value, if at all. INTENSE COMPETITION IN THE MORTGAGE LENDING INDUSTRY The Company faces intense competition, primarily from commercial banks, savings and loans and other mortgage lenders. If the Company expands into particular geographic markets, it will face competition from mortgage lenders with established positions in such markets. There can be no assurance that the Company will be able to successfully compete with these mortgage lenders. Competition can take place on various levels, including convenience in obtaining a mortgage loan, service, marketing, origination channels and pricing. Many of the Company's competitors in the financial services business are substantially larger and have more capital and other resources than the Company. Many of the Company's competitors are well established in the specialty mortgage loan market and a number of others are recent entrants into that market seeking the relatively attractive profit margins currently associated with specialty mortgage loan products. Fannie Mae and Freddie Mac are currently developing technologies and business practices that will expand the scope of mortgage loans eligible to be Agency mortgage loans to include some Alternative A and subprime mortgage loans. To the extent market pricing for the Company's mortgage loan products becomes more competitive, it may be more difficult to originate and purchase mortgage loans with attractive yields in sufficient volume to maintain profitability. There can be no assurance that the Company will be able to compete successfully in this market environment and any failure in this regard could have a material adverse effect on the Company's results of operations and financial condition. DEPENDENCE ON WHOLESALE BROKERS FOR SUCCESSFUL OPERATIONS The Company depends primarily on independent mortgage brokers and, to a lesser extent, on correspondent lenders, for the origination and purchase of its wholesale mortgage loans, which constitute a significant portion of the Company's mortgage loan production. These independent mortgage brokers deal with multiple lenders for each prospective borrower. The Company competes with these lenders for the independent brokers' business on the basis of price, service, loan fees, costs and other factors. The Company's competitors also seek to establish relationships with such brokers, who are not obligated by contract or otherwise to do business with the Company. The Company's future results of operations and financial condition may be vulnerable to changes in the volume and costs of its wholesale mortgage loans resulting from, among other things, competition from other lenders and purchasers of such mortgage loans. PERMITTING UNDERWRITING EXCEPTIONS MAY ADVERSELY IMPACT RESULTS OF OPERATIONS On a case-by-case basis, the Company's underwriters may determine that a prospective borrower warrants an exception from its underwriting guidelines. Such exceptions may include a debt service-to-income ratio exception, a loan- to-value exception or an exception from certain documentation requirements of a particular mortgage loan program. An underwriting exception will generally be allowed if the application reflects one or more compensating factors, such as a high credit score, a low loan-to-value ratio, cash reserves, stable employment, or a particularly long length of residency in the property. Accordingly, the Company may fund mortgage loans that do not satisfy all of the criteria for a particular mortgage loan program being offered by the Company. The Company's historical experience in making such exceptions is limited and, therefore, its historical 15 delinquency and foreclosure rates to date may not be indicative of future levels of performance. By permitting underwriting exceptions, the Company may diminish the consistency and control inherent in the strict application of underwriting guidelines. In addition, if such mortgage loans cannot be included in a planned securitization or other expected method of sale, the Company may be required to dispose of these mortgage loans at a lower price than contemplated at the time of origination. RELIANCE UPON MORTGAGE LOAN PRODUCT DEVELOPMENT FOR SUCCESSFUL OPERATIONS The Company plans to expand and refine its mortgage loan products in order to maintain a variety of mortgage loan products with relatively attractive "spreads" which are (i) responsive to the needs of consumers, originating brokers and the secondary markets and (ii) available in the marketplace sooner than similar mortgage loan products offered by its competitors. There can be no assurance that the Company can continue to expand and refine its mortgage loan product mix on a timely basis and the failure to do so could have a material adverse effect on the Company's results of operations, financial condition and business prospects. POTENTIAL CREDIT LOSSES ON MORTGAGE LOANS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS The Company bears the risk of credit losses on mortgage loans held for sale and on certain retained interests in securitizations which the Company has elected or is required to hold. The Company has until recently sold its mortgage loans on a non-recourse basis. Accordingly, the Company has no significant historical experience with retention of risk of loss due to mortgage loan defaults. Potential losses can arise from many factors as summarized below: Real Estate Security and the Foreclosure Process. Many of the risks of mortgage lending reflect the risks of investing directly in the real estate securing the mortgage loans. In the event of a default on the underlying mortgage loan, the ultimate extent of the loss, if any, may only be determined after a foreclosure of the mortgage encumbering the property and, if the lender takes title to the property, upon liquidation of the property. Factors such as the title to the property or its physical condition (including environmental considerations) may make a third-party unwilling to purchase the property at a foreclosure sale or at a price sufficient to satisfy the obligations of the related mortgage loan. Foreclosure laws in various states may cause a protracted foreclosure process. In addition, the condition of a property may deteriorate during the period of foreclosure proceedings. Certain borrowers on underlying mortgage loans may become subject to bankruptcy proceedings, in which case the amount and timing of amounts due may be materially adversely affected. Even assuming that the underlying property provides adequate security for the mortgage loan, substantial delays could be encountered in connection with the liquidation of a defaulted mortgage loan and a corresponding delay in the receipt and reinvestment of principal and interest payments could occur. Adverse Real Estate Market Conditions May Affect Value of Collateral. The Company's business may be adversely affected by periods of economic slowdown or recession which may be accompanied by declining property values. Any material decline in property values reduces the ability of borrowers to use equity in the property to support borrowings and increases the loan-to-value ratios of mortgage loans previously made, thereby weakening collateral coverage and increasing the possibility of a loss in the event of default. In addition, delinquencies, foreclosures and losses generally increase during economic slowdowns and recessions. Non-agency, Home Equity and Other Mortgage Loans May Have Higher Delinquency and Foreclosure Rates. Credit risks associated with non-agency, home equity and other mortgage loans may be greater than those associated with Agency mortgage loans. In originating such non-agency loans, the Company generally places an emphasis on credit scores obtained from three major credit bureaus to evaluate the credit quality of the borrowers. Such non-agency loans may differ from Agency loans with respect to loan-to-value ratios, the credit and income history of the borrowers, the documentation required for approval of the borrowers, the types of properties securing the mortgage loans, mortgage loan sizes and the borrowers' occupancy status with respect to the mortgaged property. As a result of these and other factors, the interest rates charged on the non-agency categories of mortgage loans are often higher than those charged for Agency mortgage loans. The combination 16 of different underwriting criteria and higher rates of interest may lead to higher delinquency rates and/or credit losses for these categories of mortgage loans as compared to Agency mortgage loans. Further, to the extent the Company develops mortgage loan products for lower credit quality borrowers, there may be a higher risk of delinquency and foreclosure than with mortgage loans made to high credit quality borrowers. Any failure by the Company to adequately address the higher delinquency and foreclosure rates could have a material adverse effect on the Company. Lack of Geographic Diversification. During the nine months ended September 30, 1997 and the year ended December 31, 1996, 74% and 77%, respectively, of the Company's mortgage loan originations (as measured by principal balances) were secured by property located in California. To the extent that properties underlying such mortgage loans are located in the same geographic region, such mortgage loans may be subject to a greater risk of delinquency or default in the event of adverse economic, political or business developments and natural hazard risks that may affect such region. If the region's real estate market should experience an overall decline in property values, the rates of delinquency, foreclosure, bankruptcy and loss on the mortgage loans may be expected to increase substantially, as compared to such rates in a stable or improving real estate market. Potential Environmental Liabilities. Certain properties securing mortgage loans may be contaminated by hazardous substances. As a result, the value of the property may be diminished. In the event that the Company is forced to foreclose on a defaulted mortgage loan on that property, the Company may be subject to environmental liabilities regardless of whether the Company was responsible for the contamination. While the Company intends to exercise due diligence to discover potential environmental liabilities prior to the acquisition of any property through foreclosure, hazardous substances or wastes, contaminants, pollutants or sources thereof (as defined by state and federal laws and regulations) may be discovered on properties during the Company's ownership or after a sale thereof to a third party. If such hazardous substances are discovered on a property, the Company may be required to remove those substances or sources and clean up the property at substantial expense. The Company may also be liable to tenants and users of neighboring properties. In addition, the Company may find it difficult or impossible to sell the property prior to or following any such clean-up. QUARTERLY FLUCTUATIONS IN EARNINGS The Company's revenues and net earnings have fluctuated in the past and are expected to fluctuate in the future as a result of a number of factors, including the size and timing of securitizations and whole loan sales, expansion costs incurred by the Company and the volume of mortgage loan originations and purchases. If the Company were unable to securitize profitably a sufficient number of its mortgage loans in a particular quarter, or were unable to complete a sufficient number of whole loan sales, then the Company's revenues for such quarter would decline, which could result in lower earnings or a loss reported for such quarter and have a material adverse effect on the Company's results of operations, financial condition and business prospects. INABILITY TO SUSTAIN AND MANAGE GROWTH Although the Company has experienced rapid and substantial growth in mortgage loan originations and total revenues in recent years, there can be no assurance that the Company can sustain these rates of growth or that it will be able to create an infrastructure or recruit and retain sufficient personnel to keep pace with a prolonged period of growth. The inability of the Company to sustain or keep pace with its rate of growth would have a material adverse effect on the Company's results of operations, financial condition and business prospects. Additionally, in light of such growth, the historical financial performance of the Company may be of limited relevance in predicting future performance. GENERAL ECONOMIC AND FINANCIAL CONDITIONS MAY AFFECT RESULTS OF OPERATIONS The Company's results of operation will depend on, among other things, the level of net interest income generated by the Company's mortgage loans, the market value of such mortgage loans and the supply of and demand for such mortgage loans. Prepayment rates, interest rates, borrowing costs and credit losses depend upon 17 the nature and terms of the mortgage loans, the geographic location of the properties securing the mortgage loans, conditions in financial markets, the fiscal and monetary policies of the United States government and the Board of Governors of the Federal Reserve System, international economic and financial conditions, competition and other factors, none of which can be predicted with any certainty. LEGISLATION AND REGULATION The Company's business is subject to extensive regulation, supervision and licensing by federal, state and local governmental authorities and will be subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. Regulated matters include, without limitation, mortgage loan origination marketing efforts, credit application and underwriting activities, maximum finance and other charges, disclosure to customers, certain rights of rescission on mortgage loans, closing and servicing mortgage loans, collection and foreclosure procedures, qualification and licensing requirements for doing business in various jurisdictions and other trade practices. Mortgage loan origination activities are subject to the laws and regulations in each of the states in which those activities are conducted. Activities as a lender are also subject to various federal laws. The Truth in Lending Act ("TILA") and Regulation Z promulgated thereunder, as both are amended from time to time, contain disclosure requirements designed to provide consumers with uniform, understandable information with respect to the terms and conditions of mortgage loans and credit transactions in order to give them the ability to compare credit terms. TILA also guarantees consumers a three-day right to cancel certain credit transactions. TILA also imposes disclosure, underwriting and documentation requirements on mortgage loans, known as "Section 32 loans," with (i) total points and fees upon origination in excess of 8% of the mortgage loan amount or (ii) an annual percentage rate 10% higher than comparably maturing U.S. treasury securities. The Company is also required to comply with the Equal Credit Opportunity Act of 1974, as amended ("ECOA"), which prohibits creditors from discriminating against applicants on the basis of race, color, sex, age or marital status. Regulation B promulgated under ECOA restricts creditors from obtaining certain types of information from mortgage loan applicants. It also requires certain disclosures by the lender regarding consumer rights and requires lenders to advise applicants of the reasons for any credit denial. In instances where the applicant is denied credit or the rate or charge for a mortgage loan increases as a result of information obtained from a consumer credit agency, the Fair Credit Reporting Act of 1970, as amended, requires the lender to supply the applicant with a name and address of the reporting agency. The Company is also subject to the Real Estate Settlement Procedures Act ("RESPA") and the Debt Collection Practices Act and will be required to file an annual report with the Department of Housing and Urban Development ("HUD") pursuant to the Home Mortgage Disclosure Act ("HMDA"). The Company is also subject to the rules and regulations of, and examinations by, HUD, Fannie Mae, Freddie Mac and state regulatory authorities with respect to originating, processing, underwriting, selling and servicing mortgage loans. 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 enforcement actions. There can be no assurance that the Company will maintain compliance with these requirements in the future without additional expenses, or that more restrictive local, state or federal laws, rules and regulations will not be adopted or that existing laws and regulations will not be interpreted in a more restrictive manner, which would make compliance more difficult and more expensive for the Company. The laws and regulations described above are subject to legislative, administrative and judicial interpretation, and certain of these laws and regulations have been infrequently interpreted or only recently enacted. Infrequent interpretations of these laws and regulations or an insignificant number of interpretations of recently enacted regulations can result in ambiguity with respect to permitted conduct under these laws and regulations. Any ambiguity under the regulations to which the Company is subject may lead to regulatory investigations or enforcement actions and private causes of action, such as class action lawsuits, with respect to the Company's compliance with the applicable laws and regulations. The Company may also be subject to regulatory enforcement actions and private causes of action from time to time with respect to its compliance with applicable laws and regulations. 18 ELIMINATION OF LENDER PAYMENTS TO BROKERS Class-action lawsuits have been filed against a number of mortgage lenders alleging that such lenders have violated RESPA by making certain payments to independent mortgage brokers. These lawsuits have generally been filed on behalf of a purported nationwide class of borrowers and allege that payments made by a lender to a broker in addition to payments made by the borrower to a broker are prohibited by RESPA, and are therefore illegal. If these cases are resolved against the lenders, it may cause an industry-wide change in the way independent mortgage brokers are compensated. The Company's broker compensation programs permit such payments. Future regulatory interpretations or judicial decisions may require the Company to change its broker compensation programs or subject it to material monetary judgments or other penalties. Any such changes or penalties may have a material adverse effect on the Company's results of operations, financial condition and business prospects. See "Risk Factors--Legislation and Regulation." DEPENDENCE UPON KEY PERSONNEL FOR SUCCESSFUL OPERATIONS The Company's operations will depend heavily upon the contributions of Mr. Peter T. Paul and the Company's other executive officers, Becky S. Poisson, Gilbert J. MacQuarrie and Steven M. Abreu, each of whom would be difficult to replace. The loss of any of these individuals or of other key personnel could have a material adverse effect upon the Company's business and results of operations. See "Management--Directors and Officers." FUTURE REVISIONS IN POLICIES AND STRATEGIES AT THE DISCRETION OF THE BOARD OF DIRECTORS The Company has established the operating policies and strategies set forth in this Prospectus as the operating policies and strategies of the Company. However, these policies and strategies may be modified or waived by the Board of Directors without stockholder approval. The ultimate effect of these changes may be positive or negative. POSSIBLE LIABILITY UNDER THE TAX INDEMNIFICATION AGREEMENT The Company and the Existing Shareholders have entered into a tax indemnification agreement (the "Tax Agreement") relating to their respective income tax liabilities. Because the Company will be fully subject to corporate income taxation after the termination of the Company's S corporation status, any reallocation of income and deductions between the period during which the Company was treated as an S corporation and the period during which the Company will be subject to corporate income taxation may increase the taxable income of one party while decreasing that of another party. The Tax Agreement generally provides that, if an adjustment is made to the taxable income of the Company for a year in which it was treated as an S corporation, the Company will indemnify the Existing Shareholders (up to an agreed maximum amount described below) against any increase in the Existing Shareholder's income tax liability (including interest and penalties and related costs and expenses) with respect to such tax year to the extent such increase results in a related decrease in the income tax liability of the Company (whether with respect to the year of the adjustment or over future years). Additionally, the Existing Shareholders will not be responsible for any portion of any deferred tax liability recorded on the balance sheet of the Company upon the termination of the S corporation status. The Company will also indemnify the Existing Shareholders for all taxes imposed upon them as the result of an indemnification payment under the Tax Agreement. In no event, however, will the Company be obligated to make indemnification payments under the Tax Agreement if such payments, together with the aggregate of prior payments, would exceed the amount of the deferred tax liability which may be recorded by the Company on the balance sheet of the Company at the time of the termination of the Company's S corporation status ($18.7 million at September 30, 1997). The tax indemnification agreement is not binding on the Internal Revenue Service and any payment made by the Company to the Existing Shareholders as aforesaid may be considered by the Internal Revenue Service or state taxing authorities to be non-deductible by the Company for income tax purposes. Any payment obligation of the Company under the Tax Agreement on the part of the Company, or the amount thereof, is uncertain at this time; however, any such payment may be material if an indemnification payment obligation arises. See "Termination of S Corporation Status." 19 ABSENCE OF ACTIVE PUBLIC TRADING MARKET There is currently no trading market for the Common Stock and there can be no assurance that an active trading market for the Common Stock will develop or that, if developed, it will be sustained. The initial public offering price of the Common Stock offered hereby was determined by negotiations among the Company and representatives of the Underwriters and may not be indicative of the price at which the Common Stock will trade after the closing of the Offering. See "Underwriting." Consequently, there can be no assurance that the market price for the Common Stock will not fall below the initial public offering price. POSSIBLE VOLATILITY OF STOCK PRICE In the event an active trading market for the Common Stock does develop, the market price of the Common Stock may experience fluctuations unrelated to the operating performance of the Company. In particular, the price of the Common Stock may be affected by general market price movements as well as developments specifically related to the mortgage finance industry such as interest rate movements and credit quality trends. SECURITIES ELIGIBLE FOR FUTURE SALE MAY ADVERSELY AFFECT THE MARKET PRICE OF COMMON STOCK Following the closing of the Offering (and assuming that the Underwriters' over-allotment option is not exercised), there will be outstanding 18,500,000 shares of Common Stock, of which (i) 8,000,000 shares of Common Stock are being offered hereby and (ii) 10,500,000 shares of Common Stock are held by current shareholders and subject to a 180-day "lock-up" period following the closing of the Offering. See "Underwriting." The shares of Common Stock not being offered in the Offering are "restricted securities" within the meaning of Rule 144 ("Rule 144") under the Securities Act. Such restricted securities will be available for resale pursuant to Rule 144 following a holding period ending one year from the date of issuance, (subject to the volume and other limitations imposed by Rule 144) and, unless held by affiliates of the Company will become unrestricted two years from the date of issuance. In addition, upon termination or waiver of the lock-up period, such restricted securities may be sold at any time through an effective registration statement. Future sales of restricted securities could have an adverse effect on the market price of the Common Stock. The holders of the currently restricted shares of Common Stock have certain registration rights with respect to such shares of Common Stock. See "Shares Eligible for Future Sale" and "Description of Capital Stock--Registration Rights." As of September 30, 1997, options to purchase 518,000 shares of Common Stock were outstanding under the Company's Stock Option Plan, which will vest on various dates extending through 2001. The Company will file a Form S-8 registration statement approximately 90 days following the closing of the Offering to permit shares issued pursuant to the options to be sold. POTENTIAL ISSUANCE OF PREFERRED STOCK The Company's Articles of Incorporation authorize the Board of Directors to issue shares of Preferred Stock designated in one or more classes or series. The Preferred Stock may be issued from time to time with such designations, rights and preferences as shall be determined by the Board of Directors. Preferred Stock would be available for possible future financing of, or acquisitions by, the Company and for general corporate purposes without any legal requirement that further stockholder authorization for issuance be obtained. The issuance of Preferred Stock could have the effect of making an attempt to gain control of the Company more difficult by means of a merger, tender offer, proxy contest or otherwise. The Preferred Stock, if issued, may have a preference on dividend payments which could affect the ability of the Company to make dividend distributions to the holders of Common Stock. As of the date of this Prospectus, no shares of Preferred Stock have been issued and the Company does not intend to issue any Preferred Stock prior to the closing of the Offering. 20 TERMINATION OF S CORPORATION STATUS From inception of operations, the Company has elected to be treated for federal income tax purposes as an S corporation under Subchapter S of the Code, and as an S corporation for certain state corporate income tax purposes under certain comparable state laws. As a result, the Company's historical earnings have been taxed directly to the Company's shareholders, at their individual federal and state income tax rates, rather than to the Company (except for certain state taxes). Upon the issuance of shares of Common Stock on the closing of the Offering, the Company's S corporation status will be terminated and the Company will become fully subject to federal and state income taxes. At that time, the Company will record a deferred tax liability on its balance sheet, the amount of which will depend upon timing differences between tax and book accounting relating principally to recognition of gains on sales of mortgage loans. If the S corporation status had been terminated as of September 30, 1997, the amount of the deferred tax liability would have been approximately $18.7 million. See "Capitalization." Since inception, the Company has made distributions to its shareholders of a portion of the Company's income to permit the shareholders to pay their taxes on such income. The aggregate amount of distributions to shareholders, however, has been less than the aggregate amount of taxable income of the Company during this period. The amount of this previously earned and undistributed taxable income (including estimated taxable income up to the closing of the Offering, with provision for adjustment based on final numbers) (the "Shareholders Distribution Amount") will be distributed to the Existing Shareholders out of the net proceeds of the Offering promptly following the closing of the Offering. The Shareholders Distribution Amount as of September 30, 1997 would have been approximately $18.8 million. The Company and the Existing Shareholders have entered into a tax indemnification agreement (the "Tax Agreement") relating to their respective income tax liabilities. Because the Company will be fully subject to corporate income taxation after the termination of the Company's S corporation status, any reallocation of income and deductions between the period during which the Company was treated as an S corporation and the period during which the Company will be subject to corporate income taxation may increase the taxable income of one party while decreasing that of another party. Accordingly, the Tax Agreement is intended to assure that taxes are borne either by the Company or the Existing Shareholders to the extent that such parties received the related income. The Tax Agreement generally provides that, if an adjustment is made to the taxable income of the Company for a year in which it was treated as an S corporation, each party will indemnify the other against any increase in the indemnified party's income tax liability (including interest and penalties and related costs and expenses) with respect to such tax year to the extent such increase results in a related decrease in the income tax liability of the indemnifying party (whether with respect to the year of the adjustment or over future years). However, the Tax Agreement specifically provides that the Existing Shareholders will not be responsible for any portion of any deferred tax liability recorded on the balance sheet of the Company upon termination of the S corporation status. The Company will also indemnify the Existing Shareholders for all taxes imposed upon them as the result of an indemnification payment under the Tax Agreement. In no event, however, will the Company be obligated to make indemnification payments under the Tax Agreement if such payments, together with the aggregate of prior payments, would exceed the amount of the deferred tax liability which may be recorded by the Company on the balance sheet of the Company at the time of the termination of the Company's S corporation status. Any payment made by the Company to the Existing Shareholders pursuant to the Tax Agreement may be considered by the Internal Revenue Service or state taxing authorities to be non-deductible by the Company for income tax purposes. Neither parties' obligations under the Tax Agreement are secured, and, as such, there can be no assurance that the Existing Shareholders or the Company will have funds available to make any payments which may become due under the Tax Agreement. A copy of the Tax Agreement has been filed by the Company as an exhibit to the Registration Statement of which this Prospectus is a part. See "Risk Factors--Possible Liability Under the Tax Indemnification Agreement." 21 USE OF PROCEEDS The net proceeds to the Company from the sale of the 4,500,000 shares of Common Stock offered by the Company hereby are estimated to be $61,975,000 after deducting the Underwriting Discounts and estimated offering expenses ($78,715,000 if the Underwriters' over-allotment option granted by the Company is exercised in full), assuming an initial public offering price of $15.00 per share of Common Stock. No proceeds will be realized by the Company from the sale of shares of Common Stock by the Selling Shareholders. The Company will first use a portion of the net proceeds of the Offering to pay the Shareholders Distribution Amount ($18.8 million calculated as of September 30, 1997). The Company will next use the net proceeds to pay in full the outstanding principal and interest on the stockholder notes beneficially owned by Peter T. Paul and Jessica M. Paul. As of September 30, 1997, the amount outstanding under the stockholder notes was $9.7 million plus accrued interest to date of payment. The stockholder notes bear interest at a variable rate equal to the one-year LIBOR plus 5%. Any remaining net proceeds (and the net proceeds from any exercise of the Underwriters' overallotment option to purchase up to another 1,200,000 shares of Common Stock) will be used as follows: 50% to support increased mortgage loan origination capacity (including through geographic expansion), 45% to support securitization transactions and 5% for general corporate purposes. Pending their ultimate application, the net proceeds from the Offering will be used temporarily to pay down outstanding balances under the Company's warehouse credit facilities or to invest in short-term, investment-grade, interest-bearing securities and deposit accounts. DIVIDEND POLICY The Company expects that it will retain all available earnings generated by its operations for the development and growth of its business and does not anticipate paying any cash dividends in the foreseeable future. The payment of dividends by the Company is limited under the terms of its Warehouse Facility and other credit agreements. Any future determination as to dividend policy will be made at the discretion of the Board of Directors of the Company and will depend on a number of factors, including the future earnings, capital requirements, financial condition and future prospects of the Company and such other factors as the Board of Directors may deem relevant. 22 CAPITALIZATION The following table sets forth, as of September 30, 1997, (i) the actual capitalization of the Company, and (ii) the pro forma capitalization of the Company as adjusted to give effect to the conversion of the Company from an S corporation and to the sale of the 4,500,000 shares of Common Stock offered by the Company hereby at an assumed initial offering price of $15.00 per share and the application of the estimated net proceeds therefrom to pay the Shareholders Distribution Amount and the stockholder notes. This table should be read in conjunction with the Company's financial statements and the notes thereto. See "Termination of S Corporation Status" and "Use of Proceeds."
SEPTEMBER 30, 1997 ------------------------ ACTUAL AS ADJUSTED ---------- ------------- (DOLLARS IN MILLIONS) Debt: Notes payable ................................ $ 254.7 $ 254.7 Notes payable to stockholders................. 9.7 -- ---------- ---------- Total debt.................................. 264.4 254.7 Stockholders' equity: Common Stock; 14,700,000 shares authorized and 50,000,000 shares authorized as adjusted; 14,000,000 issued and outstanding and 18,500,000 issued and outstanding as adjusted(1).................................. -- 90.6 Retained earnings(2).......................... 66.1 -- ---------- ---------- Total stockholders' equity.................. 66.1 90.6 ---------- ---------- Total capitalization...................... $ 330.5 $ 345.3 ========== ==========
- -------- (1) Excludes 518,000 shares of Common Stock subject to options. See "Management--Stock Option Plan." (2) Gives pro forma effect to (i) a distribution to the Existing Shareholders of the Shareholders Distribution Amount in the aggregate amount of $18.8 million (calculated as of September 30, 1997), and (ii) the creation of a deferred tax liability in the amount of $18.7 million (calculated as of September 30, 1997) arising in connection with the Company's termination of S corporation status. See "Termination of S Corporation Status," "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operation." 23 DILUTION The net tangible book value of the Common Stock as of September 30, 1997 was $66.1 million, or $4.72 per share of Common Stock. Net tangible book value per share of Common Stock represents the amount of the Company's stockholders' equity, less intangible assets, divided by the number of shares of Common Stock outstanding. Dilution per share of Common Stock represents the difference between the amount per share paid by purchasers of shares of Common Stock in the Offering made hereby and the pro forma net tangible book value per share of Common Stock immediately after the closing of the Offering. After (i) giving effect to the sale of 4,500,000 shares of Common Stock offered hereby by the Company at the assumed initial public offering price of $15.00 per share, (ii) deducting the Underwriting Discount and estimated offering expenses payable by the Company, (iii) giving effect to the S corporation distribution to the Existing Shareholders of an aggregate of $18.8 million (calculated as of September 30, 1997) in payment of the Shareholders Distribution Amount, and (iv) the creation of a deferred tax liability in the amount of $18.7 million (calculated as of September 30, 1997) arising in connection with the Company's termination of its S corporation status, the pro forma net tangible book value of the Company as of September 30, 1997 would have been $90.6 million or $4.90 per share of Common Stock. This represents an immediate increase in pro forma net tangible book value per share to the Existing Shareholders of $0.18 and an immediate dilution of $10.10 to new public investors purchasing Common Stock in the Offering, as illustrated in the following table: Assumed initial public offering price per share............. $15.00 Net tangible book value per share at September 30, 1997..... $ 4.72 Decrease attributable to payment of Shareholders Distribu- tion Amount.............................................. $(1.34) Decrease due to deferred tax liability.................... $(1.34) Increase in tangible book value per share attributable to new public investors..................................... $ 2.86 ====== Pro forma net tangible book value per share after the Offering................................................... $ 4.90 ====== Dilution per share to new public investors.................. $10.10 ======
The following table sets forth on a pro forma basis as of September 30, 1997 the difference between Existing Shareholders and the purchasers of shares in the Offering with respect to the number of shares purchased from the Company, the total consideration paid and the average price paid per share of Common Stock:
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE PRICE ------------------ ------------------- PER SHARE NUMBER PERCENT NUMBER PERCENT OF COMMON STOCK ---------- ------- ----------- ------- --------------- Existing shareholders(1)........ 14,000,000 75.7% $28,600,000 29.8% $ 2.04 New public investors.... 4,500,000 24.3% $67,500,000 70.2% $15.00 ---------- ----- ----------- ----- ------ Total................. 18,500,000 100.0% $96,100,000 100.0% $ 5.19 ========== ===== =========== ===== ======
- -------- (1) The sale of shares by the Selling Shareholders in the Offering will reduce the number of shares held by Existing Shareholders to 10,500,000 shares, or 56.8% of the total shares of Common Stock outstanding, and will increase the number of shares held by new investors to 8,000,000, or 43.2% of the total shares of Common Stock outstanding after the Offering. The information and tables above exclude the effect of (i) 518,000 shares of Common Stock subject to options and (ii) options to purchase up to an additional 182,000 shares of Common Stock available for issuance under the Stock Option Plan. The calculations also assume no exercise of the Underwriters' overallotment option. See "Management--Stock Option Plan," "Description of Capital Stock" and "Underwriting." 24 SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data for the years ended December 31, 1992 through 1996 are derived from the Company's audited financial statements. The selected financial data for the nine months ended September 30, 1996 and September 30, 1997 are unaudited and, in the opinion of the management of the Company, include all adjustments, consisting of normal accruals, necessary for a fair presentation. The results of operations for the nine-month period ended September 30, 1997 are not necessarily indicative of the results expected to be achieved during the entire year. The data set forth below should be read in conjunction with the consolidated financial statements of the Company and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere herein.
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------------------------------- ---------------------- 1992 1993 1994 1995 1996 1996 1997 ---------- ---------- ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA: Revenues: Net gain on sales of mortgage loans........ $ 5,061 $ 26,163 $ 6,131 $ 12,307 $ 25,599 $ 10,816 $ 45,010 Loan administration in- come.................. 6,036 8,027 14,737 13,427 11,120 8,281 7,196 Gain on sale of mort- gage servicing rights................ 10,848 11,438 7,449 8,836 11,083 11,041 9,375 Production fees........ 8,788 14,107 6,044 3,832 5,830 4,442 6,223 Net interest income.... 206 1,797 2,709 1,814 5,624 3,496 8,826 Net unrealized gain in valuation of retained interests in securitization........ -- -- -- -- -- -- 668 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total revenues......... 30,939 61,532 37,070 40,216 59,256 38,076 77,298 Operating expenses: Personnel.............. 16,604 20,363 19,610 15,515 20,545 14,670 20,799 General and administra- tive.................. 6,730 11,220 10,584 10,900 13,458 8,659 10,978 Depreciation and amor- tization.............. 704 1,373 2,965 3,484 2,919 2,245 1,983 Amortization and im- pairment of OMSR...... -- -- -- 958 2,093 635 3,600 Occupancy and rents.... 897 3,341 2,591 2,136 1,941 1,436 1,659 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total operating ex- penses................ 24,935 36,297 35,750 32,993 40,956 27,645 39,019 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Income before taxes.... 6,004 25,235 1,320 7,223 18,300 10,431 38,279 Net income............. $ 5,862 $ 24,667 $ 1,270 $ 6,971 $ 17,660 $ 10,016 $ 36,936 ========== ========== ========== ========== ========== ========== ========== Pro Forma Information: Income before taxes.... $ 6,004 $ 25,235 $ 1,320 $ 7,223 $ 18,300 $ 10,431 $ 38,279 Pro forma income tax- es(1)................. 2,462 10,599 541 3,034 7,686 4,381 16,077 Pro forma net in- come(1)............... 3,542 14,636 779 4,189 10,614 6,050 22,202 Pro forma net income per share(1)(2)....... $ 0.68 $ 1.42 Pro forma weighted av- erage number of shares outstanding(1)(2)..... 15,631 15,631 Supplemental pro forma net income per share(1)(2)(3)........ $ 0.68 $ 1.38 Supplemental pro forma weighted average num- ber of shares out- standing(1)(2)(3)..... 15,923 16,331 OPERATING DATA: Loan Origination Volume (in thousands): Agency................. $1,737,357 $2,317,692 $ 643,770 $ 562,778 $ 885,050 $ 734,114 $ 475,473 Non-agency............. 1,233,585 2,310,237 1,736,830 695,253 1,137,572 747,922 1,625,080 Home equity loans...... 4,976 970 12,110 72,580 234,308 141,467 400,782 Other.................. -- -- 17,690 24,993 26,910 20,346 25,825 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total.................. $2,975,918 $4,628,899 $2,410,400 $1,355,604 $2,283,840 $1,643,849 $2,527,160 ========== ========== ========== ========== ========== ========== ========== Loan Origination Volume (in units): Agency................. 12,637 17,432 4,978 4,546 7,093 5,852 3,815 Non-agency............. 4,690 8,608 8,212 4,380 6,068 3,994 8,759 Home equity loans...... 86 17 262 1,767 5,482 3,443 8,359 Other.................. -- -- 137 214 250 174 221 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total.................. 17,413 26,057 13,589 10,907 18,893 13,463 21,154 Loan servicing portfolio (at end of period)(3).. $2,956,000 $4,283,168 $4,779,411 $4,149,305 $4,386,814 $3,971,822 $4,003,079 Weighted average inter- est rate.............. 7.99% 6.94% 7.10% 7.80% 8.10% 7.95% 8.34% Weighted average matu- rity (months)......... 317 301 299 284 278 272 265 Weighted average serv- ice fee rate.......... 0.27% 0.26% 0.31% 0.29% 0.29% 0.29% 0.28% Total delinquencies in- cluding foreclo- sures(4).............. 3.12% 1.73% 1.81% 1.96% 2.10% 1.87% 1.48% Average mortgage loan size.................. $ 148 $ 162 $ 164 $ 152 $ 128 $ 133 $ 108
25
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ------------------------------------------ ------------------ 1992 1993 1994 1995 1996 1996 1997 ------- -------- ------- -------- -------- --------- -------- (DOLLARS IN THOUSANDS) BALANCE SHEET DATA (AT END OF PERIOD): Retained interests in securitizations........ $ -- $ -- $ 768 $ 585 $ 15,128 $ 5,263 $ 32,670 Mortgage loans held for sale, pledged.......... -- 321,536 74,623 97,088 238,172 218,559 262,296 Originated mortgage servicing rights, net(6)................. -- -- -- 7,083 20,276 16,453 25,209 Total assets............ 12,550 349,198 98,730 147,432 288,990 256,654 349,998 Warehouse and other operating debt......... -- 307,566 76,278 91,234 241,343 220,015 254,712 Notes payable to stockholders........... -- -- -- -- 9,670 9,670 9,670 Total liabilities....... 5,315 322,297 79,827 121,558 259,846 235,153 283,918 Total stockholders' equity(7).............. 7,235 26,901 18,904 25,874 29,144 21,501 66,080
- -------- (1) Prior to the closing of the Offering, the Company will be treated as an S corporation for federal and state income tax purposes. See "Termination of S Corporation Status." The pro forma presentation reflects the provision for income taxes as if the Company had always been fully subject to federal and state taxes as a C corporation at the tax rates effective for the periods presented (40% for 1992 and 1994; 42% for 1993 and 1995 through 1997). (2) Pro forma net income per share has been computed by dividing pro forma net income by the pro forma weighted average number of shares outstanding. The pro forma weighted average number of shares includes all options issued below the estimated initial public offering price within one year prior to the filing of the Registration Statement for the initial public offering and is calculated using the treasury stock method. The pro forma weighted average number of shares also includes the effect of the assumed issuance of 1,253,334 shares of Common Stock to generate sufficient cash to pay the Shareholders Distribution Amount of $18.8 million at September 30, 1997. The assumed issuance of Common Stock was based on an assumed price of $15.00, the midpoint of the estimated range of the Offering price. Historical earnings per share is not presented because it is not indicative of the ongoing entity. (3) Supplemental pro forma net income per share reflects further adjustment for the effect of the add back, net of tax, of interest expense recorded since July 1996, the inception of the notes, to be repaid from the proceeds of the Offering. In that calculation, weighted average shares outstanding include the effect of the assumed issuance of 700,000 shares of Common Stock in July 1996 to retire the notes payable to stockholders and related accrued and unpaid interest ($10.5 million at September 30, 1997). (4) The Company's mortgage loan servicing portfolio for the years 1992 and 1993 was subserviced for the Company by another servicing entity. See "Certain Management Transactions and Business Relationships--History of Arrangements with FCMC." (5) Represents the mortgage loan balances past due 30 days or more (including those in foreclosure) as a percentage of the total mortgage loan servicing portfolio. (6) At September 30, 1997, the Company's mortgage loan servicing portfolio totaled $4.0 billion of mortgage loans, including $1.7 billion for which no capitalized balance sheet value has been recorded. (7) Does not give effect to (i) a distribution to the Existing Shareholders of the Shareholders Distribution Amount in the aggregate amount of $18.8 million (calculated as of September 30, 1997), or (ii) the creation of a deferred tax liability in the amount of $18.7 million (calculated as of September 30, 1997) arising in connection with the Company's termination of S corporation status. See "Termination of S Corporation Status," "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operation." 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is primarily engaged in the origination, purchase, sale, securitization and servicing of mortgage loans secured by one- to four-family residential units. The Company's total income represents revenues derived from net gain from sales of mortgage loans, loan administration income, gain from sales of mortgage servicing rights, production income, net interest income and net unrealized gains in valuation of retained interests in securitizations. The net gain from sales of mortgage loans consists of two components: (i) gain on sale of mortgage loans sold through securitizations, which is recognized based on the sum of the selling price of the portion sold and the value of the portion retained less the carrying value of the mortgage loans sold; and (ii) net gain on mortgage loans sold through whole loan transactions, which is recognized based upon the difference between the selling price and the carrying value of the mortgage loans sold. If a whole loan is sold servicing released, the servicing release premium is included in the net gain on the sale of the mortgage loan. Loan administration income includes fees earned as servicer for mortgage loans owned by investors, net of fees paid to the subservicer. The Company recognizes gain on the sale of mortgage servicing rights which are sold separately from the mortgage loans, based upon the difference between the selling price, net of selling expenses, and the carrying value of the mortgage loan servicing rights. Production income includes fees paid to the Company by borrowers for the preparation, documentation and underwriting of mortgage loans. Net interest income consists of the net spread between interest received by the Company on its mortgage loans held for sale and interest paid by the Company under its credit facilities. It also includes interest earned on retained interests in securitizations net of interest expenses for the related investment financing. Prior to July 1, 1993, the Company's originated mortgage loans were arranged through its Mortgage Sources and funded by, and in the name of, First California Mortgage Company ("FCMC"), a related party of the Company. On July 1, 1993, the Company began originating mortgage loans in its own name as an authorized seller/servicer with FCMC acting as subservicer for the Company with respect to newly originated mortgage loans. By February 1994, the Company's Servicing Center became operational, and all of the servicing functions were transferred from FCMC to the Servicing Center by June 30, 1994. See "Certain Management Transactions and Business Relationships--History of Arrangement with FCMC." As of the date of this Prospectus, the Company had eight wholesale branches and a network of approximately 5,060 mortgage brokers. In addition, the Company initiated its correspondent and retail lending divisions in 1994 to access new mortgage loan origination markets. These strategies were designed to expand and diversify the Company's mortgage loan origination network and decrease the Company's reliance on the California real estate market. The Company has experienced significant growth in the last few years, particularly since April 1, 1995. Management believes that this growth is primarily attributable to (i) its changing mortgage loan product mix, (ii) the Company's geographic expansion, (iii) the Company's further penetration into its established markets, and (iv) the Company's increased access to additional funding sources which has enabled the Company to accumulate larger pools of mortgage loans for sales through securitizations. In connection with its growth, the Company has continued to focus its resources on developing mortgage loan production from borrowers, brokers and correspondents by designing mortgage loan products to meet the evolving needs of these customers. Any future growth will be limited by, among other things, the Company's need for continued funding sources, access to capital markets, sensitivity to economic slowdowns, ability to attract and retain qualified personnel, fluctuations in interest rates and competition from other mortgage lenders and from new market entrants. See "Business--Competition." The Company's primary source of mortgage loan servicing rights is from mortgage loans originated or acquired and sold by the Company. Of the Company's $4.0 billion of mortgage loans serviced at September 30, 1997, $3.5 billion were serviced for others and $0.5 billion were mortgage loans held for sale by the Company. 27 Of the mortgage loans serviced for others, approximately $1.5 billion were mortgage loans serviced for Fannie Mae or Freddie Mac, $1.7 billion were mortgage loans included in securities created by the Company, and $0.4 billion were mortgage loans serviced for private investors. Of the total mortgage loans serviced for others (excluding mortgage loans held for sale or investment) at September 30, 1997, December 31, 1996 and 1995, respectively, 1.2%, 1.5% and 1.4% were 30 days or more delinquent. As of September 30, 1997 and December 31, 1996 and 1995, the Company had not purchased mortgage loan servicing rights and, while from time to time it may consider purchasing mortgage loan servicing rights, the Company has no immediate plans to do so. TERMINATION OF S CORPORATION STATUS AND INCOME TAXES On the closing of the Offering, the Company's status as an S corporation will terminate. In connection with the termination of the Company's S corporation status, the Company will distribute the Shareholders Distribution Amount. The Shareholders Distribution Amount would have been $18.8 million calculated as of September 30, 1997. See "Use of Proceeds" and "Termination of S Corporation Status." As an S corporation, the Company's income, whether or not distributed, was taxed at the shareholder level for federal and state tax purposes. Upon termination of its S corporation status, the Company will be fully subject to federal and state income taxes and will record a deferred tax liability on its balance sheet. The amount of the deferred tax liability to be recorded as of the date of termination of the S corporation status will depend upon timing differences between tax and book accounting relating principally to recognition of gains on sale of mortgage loans. If the S corporation status had been terminated as of September 30, 1997, the amount of the deferred tax liability would have been approximately $18.7 million. The pro forma provision for income taxes in the selected consolidated financial data shows results as if the Company had always been fully subject to federal and state taxes at the tax rates effective for the periods presented. RESULTS OF OPERATION Nine Months Ended September 30, 1997 Compared to Nine Months Ended September 30, 1996 Summary. The financial results for the nine months ended September 30, 1997 reflect not only the growth in the Company's mortgage loan originations, but also its ability to successfully securitize and market the mortgage loans in the capital markets. Refinancing activity accounted for approximately 54% of the mortgage loans originated by the Company during the nine months ended September 30, 1997, compared to 56% during the same period in 1996. Net income for the nine months ended September 30, 1997 increased $26.9 million, or 269% to $36.9 million compared to $10.0 million for the same period in the prior year. The percentage increase in net income was higher than the percentage increase in revenue due to a relatively lower increase in operating expenses for the first nine months of 1997 from the first nine months of 1996. Revenue. Revenue for the nine months ended September 30, 1997 increased $39.2 million, or 103% to $77.3 million as compared to $38.1 million for the same period of 1996. Net gain from sales of mortgage loans increased $34.2 million, or 317%, to $45.0 million for the nine months ended September 30, 1997 compared to $10.8 million for the same period of the previous year. The increase was the result of increased mortgage loan originations and purchases as well as the corresponding increase in mortgage loans sold through securitizations and on a whole loan basis. During the nine months ended September 30, 1997, mortgage loan originations increased $883.4 million, or 54%, to $2,527.2 million compared to $1,643.8 million in the comparable period in 1996. Mortgage loans either sold or securitized during the nine months ended September 30, 1997 increased $974.4 million, or 65%, to $2,473.8 million from $1,499.4 million during the comparable period in 1996, with a weighted average net gain on sale as a percentage of mortgage loans sold or securitized of 1.8% and 0.7%, respectively. The increase in net gain on sale percentage is primarily due to the Company's ability to obtain improved pricing by securitizing pools of mortgage loans. Additionally, the Company completed a HELOC securitization during the nine months ended September 30, 1997, which has improved pricing over the non-agency securitizations. The Company retains 100% of the servicing rights on mortgage loans it sells through securitizations. See Note 2(b) to the Consolidated Financial Statements. 28 Loan administration income decreased $1.1 million, or 13%, to $7.2 million for the nine months ended September 30, 1997 from $8.3 million for the nine months ended September 30, 1996. The decrease was due primarily to a 5% decrease in the average monthly balance outstanding in the mortgage loan servicing portfolio from $3.9 billion to $3.7 billion. The decrease in the average mortgage loan servicing portfolio is primarily due to the timing of bulk mortgage loan servicing sales which occurred at the beginning of the nine months ended September 30, 1997, in contrast to the middle of the nine months ended September 30, 1996. Even though the average mortgage loan servicing portfolio decreased, the outstanding mortgage loan servicing portfolio remained at $4.0 billion at September 30, 1997 from September 30, 1996. The Company sold mortgage servicing rights relating to $1.8 billion and $1.0 billion of mortgage loan principal balances during the nine months ended September 30, 1997 and September 30, 1996, respectively, resulting in a pre- tax gain of $9.4 million and $11.0 million, respectively. These gains represent a 52 basis point and 110 basis point gain based on the outstanding principal balance of the underlying mortgage loans for the nine months ended September 30, 1997 and 1996, respectively. The decrease in gain is due to a lower book value related to the mortgage servicing rights sold in the prior period, as well as a decrease in the price of the sale to 1.11% for the nine months ended September 30, 1997 from 1.23% for the nine months ended September 30, 1996. In general, the decision to sell, buy or retain mortgage servicing rights is based upon the market for and value of mortgage servicing rights, the Company's current financial needs and objectives, including, among other things, its cash and/or capital requirements and its debt-to-equity and other financial ratios. The Company's ability to sell its mortgage servicing rights under its various mortgage loan servicing agreements with investors is generally subject to the consent of the investors. In addition, under the mortgage loan servicing provisions governing the Company's securitizations, the successor servicer is subject to prior approval of the rating agencies rating the subject securities. See "Risk Factors--Sale of Mortgage Servicing Rights" and "Use of Proceeds." Production income increased $1.8 million, or 41%, to $6.2 million for the nine months ended September 30, 1997, as compared to $4.4 million for the comparable period in 1996. The increase is due primarily to the growth in origination volume. Net interest income increased $5.3 million, or 151%, to $8.8 million during the nine months ended September 30, 1997 from $3.5 million during the comparable period in 1996. The increase in net interest income was due to several factors: (i) a higher average balance of mortgage loans held for sale during the nine months ended September 30, 1997 than the comparable period of 1996; (ii) earnings on subordinate certificates retained by the Company relating to securitizations; and (iii) the Company's ability to obtain a wider spread between mortgage coupons and borrowing rates primarily relating to home equity lines of credit. These increases are offset by an additional expense of $0.6 million during the nine months ended September 30, 1997 relating to interest on the stockholders note payable of $9.7 million. Net unrealized gain in valuation of retained interests in securitizations was $0.7 million for the nine months ended September 30, 1997. This gain was the result of an increase in the market value of retained interests in securitizations from December 31, 1996 to September 30, 1997. Expense. Operating expenses increased $11.4 million or 41% to $39.0 million during the nine months ended September 30, 1997 from $27.6 million for the same period in 1996. The increase in expense was primarily the result of additional personnel required for the greater volume of mortgage loan originations, higher operating expenses related to the increase in mortgage loan originations and an increase in amortization and impairment of originated mortgage servicing rights relating to the increase in the capitalized asset during the nine months ended September 30, 1997 as compared to the nine months ended September 30, 1996. Personnel expense increased $6.1 million or 41% to $20.8 million during the nine months ended September 30, 1997 from $14.7 million for the comparable period in 1996. The increase in personnel expense was due primarily to increased staffing in the Company's mortgage loan originations area. As of September 30, 1997, the Company employed 616 people compared to 476 people at September 30, 1996, a 29% increase. 29 General and administrative expenses increased $2.3 million or 26% to $11.0 million during the nine months ended September 30, 1997 from $8.7 million for the comparable period in 1996. The increase in general and administrative expenses is due primarily to expenses incurred in connection with the increase in loan originations, and includes such items as office supplies, telephone, computers and postage. Amortization and impairment of originated mortgage loan servicing rights increased $3.0 million or 500% to $3.6 million for the nine months ended September 30, 1997, as compared to $0.6 million for the nine months ended September 30, 1996. The increase in amortization and impairment of originated mortgage loan servicing rights was due to an increase in the related asset. Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 Summary. The financial results for the year ended December 31, 1996 principally reflect the growth in the Company's mortgage loan originations. The total volume of mortgage loans originated increased $0.9 billion or 64% to $2.3 billion for 1996 compared to $1.4 billion in 1995. This increase reflects both the expansion of the Company's mortgage loan origination network and the market for its specialized mortgage loan products. During 1996, refinancing activity accounted for approximately 56% of the mortgage loans originated by the Company compared to approximately 55% during 1995. Net income for the year ended December 31, 1996 increased $10.7 million or 153% to $17.7 million as compared to $7.0 million for the prior year. The percentage increase in net income was higher than the percentage increase in revenue due to a relatively lower increase in operating expenses from 1995 to 1996. Revenue. Revenue for the year ended December 31, 1996 increased $19.1 million or 48% to $59.3 million as compared to $40.2 million for the same period in 1995. Net gain from sales of mortgage loans increased $13.3 million or 108% to $25.6 million for the year ended December 31, 1996 as compared to $12.3 million for the previous year. The increase was attributable to the following factors: (i) an increase in the volume of mortgage loans sold of $0.8 million or 62% to $2.1 million, as compared to mortgage loans sold of $1.3 million during 1995; and (ii) the Company's ability to obtain improved pricing by securitizing pools of mortgage loans as compared to whole loan sales. Loan administration income for the year ended December 31, 1996 decreased $2.3 million or 17% to $11.1 million as compared to $13.4 million for the previous year. The change resulted from a 12% decrease in the average balance outstanding in the mortgage loan servicing portfolio for the year ended December 31, 1996 from the year ended December 31, 1995, and a decrease in the average principal balance per loan during the same period. See "Business-- Mortgage Loan Servicing." The Company sold mortgage servicing rights relating to $1.0 billion of mortgage loan balances during 1996, resulting in a pre-tax gain of $11.1 million. The Company sold mortgage loan servicing rights relating to $0.9 billion of mortgage loan principal balances in the previous year, resulting in a pre-tax gain of $8.8 million. Production income increased $2.0 million or 53% to $5.8 million for the year ended December 31, 1996 from $3.8 million for the previous year, due to the growth in mortgage loan origination volume. Net interest income increased $3.8 million or 211% to $5.6 million for the year ended December 31, 1996 from $1.8 million in the prior year. This increase is primarily attributable to the increase in average mortgage loans outstanding, as well as improved borrowing rates obtained by the Company. Expenses. Operating expenses increased $6.9 million or 21% to $39.9 million for the year ended December 31, 1996 from $33.0 million in 1995. This increase resulted from growth in the Company's base operations primarily in personnel, and from costs incurred by the Company for the negotiation and resolution of all prior business activity with affiliates (the "Settlement Agreement"). See "Certain Management Transactions and Business Relationships--Settlement Agreement." 30 Personnel expenses increased $5.0 million or 32% to $20.5 million for the year ended December 31, 1996 as compared to $15.5 million in 1995. This increase was attributable to a 27% increase in the number of employees to 512 at December 31, 1996 from 403 at the end of 1995. This increase was primarily necessary to support the growth in the Company's mortgage loan origination sale and servicing businesses. General and administrative expense increased $2.6 million or 24% to $13.5 million for 1996, as compared to $10.9 million for 1995. The increase was primarily the result of the increase in mortgage loan originations and costs relating to the Settlement Agreement between the Company and its affiliates, including telephone, legal, computer services and miscellaneous expenses. Occupancy expense decreased $0.2 million or 10% to $1.9 million for the year ended December 31, 1996 as compared to $2.1 million for 1995. This decrease is the result of costs incurred during 1995 related to branches which were closed in 1994. Depreciation and amortization expense decreased $0.6 million or 17% to $2.9 million for the year ended December 31, 1996 as compared to $3.5 million for the same period in 1995. This decrease resulted from a 14% decrease in property, equipment and leasehold improvements. Year Ended December 31, 1995 Compared to the Year Ended December 31, 1994 Summary. The mortgage industry experienced a significant decline during 1994. The yield of the 30-year treasury bond went from 6.23% at January 3, 1994 to 7.91% at December 31, 1994. This influenced the demand for mortgage loan refinancings, causing a decrease in new loan volume production nationwide. During this period of decline, the Company sold Jumbo mortgage loans to conduits at larger profit margins than those obtained by selling to the Agencies. Additionally, because of the Company's position in the niche Jumbo mortgage loan market, it was able to sustain high levels of origination volume for several months after the end of the "refinance boom" of 1993. Total revenues increased $3.1 million or 8% to $40.2 million in 1995 from $37.1 million in 1994. During the same period, the Company's total expenses decreased $2.7 million or 8% to $33.0 million in 1995 from $35.7 million in 1994. As a result, the Company's net income increased $5.7 million or 439% to $7.0 million in 1995 from $1.3 million in 1994. Revenue. Revenue increased as a result of increases in net gain from sales of mortgage loans and gain from sales of mortgage servicing rights, partially offset by decreases in loan administration income, production income and net interest income. Net gain from sales of mortgage loans increased $6.2 million or 102% to $12.3 million for the year ended December 31, 1995 compared to $6.1 million for the year ended December 31, 1994. The increase is due primarily to the adoption of SFAS No. 122 which was issued by the Financial Accounting Standards Board for implementation in 1995. Without the gain recorded by the Company in 1995 in relation to SFAS No. 122 of $8.0 million, net gain from sales of mortgage loans decreased $1.8 million or 30%. Loan administration income decreased $1.3 million or 9% to $13.4 million for the year ended December 31, 1995 compared to $14.7 million for the year ended December 31, 1994. This decrease was the result of a decrease in the average servicing portfolio of $537.5 million or 11% to $4,577.0 million for the year ended December 31, 1995 compared to $5,114.5 million for the year ended December 31, 1994. Gain from sales of mortgage servicing rights increased $1.4 million or 19% to $8.8 million for the year ended December 31, 1995 from $7.4 million for the year ended December 31, 1994. This increase is the result of an increase in the volume of mortgage loan servicing sold of $205.0 million or 28% to $941.2 million for the year ended December 31, 1995 compared to $736.2 million for the year ended December 31, 1994. Production income decreased $2.2 million or 37% to $3.8 million for the year ended December 31, 1995 compared to $6.0 million for the year ended December 31, 1994. This decrease was the result of a decrease in 31 mortgage loan production of $1,054.8 million or 44% to $1,355.6 million for the year ended December 31, 1995 compared to $2,410.4 million for the year ended December 31, 1994. Net interest income decreased $895.4 million or 33% to $1,813.9 million for the year ended December 31, 1995 compared to $2,709.3 million for the year ended December 31, 1994. This decrease was the result of a decrease in the average balance of mortgage loans held for sale during the year. Expense. Operating expenses decreased primarily as a result of a decrease in personnel expense, offset by the additional expense of amortization and impairment of originated mortgage servicing rights. Personnel expense decreased $4.1 million or 21% to $15.5 million for the year ended December 31, 1995 compared to $19.6 million for 1994. This decrease was due to a decrease in the average number of employees by 94 or 21% to 358 for the year ended December 31, 1995 compared to 452 for the year ended December 31, 1994. The Company incurred $1.0 million in amortization and impairment expense relating to originated mortgage servicing rights. This was an additional expense beginning with the year ended December 31, 1995, and was due to the implementation of SFAS No. 122. FINANCIAL POSITION September 30, 1997 Compared to December 31, 1996 The balance of mortgage loans held for sale is affected by the timing of securitizations and whole loan sales. Mortgage loans held for sale increased $24.1 million or 10% to $262.3 million at September 30, 1997 from $238.2 million at December 31, 1996. The increase in mortgage loans held for sale resulted primarily from mortgage loan originations and purchases of $2,527.2 million during the nine months ended September 30, 1997, partially offset by sales into securities of $1,442.5 million, whole loan sales of $1,031.4 million and unused HELOC credit line capacity of $15.0 million. Borrowings under warehouse lines of credit increased $13.4 million or 5.6% to $254.7 million at September 30, 1997 from $241.3 million at December 31, 1996, reflecting the mortgage loan origination, purchase and sale activity described above. The percentage increase in the borrowings under warehouse lines of credit was less than the percentage increase in the mortgage loans held for sale due to a combination of the Company's investment in the mortgage loans held for sale and the practice of investing any available cash in the warehouse lines of credit to reduce interest expense. Additionally, the Company repaid the $12.0 million balance outstanding under the servicing secured line of credit during the nine months ended September 30, 1997. Retained interests in securitizations increased $17.6 million or 117% to $32.7 million at September 30, 1997 from $15.1 million at December 31, 1996. The increase is due to four factors: (i) the Company retained subordinate tranches in the five securities it issued during the first nine months of 1997 with an estimated market value of $20.6 million; (ii) the transferor interest in the asset-backed security issued by the Company in December 1996 increased by $1.9 million in the form of overcollateralization created as a result of the excess cash flows of the security; (iii) the Company recorded an unrealized gain in the aggregate market value of $0.7 million relating to the retained interests it holds; (iv) the Company's reduction in its non- subordinated net interest in the same asset-backed security of $0.9 million; and (v) the sale of certain retained interest with a net book value at sale of $4.7 million. Accounts receivable increased $9.0 million or 118% to $16.6 million at September 30, 1997 from $7.6 million at December 31, 1996. The increase resulted primarily from an increase in servicing advances of $2.9 million or 63%, and an increase in accrued interest receivable of $0.7 million or 64%. The increase in servicing advances was due to a decrease in borrowers who made monthly payments in advance, which offset the borrowers with delinquent payments, as well as servicing advances required at the close of the Company's HELOC security during the nine months ended September 30, 1997. The increase in accrued interest receivable was primarily due to the increase in mortgage loans held for sale. 32 Accounts payable increased $7.3 million or 166% to $11.7 million at September 30, 1997 from $4.4 million at December 31, 1996. The increase resulted primarily from capital leases entered into by the Company of $4.9 million, an increase in interest payable on warehouse lines of $1.6 million, as well as a general increase due to the Company's increased mortgage loan production. Originated mortgage servicing rights increased $4.9 million or 24% to $25.2 million at September 30, 1997 from $20.3 million at December 31, 1996. The increase in originated mortgage servicing rights resulted from the sale of mortgage loans with servicing rights retained with a relative fair value of $18.4 million during the nine months ended September 30, 1997, partially offset by amortization and impairment recorded of $3.6 million and capitalized servicing sold with a net book value of $9.8 million. Property, equipment and leasehold improvements, net, increased $4.0 million or 133% to $7.0 million at September 30, 1997 from $3.0 million at December 31, 1996. As a result of the Company's ongoing commitment to modern technology, this growth reflects the purchase of upgraded computer equipment of $4.5 million, upgraded office equipment of $1.3 million and additional furniture of $0.2 million. These increases were offset by depreciation and amortization of $2.0 million. Accrued liabilities increased $3.5 million or 80% to $7.9 million at September 30, 1997 from $4.4 million at December 31, 1996. The increase was primarily due to the following factors: (i) deferred revenue was recorded by the Company in the amount of $1.5 million in connection with the building of the asset-backed security's overcollateralization as described above; (ii) the contingency reserve increased $1.2 million as a result of the Company recording a provision for contingencies of $2.4 million and sustaining actual losses of $1.2 million; and (iii) miscellaneous accrued liabilities increased $0.8 million. Stockholders' equity increased $37.0 million or 127% to $66.1 million at September 30, 1997 from $29.1 million at December 31, 1996, due to net income for the nine months ended September 30, 1997 of the same such amount. December 31, 1996 Compared to December 31, 1995 Mortgage loans held for sale increased $141.1 million or 145% to $238.2 million at December 31, 1996 from $97.1 million at December 31, 1995. The increase in mortgage loans held for sale resulted from mortgage loan originations and purchases of $2,283.8 million during the year ended December 31, 1996, partially offset by sales into securities of $598.0 million, whole loan sales of $1,532.1 million and unfunded HELOC credit line capacity of $6.0 million. Borrowings under warehouse lines of credit increased $150.1 million or 165% to $241.3 million at December 31, 1996 from $91.2 million at December 31, 1995, reflecting the mortgage loan origination, purchase and sale activity described above. The percentage increase in the borrowings under warehouse lines of credit was higher than the percentage increase in the mortgage loans held for sale primarily due to the Company's borrowings against the servicing security line of credit. Such borrowings increased to $12.0 million at December 31, 1996 from no outstandings at December 31, 1995. Cash and cash equivalents decreased $26.2 million or 91% to $2.7 million at December 31, 1996 from $28.9 million at December 31, 1995. This decrease is primarily the result of the Company's discontinued use of a $25.0 million arbitrage line of credit whereby borrowed funds were invested in higher yielding cash equivalents. This decrease in cash and cash equivalents is directly related to the $25.0 million decrease in the bank line of credit. Retained interests in securitizations increased $14.5 million or 2,417% to $15.1 million at December 31, 1996 from $0.6 million at December 31, 1995. The increase is the result of the Company's retention of subordinate tranches in the mortgage-backed securities it issued during 1996. The Company also retained a principal interest and an interest-only residual interest created by the HELOC asset-backed security issued by the Company in 1996. The interest-only residual interest is calculated based on the present value of estimated future cash flows, using market prepayment and discount rates. Prior to 1996, the Company issued one REMIC security and retained a subordinate tranche, which is represented by the $0.6 million balance at December 31, 1995. See "Risk Factors--Retained Interests in Securitization." 33 Originated mortgage servicing rights increased $13.2 million or 186% to $20.3 million at December 31, 1996 from $7.1 million at December 31, 1995. The increase in originated mortgage servicing rights resulted from the sale of mortgage loans with servicing rights retained with a relative fair value of $15.2 million during the year ended December 31, 1996, partially offset by amortization and impairment reserves recorded of $1.0 million and capitalized servicing sold with a net book value of $1.0 million. Notes payable to stockholders increased $9.7 million at December 31, 1996 from the zero balance at December 31, 1996. This payable was the result of funds borrowed by the Company out of distributions made to such stockholders. See "Certain Management Transactions and Business Relationships--Settlement Agreement." Accounts receivable increased $5.7 million or 300% to $7.6 million at December 31, 1996 from $1.9 million at December 31, 1995. The increase resulted primarily from an increase in servicing advances of $3.3 million or 255%, and a receivable relating to loans sold under a purchase and sale agreement of $1.7 million at December 31, 1996. Accounts receivable from related parties decreased $3.4 million or 97% to $0.1 million at December 31, 1996. The decrease was the result of the Company's negotiation and settlement with FCMC which occurred during 1996 relating to prior activity. See "Certain Management Transactions and Business Relationships--Settlement Agreement." Accounts payable increased $2.2 million or 100% to $4.4 million at December 31, 1996 from $2.2 million at December 31, 1995. The increase resulted primarily from a general increase in outstanding invoices due to the Company's increased mortgage loan production. Note receivable from related parties decreased 100% from the December 31, 1995 balance of $1.4 million. This decrease was the result of the note receivable becoming due and payable, and the Company receiving payment in full of the outstanding amount. Payment was received in conjunction with the payment on the account receivable from FCMC. See "Certain Management Transactions and Business Relationships--Settlement Agreement." Accrued liabilities increased $1.2 million or 38% to $4.4 million at December 31, 1996 from $3.2 million at December 31, 1995. This increase primarily reflects the contingency reserve recorded by the Company during 1996 of $3.6 million, partially offset by actual losses incurred of $2.6 million. Property, equipment and leasehold improvements, net, decreased $0.8 million or 21% to $3.0 million at December 31, 1996 from $3.8 million at December 31, 1995. This decrease reflects the Company's purchase of property and equipment of $2.1 million, offset by depreciation and amortization of $2.9 million. Real estate owned, net, decreased $0.8 million or 47% to $0.9 million at December 31, 1996 from $1.7 million at December 31, 1995. This decrease reflects the acquisition of four properties by the Company through the foreclosure process, and the sale of the eight properties owned by the Company at December 31, 1995. Mortgage loans held for investment, net, decreased $0.4 million or 36% to $0.7 million at December 31, 1996 from $1.1 million at December 31, 1995. The decrease is primarily due to the Company's ability to sell a portion of the portfolio in the secondary market. Stockholders' equity increased $3.2 million or 12% to $29.1 million at December 31, 1996 from $25.9 million at December 31, 1995. This increase reflects net income of the Company for the year ended December 31, 1996 of $17.7 million, partially offset by distributions to stockholders of $14.4 million. See "Certain Management Transactions and Business Relationships-- Settlement Agreement." LIQUIDITY AND CAPITAL RESOURCES The Company's principal liquidity requirements include the funding or payment of: (i) mortgage loan originations and purchases; (ii) investments and overcollateralization requirements in connection with its securitization program; (iii) fees and expenses incurred in connection with securitizations; (iv) advances of delinquent principal and interest payments and escrow balances required to be made as a mortgage loan servicer; and (v) ongoing administrative and other operating expenses. 34 The Company must be able to sell mortgage loans and obtain adequate credit facilities and other sources of funding in order to continue to originate and purchase mortgage loans. As a result of increased loan originations and purchases as well as an increase in its securitization program, the Company during 1995, 1996, and the nine months ended September 30, 1997, used cash of approximately $12.0 million, $147.0 million, and $7.2 million, respectively. The Company utilizes short-term warehouse facilities and repurchase agreements to fund mortgage loan originations and purchases. Increased loan production resulted in cash provided by financing activities of $40.0, $120.4, and $13.4 million during 1995, 1996, and the nine months ended September 30, 1997, respectively. In October 1993, the Company entered into a mortgage loan warehousing agreement (the "Warehouse Facility"). Under the terms of the Warehouse Facility, the Company has available a $215 million warehouse line of credit secured by the mortgage loans the Company originates or purchases. The facility extends through November 4, 1999. The Company is required to comply with various operating and financial covenants in the Warehouse Facility. Such covenants include restrictions on (i) changes in the Company's business that would materially and adversely affect the Company's ability to perform its obligations under the facility, (ii) selling any asset other than in the ordinary course of business, and (iii) maximum debt and distributions allowed. Such covenants also contain requirements for (i) minimum net worth and mortgage loan servicing portfolio balances, and (ii) maximum leverage ratios. At September 30, 1997, the outstanding balance under the Warehouse Facility was $133.9 million. In addition to the Warehouse Facility, the Company makes regular use of certain uncommitted lines of credit, short-term credit facilities and purchase and sale agreements (such as repurchase or "gestation" agreements) provided by major investment banks and a major corporation. These facilities permit the Company to diversify its borrowing resources, while accelerating the turnover of mortgage loans in inventory, reducing interest costs and permitting greater origination volumes. The Company currently has two uncommitted whole loan repurchase agreements with major investment banks. Under the terms of these agreements, the Company may pledge mortgage loans originated or purchased to obtain additional liquidity while mortgage loans are held until securitization or are sold through whole loan sales. Amounts outstanding under these agreements at September 30, 1997 were $79.2 million and $36.7 million. In addition, the Company has entered into an uncommitted mortgage loan purchase and sale agreement with a major investment bank. Under the terms of this agreement, mortgage loans which are subject to a "take-out" commitment between the Company and an investor, but have not yet been purchased, may be sold to the investment bank with the accompanying trade assignment. This allows the Company to accelerate turnover and provide additional liquidity to fund additional mortgage loans. The last of the Company's warehousing facilities is a $15.0 million warehouse line of credit with a major corporation. This agreement expires on October 31, 1998. At September 30, 1997, the Company had $1.6 million outstanding under this facility. In addition to these financing sources, the Company also has various repurchase agreements with major investment banks which are collateralized by certificates reflecting interest in the Company's private securities. At September 30, 1997, the Company had $3.4 million outstanding under these agreements. The Company used cash of $.9 million, $2.1 million, and $6 million for the purchase of property, equipment and leasehold improvements during 1995, 1996, and the nine months ended September 30, 1997, respectively. The increase during the nine months ended September 30, 1997 represents upgrades to computer equipment, office equipment and the purchase of additional furniture. The Company has entered into various capital leases to fund a substantial amount of these purchases. The Company also has a $12.0 million operating line of credit from a group of commercial banks who are also lenders in the Warehouse Facility. This operating line of credit is secured by certain servicing contracts of 35 the Company and is limited by the amount of servicing pledged as security. This operating line of credit, which has a conversion option to a term loan, is renewable from time to time and expires on November 4, 1998. At September 30, 1997, the Company had no outstanding balance under this line of credit. The Company is required to comply with various operating and financial covenants as provided in the agreements as described above, the most restrictive of which are those relating to the Warehouse Facility as described above. The Company relies on securitizations and whole loan sales to generate cash proceeds for repayment of its warehouse facilities and to create availability to purchase additional mortgage loans. Further, gains on sales from the Company's securitizations represent a significant portion of the Company's revenue. Several factors affect the Company's ability to complete securitizations of its mortgage loans, including conditions in the securities markets generally, conditions in the asset-backed securities market specifically, and the credit quality of the Company's portfolio of mortgage loans. If the Company were unable to securitize profitably a sufficient number of its mortgage loans in a particular reporting period, then the Company's revenues for such period would decline which could result in lower income or a loss for such period. In addition, unanticipated delays in closing a securitization could also increase the Company's interest rate risk by increasing the warehousing period for its mortgage loans. The Company endeavors to effect timely and consistent public securitizations of its mortgage loan pools. However, market and other considerations affect the timing of such transactions. Any delay in the sale of a pool of mortgage loans beyond a quarter-end would postpone the recognition of gain related to such mortgage loans and would likely result in lower income or a loss for such quarter being reported by the Company. The Company believes that the Company's current warehousing and other credit facilities will adequately fund the Company's mortgage banking operations. The liquidity needs of the Company arise in operating its mortgage banking operations, not only to meet operating expenses but also for its contractual obligation as a mortgage servicer. As a mortgage servicer, the Company is required to make advances to investors when a borrower is delinquent in meeting its payment obligations under a particular mortgage loan. Although most of these advances are recaptured either when the borrower becomes current or through a foreclosure proceeding, the uncertainty as to when an advance will be necessary requires the Company to maintain adequate liquidity. See "Business--Mortgage Loan Servicing." The net proceeds to the Company from the Offering will be used in part to fund payment to Existing Shareholders of the Shareholders Distribution Amount and to retire the subordinated notes to stockholders. See "Termination of S Corporation Status" and "Use of Proceeds." At this time, the Company anticipates that the remaining net proceeds from the Offering, together with the funds available under its warehouse facilities and credit facilities will be sufficient to fund its operations for the next 12 months, if the Company's future operations are consistent with management's expectations. There can be no assurance that the Company will be able to obtain financing on a favorable or timely basis. The type, timing and terms of financing selected by the Company will depend on its cash needs, the availability of other financing sources and the prevailing conditions in the financial markets. CERTAIN ACCOUNTING CONSIDERATIONS Retained Interests in Securitizations The Company derives a substantial portion of its income by recognizing gain on sale of mortgage loans sold through securitizations, which is partially represented by the subordinate certificates and interest-only residual interests that the Company retains. In the non-agency securitizations, the Company sells mortgage loans that it has originated or purchased to a trust for a cash purchase price and the subordinate certificates. The cash purchase price is raised through an offering by the trust of pass-through certificates representing senior interests in the trust. Following the securitizations, the purchasers of the pass-through certificates receive their respective allocations of the principal collected and the investor pass-through interest rate on the principal balance. 36 In home equity mortgage loan securitizations, the Company sells mortgage loans that it has originated or purchased to a trust in return for a cash purchase price and the interest-only residual interest. The Company also retains a portion of the principal interest in the trust as a subordinate credit enhancement for the senior certificate or note holders. The Company receives its proportionate share of interest collected from borrowers relating to the principal interest it retains, but receives principal distributions only to the extent that the principal balance of the Company's interest exceeds the minimum subordination requirements of the trust. In addition to the distributions the Company receives relating to its principal interest, the Company receives the excess of the interest rate payable by an obligor on a mortgage loan over the interest rate passed through to the purchasers of the notes or certificates with respect to the interest-only residual interests, as well as the Company's normal servicing fee and other recurring fees. The subordinate and residual interests which are capitalized on the Company's balance sheet are reduced as cash distributions are received. The subordinate and interests-only residual interests are accounted for as trading securities in accordance with SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities," and, as such, they are recorded at their fair value. Changes in fair value are reflected in the statement of operations. Fair value of the subordinate certificates is determined based on market prices for similar securities, and the fair value of the interest-only residual interests is determined based on various economic factors, including considerations of mortgage loan type, size, date of origination, interest rate, term, collateral value and geographic location. Higher than anticipated rates of mortgage loan prepayments or losses would require the Company to write down the fair value of the interest-only residual interests, adversely impacting earnings. Similarly, if delinquencies, or losses were greater than was initially assumed, the fair value of the residual certificates would be negatively impacted which would have an adverse effect on income for the period in which such events occurred. SFAS No. 91 In December 1986, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 91, "Accounting for Non-Refundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases." SFAS No. 91 establishes the accounting for nonrefundable fees and costs associated with lending, committing to lend, or purchasing a loan or a group of loans. Under SFAS No. 91, direct loan origination costs, net of loan origination fees, are recognized as a reduction of the loan's yield over the earlier of the life of the related loan or the sale of the loan. In effect, SFAS No. 91 requires that origination fees be offset by their related direct loan costs and that net deferred fees be recognized over the earlier of the life of the loan or the sale of the loan, whether the loan is sold through securitization or on a whole loan basis. Subsequent to the second quarter of 1996, the Company generally sold mortgage loans through securitization on a bimonthly basis and, as such, carried a larger inventory of mortgage loans on its books from quarter to quarter and from year to year, which resulted in SFAS No. 91 adjustments being made during those periods. The Company contemplates that in the future it will sell substantially all of its mortgage loan originations and purchases on a bimonthly basis primarily through securitizations and, to a lesser extent, on a whole loan basis. SFAS No. 122 In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage Servicing Rights," which amends SFAS No. 65 "Accounting for Certain Banking Activities." Effective January 1, 1995, the Company adopted SFAS No. 122. Because SFAS No. 122 prohibits retroactive application to years prior to adoption thereof, the Company's historical financial results for periods prior to 1995 have not been restated and, accordingly, are not directly comparable to the financial results for 1995 and thereafter. Mortgage servicing rights retained by the Company relating to loans originated prior to 1995 remain as an "off-balance sheet" asset and the net income produced by this asset is recognized over the life of the mortgage loans in the form of servicing income or at the time the servicing rights are sold. 37 SFAS No. 122 requires mortgage banking entities to recognize as a separate asset the rights to service mortgage loans for others, regardless of how those servicing rights are acquired. Mortgage banking entities that acquire or originate mortgage loans and subsequently sell or securitize those mortgage loans and retain the mortgage loan servicing rights are required to allocate the total cost of the loans to the mortgage servicing rights and the mortgage loans. The Company determines fair value based upon the present value of estimated net future servicing revenues less the estimated cost to service loans. The cost allocated to these servicing rights is amortized in proportion to and over the period of estimated net future cash flows related to servicing income. As a result of the adoption of SFAS No. 122, the Company recognizes greater revenues at the time a mortgage loan is sold and smaller revenues during the period such loan is serviced. To this end, adoption of SFAS No. 122 resulted in additional income recorded as net gain from sales of mortgage loans of approximately $16.2 million and $8.0 million during the years ended 1996 and 1995, respectively. Additionally, as the amount of uncapitalized mortgage servicing rights decreases, the Company's ability to obtain significant gains from sales of mortgage servicing rights also decreases. SFAS No. 122 also requires impairment evaluations of all amounts capitalized as servicing rights, based upon the fair value of the underlying mortgage loan servicing rights. The Company periodically performs these evaluations on a disaggregated basis for the predominant risk characteristics of the underlying mortgage loans, including loan type and interest rate. Higher than anticipated rates of loan prepayments or losses would require the Company to write down the fair value of the mortgage loan servicing rights, adversely impacting earnings. A key component of the Company's ongoing business strategy is the retention of its originated servicing as financial and operational considerations allow. The Company, however, may sell some of its servicing on a "bulk" or "flow" basis to generate current earnings and cash flow, depending upon circumstances. As a consequence, the Company's owned mortgage loan servicing portfolio at September 30, 1997 consisted of servicing rights to mortgage loans with an aggregate outstanding principal balance of $4.0 billion, including $1.7 billion for which no capitalized balance sheet value has been recorded. During 1996 and 1995, the Company sold mortgage loan servicing rights with aggregate principal balances of $1.0 billion and $0.9 billion, respectively, and for gains of 111 and 98 basis points, respectively. The prices at which mortgage loan servicing rights may be sold vary over time according to prevailing interest and prepayment rates among other factors. Accordingly, there can be no assurance of a continued market for mortgage loan servicing rights at prices received by the Company in the past. Moreover, mortgage loan servicing rights sold by the Company have generally related to Agency mortgage loans recently originated by the Company, and such servicing rights may, during certain interest rate environments, have relatively higher market values than non-agency or more seasoned mortgage loans in the Company's mortgage loan servicing portfolio. SFAS No. 125 In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", which superceded SFAS No. 122. SFAS No. 125 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities. Those standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS No. 125 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 125 requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value, if practicable. It also requires that servicing assets and other retained interest in the transferred assets be measured by allocating the previous carrying amount between the assets sold, if any, and retained interests, if any, based on their relative fair values at the date of the transfer. SFAS No. 125 provides implementation guidance for assessing isolation of transferred assets and for accounting for transfers of partial interests, servicing of financial assets, securitizations, transfers of sales- type and direct 38 financing lease receivables, securities lending transactions, repurchase agreements including "dollar rolls," "wash sales," loan syndications and participations, risk participations in banker's acceptances, factoring arrangements, transfers of receivables with recourse, and extinguishment of liabilities. SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after December 31, 1996, and is to be applied prospectively. In December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125." The Statement defers for one year the effective date of SFAS No. 125 relating to certain transactions such as repurchase agreements and securities lending. Other Recent Accounting Pronouncements In February 1997, the FASB issued SFAS No. 128, "Earnings per Share." This Statement specifies the computation, presentation, and disclosure requirements for earnings per share for entities with publicly held common stock or potential common stock. This Statement shall be effective for financial statements for both interim and annual periods ending after December 15, 1997. Earlier application is not permitted. At this time the Company has determined that this Statement will have no significant impact on the financial position or results of operations for 1997. In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure." This Statement shall be effective for financial statements for both interim and annual periods ending after December 15, 1997. At this time the Company has determined that this Statement will have no significant impact on the financial position or results of operations for 1997. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement shall be effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. At this time the Company has determined that this Statement will have no significant impact on the financial position or results of operations for 1997. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that enterprises report selected information about operating segments in interim financial reports issued to shareholders. This Statement shall be effective for fiscal years beginning after December 15, 1997. In the initial year of application, comparative information for earlier years is to be restated. At this time the Company has determined that this Statement will have no significant impact on the financial position or results of operations for 1997. 39 BUSINESS OVERVIEW The Company is a specialty mortgage banking company in the business of originating, selling, securitizing and servicing mortgage loans secured by one- to four-family residences. The Company was incorporated in California and commenced its mortgage banking business in 1986. As a specialty mortgage lender, the Company's strategy is to focus on specialized mortgage loan products for primarily high credit quality borrowers. The Company generally places an emphasis on credit scores obtained from three major credit bureaus to evaluate the credit quality of borrowers. The Company considers "high credit quality borrowers" to be those whose credit scores equal or exceed levels required for the sale or exchange of their mortgage loans through Fannie Mae or Freddie Mac. The specialized mortgage loans targeted by the Company provide a relatively greater "spread" (i.e., greater interest and other income to the originator relative to the cost associated with funding and selling the mortgage loans) compared to other mortgage loans that present a similar credit risk. The Company believes that its wholesale lending channel (which generates a majority of its total originations), supported by its correspondent and retail lending channels, provides an efficient and responsive origination system for the types of mortgage loans it seeks to originate. The Company seeks the most efficient method of execution for sales of its mortgage loans and in recent years has increasingly utilized securitization in addition to traditional whole loan sales. The Company's business objective is to increase mortgage loan originations through geographic expansion and by providing a diversified range of mortgage loan products through its wholesale, correspondent and retail lending channels. During the year ended December 31, 1996, the Company originated $2.3 billion of residential mortgage loans, 77% in California and 23% in other states. During the nine months ended September 30, 1997, the Company originated $2.5 billion of residential mortgage loans, 74% in California and 26% in other states. According to National Mortgage News (October 6, 1977), for the six months ended June 30, 1997 the Company was ranked as the second largest wholesale originator in the United States that is not publicly owned or affiliated with a public company, and ranked 14th among all wholesale originators. As of September 30, 1997, the Company's mortgage loan servicing portfolio totaled $4.0 billion of mortgage loans. The Company is led by President Peter T. Paul, the founder and major shareholder of the Company. Mr. Paul has 25 years of experience in the residential mortgage industry. Mr. Paul and the Chief Financial Officer of the Company have worked together since 1987, and various other members of the executive management team have worked together for more than six years. See "Management--Directors and Executive Officers." BUSINESS STRATEGY MORTGAGE LOAN ORIGINATION Mortgage Loan Product Development. An important element of the Company's mortgage loan origination strategy is to provide a variety of mortgage loan products that are designed to respond to consumer needs and competitive factors and be readily saleable at prices that will generate the Company's targeted rate of return. The Company seeks those mortgage loan products with relatively greater spreads compared to mortgage loans that present a similar credit risk and chooses not to rely on discount pricing to increase mortgage loan origination volume. This approach generally focuses the Company's development process on mortgage loans that fail to satisfy one or more of the standardized criteria (other than credit quality of the borrower) required for sale or exchange through one of the Agencies or one of the national privately- sponsored mortgage conduits. To date, the Company has tailored its loan products primarily for high credit quality borrowers as described above. The Company's secondary marketing department identifies a variety of new mortgage loan products that it believes will respond to consumer needs and that in many cases are not being widely offered by competitors. Such new mortgage loan products may be created by the Company itself or may be introduced by a competitor and identified by the Company as attractive for origination. The Company generally requires that all of its 40 mortgage loan products be readily saleable through the Company's securitization programs or to secondary market investors. The Company presently has under development and review a variety of mortgage loan products that it expects to promote in 1998. Among the products that the Company intends to launch on a pilot basis is a mortgage loan for high credit quality borrowers that permits a higher loan-to-value ratio than is permitted in mortgage loans currently being originated by the Company. Another product to be introduced is a mortgage loan that is designed primarily for lower credit quality borrowers which will require more extensive mortgage insurance than is required on the Company's other mortgage loan products. All new mortgage loan products introduced by the Company are carefully pre-tested in the market over a period of time to assess both marketability to consumers and performance of the mortgage loan product as an investment for secondary market investors. Current Mortgage Loan Products. The Company presently offers a broad range of mortgage loan products in order to provide maximum flexibility to borrowers and the mortgage brokers and other entities through which it originates mortgage loans (the "Mortgage Sources"). The Company offers approximately 85 different mortgage loan programs at any given point in time, including a full range of single-family mortgage loan products. Mortgage loan applicants can choose among fixed-rate mortgage loans with several different term options, including standard 15-year and 30-year terms, and "balloon" mortgage loans with relatively shorter terms, such as five or seven years, and longer amortization schedules, such as 30 years. An array of adjustable rate mortgage loans with rates tied to various indices is also available. The Company offers a wide variety of combinations of interest rates and origination fees ("points") on many of its mortgage loan products so that borrowers may elect to pay higher points at closing and lower interest over the life of the mortgage loan, or pay a higher interest rate and reduce or eliminate points payable at closing. In addition, the Company offers buydown-type mortgage loans which allow a borrower to make lower monthly payments for the first one, two or three years of the loan. Of the mortgage loans originated during the nine months ended September 30, 1997 and in the fiscal years 1996 and 1995, fixed rate mortgage loans comprised 73%, 73% and 75%, respectively, adjustable rate mortgage loans comprised 27%, 27% and 25%, respectively. The Company's broad range of current mortgage loan products can be categorized as follows: . Agency Mortgage Loans. These mortgage loans conform to the underwriting criteria for sale or exchange through one of the Agencies. . Non-agency Mortgage Loans. These mortgage loans fail to satisfy the criteria to be Agency mortgage loans for one or more reasons. Certain of these mortgage loans (i.e., Jumbos) generally meet the Agency criteria but exceed the maximum loan size (currently $214,600 for single-family, one- unit mortgage loans in the continental United States). Jumbos are generally eligible for sale to one of the national privately-sponsored mortgage conduits. Certain other non-agency mortgage loans may fail to satisfy other elements of the Agency underwriting criteria, such as those relating to documentation, employment history, income verification, loan-to-value ratios, qualifying ratios or required borrower net worth. Beginning in 1995, the Company began to emphasize the origination of mortgage loans which failed to satisfy one or more of the Agency and national conduit underwriting criteria but which, from a credit risk standpoint as determined primarily by credit score, presented a comparable risk profile. The Company refers to this category of mortgage loans generally as "Alternative A" mortgage loans. The Company focuses on an applicant's credit score, in conjunction with other factors, in underwriting its Alternative A mortgage loans. While some Alternative A mortgage loans exceed the maximum loan size eligible for sale through one of the Agencies, many have principal balances within the Agency limits. . Home Equity Mortgage Loans. Home equity mortgage loans are generally secured by second liens on the related property. Home equity mortgage loans can take the form of a home equity line of credit (i.e., HELOC) or a closed-end loan. Both types of home equity mortgage loans are designed primarily for high credit quality borrowers and are underwritten according to the Company's criteria for second-lien 41 mortgage loans. HELOCs generally provide for either a 5-year or 15-year draw period, during which the borrower may make cash withdrawals, and a 10-year repayment period during which the amount outstanding at the end of the draw period is repaid. Interest only is due during the draw period. Home equity mortgage loans that are closed-end loans are fixed in amount at the time of origination and amortize over their terms. Both types of home equity mortgage loans generally bear adjustable interest rates. Home equity mortgage loans are originated in some instances in conjunction with the Company's origination of a first-lien mortgage loan on the related property. . Other Mortgage Loans. This category consists of mortgage loans for borrowers who have impaired or limited credit profiles or higher debt-to- income ratios than would be acceptable for sale of such loans to one of the Agencies. Such mortgage loans may also fail to satisfy the Agency underwriting criteria in other ways. The Company categorizes these mortgage loans as "A-" or "B" loans and believes they would generally be considered "subprime" mortgage loans in the secondary mortgage market. The Company does not originate mortgage loans that it would categorize as "C" or "D" loans. In 1994, the Company originated a substantial volume of non-agency mortgage loans in the form of Jumbos which it sold to national mortgage conduits and other private investors. In 1995, the Company's volume of Jumbo originations declined with the general decrease nationwide in the origination volume of residential mortgage loans and the general increase in competition that reduced the spread available for this mortgage loan product. The increase in originations of non-agency mortgage loans and home equity loans in 1996 reflects the Company's successful development of its Alternative A mortgage loan products and its HELOC and closed-end second-lien products and the launch of the Company's securitization programs for such mortgage loan products. The following table summarizes the Company's originations of the above categories of mortgage loans:
YEAR ENDED NINE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------------- ---------------------- 1994 1995 1996 1996 1997 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Agency Mortgage Loans Number of mortgage loans............ 4,978 4,546 7,093 5,852 3,815 Volume of mortgage loans............ $ 643,770 $ 562,778 $ 885,050 $ 734,114 $ 475,473 Percent of total volume............. 26.71% 41.51% 38.75% 44.66% 18.81% Non-agency Mortgage Loans Number of mortgage loans............ 8,212 4,380 6,068 3,994 8,759 Volume of mortgage loans............ $1,736,830 $ 695,253 $1,137,572 $ 747,922 $1,625,080 Percent of total volume............. 72.06% 51.29% 49.81% 45.50% 64.31% Home Equity Mortgage Loans Number of mortgage loans............ 262 1,767 5,482 3,443 8,359 Volume of mortgage loans............ $ 12,110 $ 72,580 $ 234,308 $ 141,467 $ 400,782 Percent of total volume............. 0.50% 5.35% 10.26% 8.60% 15.86% Other Mortgage Loans Number of mortgage loans............ 137 214 250 174 221 Volume of mortgage loans............ $ 17,690 $ 24,993 $ 26,910 $ 20,346 $ 25,825 Percent of total volume............. 0.73% 1.84% 1.18% 1.24% 1.02% Total Mortgage Loans Number of mortgage loans............ 13,589 10,907 18,893 13,463 21,154 Volume of mortgage loans............ $2,410,400 $1,355,604 $2,283,840 $1,643,849 $2,527,160 Average principal balance........... $ 177 $ 124 $ 121 $ 122 $ 119
42 The Company's origination of home equity loans has increased as a percentage of total mortgage loans originated in recent years. In 1994, the Company's new product development group identified home equity loans as an attractive potential product for the Company. The origination volume of this type of mortgage loan has increased steadily as the Company's lending and servicing staff has gained experience in marketing and servicing this specialized mortgage loan product. The following table illustrates the growth in home equity mortgage loan production and provides detail regarding the breakdown of home equity mortgage loans between HELOCs and closed-end mortgage loans.
YEAR ENDED NINE MONTHS DECEMBER 31, ENDED SEPTEMBER 30, ---------------------- ------------------- 1994 1995 1996 1997 ------ ------ ------ ------------------- PERCENT OF MORTGAGE LOANS ORIGINATED (BASED ON PRINCIPAL BALANCES): First mortgage loans.............. 99.49% 94.63% 89.73% 84.14% Home equity mortgage loans HELOC........................... 0.36% 4.36% 8.42% 12.90% Closed-end...................... 0.15% 1.01% 1.85% 2.96% ------ ------ ------ ------ Total home equity mortgage loans......................... 0.51% 5.37% 10.27% 15.86% ------ ------ ------ ------ 100.00% 100.00% 100.00% 100.00% ====== ====== ====== ======
Mortgage Loan Origination Channels. The Company originates mortgage loans through its wholesale, correspondent and retail lending channels. Wholesale Lending. The Company's wholesale lending channel, established in 1986, obtains its mortgage loan volume through a network of approximately 5,060 independent mortgage brokers approved by the Company (of which approximately 4,420 submitted mortgage loans in 1996). Mortgage brokers are qualified to participate in the wholesale program after satisfactory completion of a formal application process administered by the Company's Quality Assurance Department. The responsibilities of the Quality Assurance Department include the review of licensing, financial statements and resumes on key personnel combined with credit and reference investigations to determine the history, reputation and general lending expertise of the applicant. Approved mortgage brokers are monitored by the Company's wholesale account executive staff and the broker management division within the Quality Assurance Department. The Company underwrites each mortgage loan application obtained from its mortgage brokers and funds those mortgage loans which meet the Company's underwriting criteria. No single Mortgage Source accounts for more than 5% of the total mortgage loan originations of the Company. The Company's wholesale lending channel generally enables the Company to achieve a relatively high volume of mortgage loan originations at a lower net cost than traditional retail mortgage loan originations because mortgage brokers perform most of the labor intensive functions of the origination process (in return for receipt of a mortgage loan origination fee), such as taking and processing the mortgage loan application. The building of the Company's mortgage loan origination volume through wholesale originations has been cost efficient for the Company because it has increased economies of scale, generated fee-based income, decreased overhead expenses and enabled the Company to centralize its quality assurance and other support functions. See "--Quality Assurance." The Company believes that its wholesale lending channel is well-suited to originate the types of mortgage loans that the Company seeks to originate. The wholesale lending channel permits the Company to respond quickly to changes in market conditions and consumer preferences. The Company can move quickly to introduce a new mortgage loan product by disseminating it throughout the broker network. By revising the terms on which it will fund mortgage loans submitted by its mortgage brokers, the Company may also move quickly to increase the level of origination of some loan products or to decrease originations of other loan products that, due to market or other changes, may no longer meet the Company's targeted rate of return or other origination objectives. The Company believes that its flexibility would be reduced if it maintained a large retail branch system with the attendant fixed investment and overhead costs. 43 The wholesale lending channel also permits the Company to obtain non-agency and other types of mortgage loans from mortgage brokers that generally only originate Agency mortgage loans. The Company builds its relationship with those mortgage brokers by providing access to specialty mortgage loan products. The Company's wholesale origination system currently operates out of the Larkspur headquarters office and eight branch offices producing mortgage loans in the western and southeast regions of the United States. The wholesale lending channel originates mortgage loans through its sales force of approximately 80 wholesale account executives. Each branch office's account executives are responsible for developing and maintaining relationships with mortgage brokers in specified territories. The quality of the approved mortgage broker client base is supported by the branch sales and inside sales support staff, who provide information and training in the appropriate marketing and proper packaging of mortgage loan products as well as updates on changes in underwriting practices. Additional and separate personnel in each branch office underwrite all mortgage loans originated in that office. Mortgage loan fundings remain centralized at the Company's Larkspur headquarters. See "--Underwriting" and "--Quality Assurance." The Company plans to continue the expansion of its wholesale lending channel on a nationwide basis. The Company is actively seeking to expand its wholesale lending channel pursuant to selected demographic statistics and other criteria developed by the Company, which are intended to identify the most attractive markets for the Company's mortgage loan products. The Company typically enters into a new market using its national sales team, which initially penetrates a market, to recruit selected brokers from the Company's unaffiliated wholesale mortgage loan network. The Company's sales strategy is to limit the number of branch centers in order to efficiently originate, process and underwrite mortgage loans. The following table sets forth the geographic distribution of origination volume according to location of the mortgaged property:
NINE MONTHS ENDED SEPTEMBER YEAR ENDED DECEMBER 31, 30, ---------------------------------------------- ------------------------------ STATE 1994 1995 1996 1996 1997 - ----- -------------- -------------- -------------- -------------- -------------- (DOLLARS IN THOUSANDS) California.............. $2,270,520 94% $1,003,354 74% $1,752,320 77% $1,262,149 77% $1,860,830 74% Other................... 139,880 6 352,250 26 531,519 23 381,700 23 666,330 26 ---------- --- ---------- --- ---------- --- ---------- --- ---------- --- Totals................. $2,410,400 100% $1,355,604 100% $2,283,839 100% $1,643,849 100% $2,527,160 100% ========== === ========== === ========== === ========== === ========== ===
Correspondent Lending. The correspondent lending program is designed to allow the Company to acquire closed mortgage loans on terms similar to those it acquires on a wholesale basis from its mortgage brokers. The correspondents are generally small- to medium-sized mortgage companies, banks and thrifts located throughout the U.S. who may have limited access to the capital markets. The Company provides its correspondents with on-site sales support and an interactive internet-based electronic link. The correspondents benefit by gaining access to the Company's broad range of innovative mortgage loan products without having to invest their resources in the development phase of the mortgage loan products. The correspondents also benefit from attractive pricing for sales to the Company, made possible by the Company's access to the capital markets and the secondary mortgage loan markets. Retail Lending. The retail channel, through a centralized operation, markets to existing and new customers. The Company markets to existing customers through inserts in the monthly mortgage statements, letters targeted to a specific group (i.e., borrowers with interest rates above a designated level) and outbound customer service calls. New customers are sought through national direct mail campaigns, regional radio advertising and telemarketing. New customers are also sought through several "affinity marketing" programs. Groups targeted for affinity marketing purposes include banks and credit unions for whom the Company will provide mortgage loan services from processing through funding. Affinity marketing programs also target trade groups and associations offering special pricing and discounts for group members when the Company is endorsed by the respective group or association. An additional segment targeted for affinity marketing are employers. Employees of participating companies are offered the opportunity to apply for a mortgage loan from the Company at a discounted price as part of the Company's standard employee benefits package. 44 The following table sets forth the volume of mortgage loan originations by channel:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, -------------------------------------------------------- ------------------ 1994 1995 1996 1997 ------------------ ------------------ ------------------ ------------------ VOLUME PERCENT VOLUME PERCENT VOLUME PERCENT VOLUME PERCENT ---------- ------- ---------- ------- ---------- ------- ---------- ------- (DOLLARS IN THOUSANDS) Wholesale............... $2,359,696 98% $1,253,405 92% $2,154,255 94% 2,342,394 93% Correspondent........... 44,974 2 95,704 7 72,832 3 117,157 4 Retail.................. 5,730 -- 6,495 1 56,753 3 67,609 3 ---------- --- ---------- --- ---------- --- ---------- --- Total.................. $2,410,400 100% $1,355,604 100% $2,283,840 100% $2,527,160 100% ========== === ========== === ========== === ========== ===
Underwriting. The Company relies on its underwriting administrative procedures and mortgage loan underwriting standards to implement its origination strategy and achieve the quality of mortgage loans required by its secondary market investors. Administration. Mortgage loan applications must be approved by the Company's underwriters in accordance with its underwriting criteria, including credit scores, loan-to-value ratios, borrower income qualifications, investor requirements, necessary insurance coverages and property appraisal requirements. To maintain the consistency of underwriting quality, the Company's mortgage loan production personnel, such as account executives and telemarketers, are not permitted to underwrite the mortgage loan packages submitted by Mortgage Sources. Mortgage loan applications are assigned to an underwriter at the Company based on the size and complexity of the mortgage loan and the underwriter's experience level. The Company's chief underwriter is located in the corporate headquarters in Larkspur and is responsible for disseminating all underwriting policies. The Company generally performs a pre-funding audit on each mortgage loan. This audit includes a review for compliance with applicable underwriting program guidelines and accuracy of the credit report and telephone verification of employment. The Company performs a post-funding quality control review on a minimum of 10% of the mortgage loans originated or acquired for complete re-verification of employment, income and liquid assets used to qualify for such mortgage loan. Such review also includes procedures intended to detect evidence of fraudulent documentation and/or imprudent activity during the processing, funding, servicing or selling of the mortgage loan. Verification of occupancy and applicable information is made by regular mail. One- to four-family residential properties are appraised by qualified independent appraisers who are approved by the Company. All appraisals are required to conform to the Uniform Standards of Professional Appraisal Practice adopted by the Appraisal Standards Board of the Appraisal Foundation and must be on forms acceptable to Fannie Mae and Freddie Mac. As part of the Company's pre-funding quality control procedures, either field or desk appraisal reviews are obtained on 10% of all mortgage loans. Standards. Conforming mortgage loans originated for sale to the Agencies must satisfy the underwriting standards for one of the programs sponsored by such entities. All other mortgage loans originated or acquired by the Company (including Alternative A loans and home equity loans) are underwritten by the Company according to its credit, appraisal and underwriting standards. Such underwriting standards are applied to evaluate the prospective borrower's credit standing and repayment ability and the value and adequacy of the mortgaged property as collateral. These standards, which are summarized below, are applied in accordance with applicable federal and state laws and regulations. Exceptions to the underwriting standards are permitted when compensating factors are present. The Company's underwriting standards for purchase money or rate/term refinance mortgage loans secured by one- to two-family primary residences generally allow loan-to-value ratios at origination of up to 95% for mortgage loans with original principal balances of up to $400,000, up to 90% for mortgage loans secured by one- to four-family primary residences with original principal balances of up to $400,000, up to 85% for mortgage loans with original principal balances of up to $500,000 and up to 80% for mortgage loans with original principal balances up to $650,000. The Company may acquire mortgage loans with principal balances 45 up to $3,000,000 ("super jumbos") if the mortgage loan is secured by the borrower's primary residence. The loan-to-value ratio for super jumbos generally may not exceed 60%. For cash-out refinance mortgage loans, the maximum loan-to-value ratio generally is 80%, and the maximum "cash out" amount permitted is based in part on the original amount of the related mortgage loan. The Company's underwriting standards for mortgage loans secured by investment properties generally allow loan-to-value ratios at origination of up to 90% for mortgage loans with original principal balances up to $250,000. The Company's underwriting standards permit mortgage loans secured by investment properties to have higher original principal balances if they have lower loan-to-value ratios at origination. For each mortgage loan secured by a first lien with a loan-to-value ratio at origination exceeding 80%, the Company generally requires a primary mortgage insurance policy insuring a portion of the balance of the mortgage loan at least equal to the product of the original principal balance of such mortgage loan and a fraction, the numerator of which is the excess of the original principal balance of such mortgage loan over 75% of the lesser of the appraised value and selling price of the related mortgage property and the denominator of which is the original principal balance of the related mortgage loan plus accrued interest thereon and related foreclosure expenses. In certain circumstances, however, the Company does not require primary mortgage insurance on mortgage loans with principal balances up to $500,000 that have loan-to-value ratios exceeding 80% but less than or equal to 85%. All residences, except cooperatives and certain high-rise condominium dwellings, are eligible for this program. Each qualifying mortgage loan will be made at an interest rate that is higher than the rate would be if the loan-to-value ratio was 80% or less or if primary mortgage insurance was obtained. In determining whether a prospective borrower has sufficient monthly income available (i) to meet the borrower's monthly obligation on the proposed mortgage loan and (ii) to meet monthly housing expenses and other financial obligations, including the borrower's monthly obligations on the proposed mortgage loan, the Company generally considers, when required by the applicable documentation program, the ratio of such amounts to the proposed borrower's acceptable monthly gross income. Such ratios vary depending on a number of underwriting criteria, including loan-to-value ratios, and are determined on a loan-by-loan basis. The Company also examines a prospective borrower's credit report. Generally, each credit report provides a credit score for the borrower. Credit scores generally range from 350 to 850 and are available from three major credit bureaus: TRW, Equifax and Trans Union. The Company attempts to obtain for each borrower a credit score from each credit bureau. If three credit scores are obtained, the Company applies the middle score of the primary wage earner. If two scores are obtained, the Company applies the lower score of the primary wage earner. These scores estimate, on a relative basis, which mortgage loans are most likely to default in the future. Lower scores imply higher default risk relative to a higher score. Credit scores are empirically derived from historical credit bureau data and represent a numerical weighing of a borrower's credit characteristics over a two-year period. A credit score is generated through the statistical analysis of a number of credit-related characteristics or variables. Common characteristics include number of credit lines (trade lines), payment history, past delinquencies, severity of delinquencies, current levels of indebtedness, types of credit and length of credit history. Attributes are the specific values of each characteristic. A scorecard (the model) is created with weights or points assigned to each attribute. An individual mortgage loan applicant's credit score is derived by summing together the attribute weights for that applicant. The Company originates and acquires mortgage loans under one of five documentation programs: full documentation, alternative documentation, limited documentation, no ratio loan documentation and no income/no asset verification. 46 Under full documentation, the prospective borrower's employment, income and assets are verified through written and telephonic communications. Alternative documentation provides for alternative methods of employment verification generally using W-2 forms or pay stubs. Generally, under a full documentation program, a prospective borrower is required to have a minimum credit score of 620 and, under alternative documentation, a minimum credit score of 640. Under the limited documentation program, more emphasis is placed on the value and adequacy of the mortgaged property as collateral and other assets of the borrower than on credit underwriting. Mortgage loans underwritten using the limited documentation program are limited to borrowers with credit histories that demonstrate an established ability to repay indebtedness in a timely fashion. Under the limited documentation program, a prospective borrower is required to have a minimum credit score of 640. Under the limited documentation program, certain credit underwriting documentation concerning income or income verification and/or employment verification is waived. Mortgage loans originated and acquired with limited documentation include cash-out refinance loans, super jumbos and mortgage loans secured by investor- owned properties. Permitted maximum loan-to-value ratios (including secondary financing) under the limited documentation program, which range up to 80%, are more restrictive than mortgage loans originated with full documentation or alternative documentation. Under the no ratio loan documentation program, income ratios for the prospective borrower are not calculated. Mortgage loans underwritten using the no ratio loan documentation program have loan-to-value ratios less than or equal to 80% and meet the standards for the limited documentation program. A minimum credit score of 680 is required for this program. Under the no income/no asset verification program, emphasis is placed on the value and adequacy of the mortgaged property as collateral and credit history rather than on verified income and assets of the borrower. Mortgage loans underwritten under no income/no asset verification are limited to borrowers with excellent credit histories. A minimum credit score of 680 is required. Under the no income/no asset verification program, credit underwriting documentation concerning income, employment verification and asset verification is waived and income ratios are not calculated. Exceptions. On a case-by-case basis, the Company's underwriters may determine that the prospective borrower warrants an exception from its underwriting guidelines. Such exceptions may include a debt service-to-income ratio exception, a loan-to-value exception or an exception from certain documentation requirements of a particular mortgage loan program. An exception may generally be allowed if the application reflects certain compensating factors, including among others: a high credit score; a low loan-to-value ratio; cash reserves; stable employment; and the length of residence in the subject property. Accordingly, the Company may classify certain mortgage loan applications into a more extensive documentation program than other mortgage loan applications that, in the absence of such compensating factors, would only satisfy the criteria of a less extensive documentation program and may fund mortgage loans that do not satisfy all of the criteria discussed above for any particular documentation program. 47 The following table sets forth for the periods indicated additional detail on the Company's mortgage loan originations by category of mortgage loan:
FIRST QUARTER 1996 SECOND QUARTER 1996 ---------------------------------------------- ---------------------------------------------- DOLLAR AVERAGE WEIGHTED WEIGHTED AVERAGE DOLLAR AVERAGE WEIGHTED WEIGHTED AVERAGE VOLUME PRINCIPAL AVERAGE AVERAGE CREDIT VOLUME PRINCIPAL AVERAGE AVERAGE CREDIT (IN 000'S) BALANCE LTV COUPON SCORE (IN 000'S) BALANCE LTV COUPON SCORE ---------- --------- -------- -------- ------- ---------- --------- -------- -------- ------- Agency.................. $ 284,499 $131,652 76% 7.34% 680 $ 280,240 $124,000 75% 7.86% 680 Non-agency.............. 218,617 177,882 74 8.25 679 237,718 190,327 74 8.44 706 Home equity loans....... 25,019 38,849 87 9.36 682 47,820 40,389 86 8.60 713 Other................... 5,663 106,849 69 9.41 615 7,613 131,263 73 10.33 598 ---------- --------- Totals................. $ 533,798 $ 573,391 ========== ========= THIRD QUARTER 1996 FOURTH QUARTER 1996 ---------------------------------------------- ---------------------------------------------- DOLLAR AVERAGE WEIGHTED WEIGHTED AVERAGE DOLLAR AVERAGE WEIGHTED WEIGHTED AVERAGE VOLUME PRINCIPAL AVERAGE AVERAGE CREDIT VOLUME PRINCIPAL AVERAGE AVERAGE CREDIT (IN 000'S) BALANCE LTV COUPON SCORE (IN 000'S) BALANCE LTV COUPON SCORE ---------- --------- -------- -------- ------- ---------- --------- -------- -------- ------- Agency.................. $ 169,375 $118,362 76% 8.18% 687 $ 150,936 $120,460 75% 7.91% 700 Non-agency.............. 291,587 192,339 75 8.53 700 389,650 186,793 74 8.31 710 Home equity loans....... 68,628 42,494 82 7.66 705 92,841 45,555 84 7.52 707 Other................... 7,070 112,218 75 10.43 632 6,564 123,852 77 10.16 621 ---------- --------- Totals................. $ 536,660 $ 639,991 ========== ========= FIRST QUARTER 1997 SECOND QUARTER 1997 ---------------------------------------------- ---------------------------------------------- DOLLAR AVERAGE WEIGHTED WEIGHTED AVERAGE DOLLAR AVERAGE WEIGHTED WEIGHTED AVERAGE VOLUME PRINCIPAL AVERAGE AVERAGE CREDIT VOLUME PRINCIPAL AVERAGE AVERAGE CREDIT (IN 000'S) BALANCE LTV COUPON SCORE (IN 000'S) BALANCE LTV COUPON SCORE ---------- --------- -------- -------- ------- ---------- --------- -------- -------- ------- Agency.................. $ 137,450 $123,717 75% 7.70% 696 $ 164,577 $123,649 77% 7.92% 697 Non-agency.............. 441,147 192,305 73 8.17 710 495,176 179,868 75 8.53 710 Home equity loans....... 104,429 47,082 84 7.95 707 155,999 49,904 84 8.17 704 Other................... 9,133 120,178 73 9.90 627 9,508 113,190 77 10.24 625 ---------- --------- Totals................. $ 692,159 $ 825,260 ========== ========= THIRD QUARTER 1997 ---------------------------------------------- DOLLAR AVERAGE WEIGHTED WEIGHTED AVERAGE VOLUME PRINCIPAL AVERAGE AVERAGE CREDIT (IN 000'S) BALANCE LTV COUPON SCORE ---------- --------- -------- -------- ------- Agency.................. $ 173,446 $126,327 77% 7.65% 706 Non-agency.............. 688,757 185,549 75 8.24 712 Home equity loans....... 140,355 46,552 84 7.91 707 Other................... 7,183 117,759 73 9.71 627 ---------- Totals................. $1,009,741 ==========
48 Quality Assurance. The Company's Quality Assurance Department (the "QAD") consists of eighteen people who operate out of its corporate headquarters in Larkspur but also includes a two-person staff based in Southern California which performs pre-funding quality control reviews for the Company's Southern California Region. Since the Company's wholesale loan origination process relies heavily on its Mortgage Sources, one of the primary functions of the QAD includes the approval and related monitoring of its Mortgage Sources. Other related functions for the QAD include the approval and monitoring of third-party appraisers, escrow companies and title companies. Another primary function of the QAD is to monitor overall mortgage loan quality to seek to ensure that the mortgage loan originations comply with the Company's quality standards as well as those of investors and mortgage insurers. This is accomplished through a sampling of mortgage loan files for review by the quality control unit within the QAD and through administration of a verification of income program with the Internal Revenue Service. The quality control unit of the QAD performs loan file reviews before funding and has placed an increasing emphasis on its pre-funding review since early 1997. The objective of pre-funding reviews is to ensure data integrity of the information used by the Company's underwriters in evaluating mortgage loans. The extent of the review may include validating all information or just selected elements based on assessment of risk and other selection criteria. The percentage of mortgage loans subjected to some form of additional verification prior to funding either through the special IRS program or through mortgage loan file reviews by the QAD is approximately 14% of loans submitted for origination. The quality control unit of the QAD also selects approximately 4% of funded loans for a post-funding review. A post-funding review includes a full underwriting of the mortgage loan file, including a reverification of credit, employment income and source of funds as well as a review of various closing documents. The QAD also reviews mortgage loans which revert to early payment default status. All material findings are submitted to management for response. Reporting to senior management for the pre-funding reviews occurs monthly and reporting for the post-funding reviews occurs quarterly. The Company devotes substantial resources and attention to improving its quality assurance functions. Notwithstanding these efforts, there can be no assurance that the Company's quality assurance procedures will prevent or mitigate losses on the mortgage loans produced or serviced by the Company. See "Risk Factors--Mortgage Loan Sales." MORTGAGE LOAN SALES As a mortgage banker, the Company originates all of its mortgage loans with the intent of selling such loans. A primary component of the Company's business strategy is to seek the most efficient method of selling its mortgage loans. In recent years, the Company has developed the capacity to access the capital markets by securitizing its mortgage loans in addition to selling them in whole loan sale transactions. The Company evaluates the sale of each mortgage loan type and compares prices available for each alternative method of sale, given current market conditions at the time and the risk characteristics of the mortgage loan type to determine which method of sale to utilize. The following table shows the method of sale for the Company's mortgage loans for the periods indicated:
NINE MONTHS YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30, -------------------------------- --------------------- 1994 1995 1996 1996 1997 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Loans sold through securitization......... $ 295,290 $ -- $ 597,965 $ 175,923 $1,442,468 Whole loan sales........ 2,502,396 1,330,484 1,532,119 1,323,468 1,031,351 ---------- ---------- ---------- ---------- ---------- Total................. $2,797,686 $1,330,484 $2,130,084 $1,499,391 $2,473,819 ========== ========== ========== ========== ==========
Securitization. In the second half of 1996, the Company began to securitize substantially all of its non-agency mortgage loans and home equity mortgage loans. Securitization is the process of pooling mortgage loans and issuing securities, such as mortgage pass-throughs, or collateralized mortgage bonds or notes. Under SFAS No. 125, regardless of whether the securities issued are in the form of equity or debt securities, the transaction 49 will generally be treated for accounting purposes as a sale of the underlying mortgage loans. The Company intends to structure all of its securitizations to qualify as sales for accounting purposes, with a resulting gain reflected at the time of sale. Only the net retained interest in the securitized mortgage loans remains on the balance sheet. Net cash proceeds from such securitizations will be available to support new mortgage loan originations and to repay borrowings under the Company's warehouse facilities. The Company carries out its securitizations through its wholly-owned subsidiary Headlands Mortgage Securities, Inc. ("HMSI"). HMSI maintains separate shelf registration statements for the non-agency mortgage loan and home equity mortgage loan securitization programs. The Company believes that its ability to access the capital markets through securitization is important to its overall business strategy in several ways. Securitization is a very efficient method of selling the Company's non-agency and home equity mortgage loans. Under the non-agency mortgage loan securitization program, the Company generally sells the more senior classes of the securities produced by the securitization for cash and retains one or more of the subordinated classes. Such securities are carried on the balance sheet at their estimated fair market value (based on market prices for similar securities) under the line item "retained interests in securitizations." Due to the relatively high credit quality of the mortgage loans in these securitizations, the amount of subordinated securities retained by the Company represents a relatively small percentage (generally less than 2%) of the total principal of the mortgage loans securitized. In addition, the market value of the classes of securities sold generally permits the Company to receive cash in an amount equal to or greater than its cost of funding the mortgage loans. As a result, the securitization of the Company's non-agency mortgage loans to date has not required a substantial amount of the Company's available cash. In the future, the Company may elect to retain additional classes of securities in such securitizations which would require additional funds. Under the home equity mortgage loan securitization program, the Company generally sells the home equity mortgage loan securities for cash and a retained trust interest that represents (i) an interest (which is subordinated to payment on the securities sold) in the principal of the mortgage loans securitized (the "Principal Amount") and (ii) the right to the excess of future expected interest payments to be received on the mortgage loans securitized over the future interest payments required to be made on the securities sold (the "Interest-only Residual"). The estimated values of the Principal Amount and is the Interest-only Residual are shown on the balance sheet under the line item "retained interests in securitizations." The securitizations of the Company's home equity mortgage loans generate negative cash flow compared to the cost of the mortgage loans securitized. The Company to date has elected to mitigate the extent of negative cash flow by selling a portion of the Interest-only Residual in connection with the home equity mortgage loan securitizations. In the future, the Company may elect to retain the full amount of the Interest-only Residual in order to receive the future cash flows generated thereby. In such event, the negative cash flow at the time of effecting the securitization would be increased. Securitization also supports the Company's wholesale origination channel by increasing its flexibility in competing for non-agency mortgage loans. The parameters of mortgage loan characteristics that may be included in a pool to be securitized are generally broader than would be the case if the pool were to be sold in a traditional whole loan sale to a financial institution. Mortgage loan characteristics in securitizations are subject to the requirements of the rating agencies and of any third-party credit enhancer that may be involved, such as a monoline insurance company. The Company believes, however, that these requirements generally provide more flexibility in originating mortgage loans than would be the case under a traditional whole loan sale method. This additional flexibility enables the Company to compete more aggressively for mortgage loans and provide better service to its Mortgage Sources. The retained interests in the non-agency mortgage loan securitizations are in the form of classes of subordinated securities which can be sold or pledged by the Company. The retained interests in the home equity mortgage loan securitizations are in the form of trust interests that are restricted as to transfer and cannot be sold by the Company. The Company's retained interests in its securitizations, regardless of the form, are subordinated to the classes of securities issued to investors in such securitizations with respect to future losses of principal and interest on the underlying mortgage loans. Accordingly, any such losses incurred on the underlying mortgage 50 loans will be applied first to reduce the remaining amount of the Company's subordinated retained interest, until reduced to zero. In addition, with respect to the Interest-only Residual retained in the home equity loan securitizations, to the extent the actual loss rates, prepayment rates or other characteristics experienced on a pool of mortgage loans differ adversely from the assumptions used to evaluate the residual interest at the time of sale, a reduction in the fair value of such interest on the balance sheet may be required in a future period, with a corresponding charge to income. Whole Loan Sales and Exchanges. Sales of mortgage loans and exchanges of pooled mortgage loans for securities are conducted by the Company's Secondary Marketing Department. The Company's whole loan sales and exchanges of mortgage loans are generally made without recourse to the Company. The Company sells or exchanges substantially all of its Agency mortgage loans through normal secondary channels. The Company also generally sells its closed-end home equity mortgage loans through whole loan sales rather than through the home equity mortgage loan securitization program when the price received from whole loan sales is more attractive to the Company. From time to time the Company sells qualifying Jumbos to one of the privately-sponsored national mortgage conduit programs; such Jumbos are also included at times in the Company's non- agency mortgage loan securitization program along with the Alternative A mortgage loans. The Company sells substantially all of its other mortgage loans (i.e., subprime mortgage loans) on a whole loan basis (servicing released) in order to avoid the credit risk associated with such mortgage loans. Representations and Warranties. In connection with both securitizations and whole loan sales and exchanges, the Company makes representations and warranties to the buyers thereof which it believes are customary in the industry relating to, among other things, compliance with laws, regulations and program standards and accuracy of information. In the event of a breach of these representations and warranties, the Company may be required to repurchase these mortgage loans and indemnify the investors for damages caused by the breach. If a repurchase request is made, the Company will either (i) attempt to remedy the deficiency and have the investors rescind the rejection of the mortgage loan or (ii) refinance or sell the mortgage loan, sometimes at a loss. Mortgage loans repurchased from investors have represented an insignificant percentage of total mortgage loan originations based on the aggregate principal balance over the last three fiscal years. The Company has implemented a stringent quality assurance program monitoring the most important stages of the mortgage loan origination process to minimize the number of mortgage loans rejected by investors. See "--Quality Assurance" and "--Mortgage Loan Servicing--Credit and Contractual Risks." OPERATIONS AND INFORMATION SERVICES The Company's offering of a broad range of conventional and specialized mortgage loan products requires the timely delivery of such mortgage loan products to the branches and careful monitoring and tracking of the origination of such mortgage loan products through delivery to the ultimate investor. For this reason, the Company focuses on the development of its operations and technology capabilities and has organized many of the production and servicing functions under the Operations Department in order to promote the coordination of these functions. The Operations Department includes the following key functions: .Underwriting/Branch Operations .Loan Delivery .Loan Closing/Document Tracking .Quality Assurance .Systems Support .Corporate Training .Computer Services .Servicing
Each department manager is responsible for the day-to-day activities of specified areas and reports to the Executive Vice President of Operations with respect to communications between departments, coordinating services to branch offices and long range planning issues, such as technology development. The Company uses a mortgage loan origination and administration system modified to meet the Company's specific needs, that has largely eliminated many of the manual efforts associated with underwriting, funding and loan delivery. This system provides real-time access to the information used by each department in operations as 51 well as the secondary marketing and treasury departments. This Company-wide system provides a smooth flow of data from the origination process until the mortgage loan is purchased by the investor. These integrated systems also improve data integrity because information is not re-keyed or transferred to multiple mortgage loan-tracking systems. Prior to 1997, functions that were formerly conducted from a central location in Larkspur were decentralized and moved to the branch offices. Underwriting and closing document preparation are two such functions. Decentralization of these functions has enabled the Company to offer prompt and efficient service. Staffing each branch with management and staff who have an understanding of the local market also increased the Company's ability to assess mortgage loan quality and resolve broker-related issues more efficiently. Operations functions which remain centralized include quality assurance, systems programming and support, loan delivery and servicing. Branch operations management has substantial contact with and receives direction from senior management at the the Company's headquarters office. Typical daily interaction between a branch operations officer and the headquarters' staff include resolutions of underwriting exceptions, interpretation of investor guidelines and requests from a branch for systems support. The Company's operations procedure manual specifies workflow and communication methods and underwriting requirements not specifically mentioned in investor guidelines, but which the Company determines are prudent. The procedure manual is also the vehicle by which internal procedures and controls are disseminated to all operations personnel. All such procedures are designed to ensure consistent, investment quality mortgage loan originations and an efficient production environment. The Information Services Department is responsible for implementing, supporting and improving the software and hardware technology employed in the Company. Specifically, the Information Services Department concentrates on applications programming, applications development and analysis of new software technologies which can be used within the Company to improve information flow and operating efficiencies. The Information Services Department also focuses on the integration and support of hardware technologies including those established in the branch offices. HEDGING ACTIVITIES The Company originates and purchases mortgage loans and sells them primarily through securitizations and whole loan sales. The market value of fixed-rate mortgage loans are sensitive to changes in market interest rates. If interest rates rise between the time the Company commits to originate at a specific rate ("rate lock") or originates or purchases the mortgage loans and the time the mortgage loans are committed for sale, there may be a decline in the market value of the mortgage loans. To protect against such possible declines, the Company has adopted a hedging strategy. The Company retains the services of Tuttle & Co., an unaffiliated advisory firm specializing in mortgage loan pipeline management to assist the Company in seeking to minimize the interest rate risk associated with the time lag between when loans are rate-locked and when they are committed for sale or exchanged in the secondary market. Individual mortgage loan risks are aggregated by note rate, mortgage loan type and stage in the pipeline, and are then matched, based on duration, with the appropriate hedging instrument, thus mitigating basis risk until closing and delivery. The Company currently hedges its mortgage loan pipeline through a combination of forward sales of Fannie Mae mortgage-backed securities and forward whole loan sales. The Company determines which alternative provides the best execution in the secondary market. As a managed account of Tuttle & Co., the Company is able to take advantage of Tuttle's reporting services, including pipeline, mark-to-market, commitment and position reporting. Gains and losses on hedging transactions are recorded at the time of settlement with the counterparty to the transaction, while the related gain or loss on the mortgage loans in the pipeline are recorded at settlement. The Company believes that it has implemented a cost-effective hedging program to provide a level of protection against changes in the market value of its fixed-rate mortgage loans held for sale. However, an 52 effective hedging strategy is complex and no hedging strategy can completely insulate the Company against such changes. The Company does not presently hedge against declines in value in its servicing portfolio and hedges only to a limited extent against declines in value of its retained interests in securitizations. Such declines could occur due to market interest rate changes and the effects of early prepayments of the mortgage loans serviced. MORTGAGE LOAN SERVICING General. Mortgage loan servicing includes collecting payments from borrowers and remitting those funds to investors, accounting for mortgage loan principal and interest, reporting to investors, holding custodial funds for payment of mortgage-related expenses such as taxes and insurance, advancing funds to cover delinquent payments, inspecting the mortgaged premises as required, contacting delinquent borrowers, supervising foreclosures and property disposition in the event of unremedied defaults, and otherwise administering the mortgage loan. The Company's fees for servicing mortgage loans generally range from 0.25% to 0.50% per annum on the outstanding principal balances of the mortgage loans. Servicing fees are collected by the Company out of monthly remittances to investors. Other sources of mortgage servicing rights revenues include late charges, assumption and modification fees and prepayment penalties. The Company must cover general overhead and other normal costs associated with mortgage servicing rights, such as computer and personnel costs. The Company is also required to pay certain costs in connection with foreclosure proceedings on defaulted mortgage loans for which it may not be fully reimbursed. Potential exposure to foreclosure costs is contrasted to losses on principal amounts, as to which the Company has limited liability because substantially all of the mortgage loans in its mortgage loan servicing portfolio are sold or exchanged to investors in the secondary mortgage market on a nonrecourse basis. See "--Credit and Contractual Risks." In 1993, the Company established its Servicing Center in Santa Rosa, California. The Servicing Center became operational in February 1994 and presently occupies approximately 13,000 square feet. The Servicing Center is fully integrated into the Company's networking system and employs a well- established, experienced provider of computing services, Alltel Information Services Inc. for its mortgage loan servicing computing services. The Company believes that the Servicing Center has the capacity to substantially increase the number of mortgage loans that it services without significantly increasing its fixed operating costs. Prior to the time the Servicing Center became operational, the Company's mortgage loan servicing portfolio was subserviced by a separate servicing entity and the Company was not actively engaged in servicing activities. The following table provides certain information regarding changes in the Company's mortgage loan servicing portfolio:
NINE MONTHS YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30, -------------------------- -------------------- 1994 1995 1996 1996 1997 ------- ------- -------- --------- --------- (DOLLARS IN MILLIONS) Beginning Servicing Portfolio............... $ 4,283 $ 4,779 $ 4,149 $ 4,149 $ 4,387 Add: Originations........ 2,410 1,356 2,284 1,644 2,527 Less: Bulk sales of servicing rights........ (736) (943) (1,033) (1,033) (1,823) Less: Amortization and prepayments............. (611) (507) (543) (386) (522) Less: Service released sales................... (567) (536) (470) (402) (566) ------- ------- -------- --------- --------- Ending Servicing Portfolio............... $ 4,779 $ 4,149 $ 4,387 $ 3,972 $ 4,003 ======= ======= ======== ========= =========
53 The following table sets forth certain information regarding the Company's mortgage loan servicing portfolio:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, ---------------------------- ------------------ 1994 1995 1996 1996 1997 -------- -------- -------- -------- -------- Agency mortgage loans: Number of mortgage loans......... 18,677 15,835 17,118 16,497 12,899 Percent of total number.......... 64.24% 58.09% 49.82% 55.24% 34.88% Principal amount (in millions)... $ 2,371 $ 1,911 $ 2,026 $ 1,954 $ 1,465 Percent of total principal amount.......................... 49.61% 46.06% 46.18% 49.19% 36.61% Non-agency mortgage loans: Number of mortgage loans......... 10,133 11,178 12,487 10,729 13,269 Percent of total number.......... 34.85% 41.00% 36.34% 35.93% 35.87% Principal amount (in millions)... $ 2,396 $ 2,228 $ 2,192 $ 1,926 $ 2,136 Percent of total principal amount.......................... 50.14% 53.70% 49.97% 48.50% 53.35% Home equity mortgage loans: Number of mortgage loans......... 266 248 4,695 2,636 10,739 Percent of total number.......... 0.91% 0.91% 13.66% 8.83% 29.04% Principal amount (in millions)... $ 12 $ 10 $ 161 $ 92 $ 394 Percent of total principal amount.......................... 0.25% 0.24% 3.67% 2.31% 9.83% Other mortgage loans(1): Number of mortgage loans......... -- -- 63 -- 78 Percent of total number.......... -- -- 0.18% -- 0.21% Principal amount (in millions)... -- -- $ 8 -- $ 8 Percent of total principal amount.......................... -- -- 0.18% -- 0.21% Total mortgage loans serviced: Number of mortgage loans......... 29,076 27,261 34,363 29,862 36,985 Principal balance (in millions).. $ 4,779 $ 4,149 $ 4,387 $ 3,972 $ 4,003 Average principal balance ....... $164,362 $152,195 $127,666 $133,006 $108,235 Average coupon--first lien....... 7.13% 7.79% 8.05% 7.94% 8.17% Average coupon--home equity...... 9.55% 9.46% 9.60% 8.15% 9.93%
- -------- (1) Consists of subprime mortgage loans. The following table sets forth certain information regarding the number and aggregate principal balance of the mortgage loans serviced by the Company at September 30, 1997, including both fixed and adjustable rate mortgage loans, at various mortgage interest rates:
PERCENT OF NUMBER PERCENT OF TOTAL TOTAL PRINCIPAL AGGREGATE MORTGAGE INTEREST RATE OF LOANS NUMBER OF LOANS BALANCE PRINCIPAL BALANCE ---------------------- -------- ---------------- --------------- ----------------- (IN THOUSANDS) 0.00-6.99%.............. 5,190 14.03% $ 495,675 12.38% 7.00-7.49............... 2,856 7.72 374,804 9.36 7.50-7.99............... 3,410 9.22 453,338 11.32 8.00-8.49............... 4,695 12.69 728,904 18.21 8.50-8.99............... 7,089 19.17 1,072,629 26.80 9.00-9.49............... 3,195 8.64 364,132 9.10 9.50-9.99............... 1,885 5.10 148,095 3.70 10.00 and over.......... 8,665 23.43 365,502 9.13 ------ ------ ---------- ------ Total................. 36,985 100.00% $4,003,079 100.00% ====== ====== ========== ======
54 As of September 30, 1997, approximately 73% of the above mortgage loans serviced by the Company were fixed interest rate mortgage loans. If mortgage interest rates decline the Company's prepayment rate is likely to increase, thereby negatively affecting the Company's income. See "Risk Factors--Interest Rate Fluctuations-- Servicing Operations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview--Mortgage Loan Servicing Portfolio." This negative effect on the Company's income may be offset by a rise in origination and servicing income attributable to new mortgage loan originations, which historically have increased as mortgage interest rates have declined. The Company believes the credit quality of the mortgage loans that it originates, the relative age of mortgage loans it services and the economic factors impacting the areas it serves, among other factors, have resulted in relatively low delinquency ratios of the Company's mortgage loan servicing portfolio compared to industry averages. See "Risk Factors--Delinquency and Default." The Servicing Center is responsible for administering the collection of mortgage loans, maintenance of those properties in foreclosure and REO. Pursuant to the Company's procedures, once a borrower has missed a scheduled payment, over the next 45 days the Company's collections department attempts to establish contact with the borrower both by telephone and by sending two automatic notices of delinquency to solve the delinquency. In many instances, the delinquency is resolved, but if it is not, the collections department generally records a notice of default, subject to prior notice to the borrower, and commences foreclosure proceedings. Approximately seven months after the delinquency, and after meeting all the legal requirements for foreclosure, the property is sold at a trustee sale absent any intervening act by the borrower. The following table shows (with the principal amount of delinquent and foreclosed mortgage loans as a percentage of the principal amount of the Company's total mortgage loan servicing portfolio) the Company's recent delinquency statistics:
AT AT DECEMBER 31, SEPTEMBER 30, ------------------- -------------- 1994 1995 1996 1996 1997 ----- ----- ----- ------ ------ Delinquency of Mortgage Loans Serviced (at end of period): 30 days............................ 1.12% 1.03% 1.36% 1.02% 0.96% 60 days............................ 0.17 0.23 0.13 0.15 0.13 90 days or more.................... 0.17 0.17 0.04 0.06 0.13 ----- ----- ----- ------ ------ Total delinquencies.............. 1.46% 1.43% 1.53% 1.23% 1.22% ===== ===== ===== ====== ====== Foreclosures Pending................. 0.35% 0.53% 0.57% 0.64% 0.26%
Purchase and Sale of Mortgage Servicing Rights. The Company intends to increase the size of its mortgage loan servicing portfolio by retaining a significant portion of the mortgage loan servicing rights related to the mortgage loans it originates. The Company has no plans to increase its mortgage loan servicing rights portfolio through bulk or flow purchase of mortgage loan servicing rights from others, although it may do so if a strategic purchase opportunity presents itself. The Company may from time to time sell portions of its mortgage loan servicing portfolio, and may elect to sell mortgage loans it has originated on a servicing-released basis, based on strategic factors, such as market conditions and financial objectives. These sales increase revenue at the time of sale but reduce future servicing fee income. Prices obtained for mortgage loan servicing rights vary, and it is not possible to anticipate what price the Company will receive for any future sales. Among the factors that influence the value received for mortgage servicing rights are servicing fee rates, anticipated prepayment rates, average mortgage loan balances, servicing costs, custodial account balances, delinquency and foreclosure experience, and purchasers' required rates of return. The Company's owned servicing portfolio at September 30, 1997 consisted of servicing rights to mortgage loans with an aggregate outstanding principal balance of $4.0 billion, of which $2.3 billion was capitalized on the Company's balance sheet. During 1996 and 1995, the Company sold mortgage servicing rights with aggregate principal balances of $1.0 billion and $0.9 billion, respectively. 55 In general, the decision to sell, buy or retain mortgage loan servicing rights is based upon the market for and value of mortgage loan servicing rights, the Company's current financial needs and objectives, including, among other things, its cash and/or capital requirements and its debt-to-equity and other financial ratios. The Company's ability to sell its servicing rights under its various servicing agreements with investors is generally subject to the consent of the investors. In addition, under the servicing provisions governing the Company's securitizations, the successor servicer is subject to prior approval of the rating agencies rating the subject securities. Credit and Contractual Risks. As a seller and servicer of mortgage loans, the Company contractually obligates itself to assume certain risks with respect to the mortgage loans that it sells and services. Mortgage loan servicers, such as the Company, are also typically required to pay (or at least advance) delinquent mortgage loan payments and certain costs in connection with foreclosure proceedings on defaulted mortgage loans, for which the servicers may not be fully reimbursed. The Company must bear the costs associated with making such advances. The Company's underwriting, quality assurance and internal audit procedures are designed in part to limit its delinquency and default risk. The Company also follows policies and procedures designed to minimize risks associated with representations and warranties made by the Company with respect to mortgage loans that it sells. See "--Mortgage Loan Originations--Underwriting" and "--Quality Assurance." Mortgage loan servicing rights represent a contractual right and not a beneficial ownership interest in the underlying mortgage loans. Failure to service the mortgage loans in accordance with contract requirements may lead to a termination of the mortgage loan servicing rights without the payment of any compensation. MORTGAGE LOAN FUNDING AND BORROWING ARRANGEMENTS The Company utilizes short-term warehouse facilities and repurchase agreements to fund mortgage loan originations and purchases. In October 1993, the Company entered into a mortgage loan warehousing agreement (the "Warehouse Facility"). Under the terms of the Warehouse Facility, the Company has available a $215 million warehouse line of credit secured by the mortgage loans the Company originates or purchases. The Company is required to comply with various operating and financial covenants as defined in the agreements governing the agreement. Such covenants include restrictions on (i) changes in the Company's business that would materially and adversely affect the Company's ability to perform its obligations under the facility, (ii) selling any asset other than in the ordinary course of business, and (iii) maximum debt and distributions allowed. Such covenants also contain requirements for (i) minimum net worth and mortgage loan servicing portfolio balances and (ii) maximum leverage ratios. In accordance with industry practice, the Warehouse Facility is renewable by the lenders annually and currently expires on November 4, 1999. The Company expects, although there can be no assurance, that the Warehouse Facility will continue to be available in the future. At September 30, 1997, the outstanding balance under the Warehouse Facility was $133.9 million. In addition to the Warehouse Facility, the Company makes regular use of certain uncommitted lines of credit, short-term credit facilities and purchase and sale agreements (such as repurchase or "gestation" agreements) provided by major investment banks and a major corporation. These facilities permit the Company to diversify its borrowing resources, while accelerating the turnover of mortgage loans in inventory, reducing interest costs and permitting greater mortgage loan origination volumes. The Company currently has two uncommitted whole loan repurchase agreements with major investment banks. Under the terms of these agreements, the Company may pledge mortgage loans originated or purchased to obtain additional liquidity while mortgage loans are held until securitization or are sold through whole loan sales. Amounts outstanding under these agreements at September 30, 1997 were $79.2 million and $36.7 million. In addition, the Company has entered into an uncommitted mortgage loan purchase and sale agreement with a major investment bank. Under the terms of this agreement, mortgage loans which are subject to a "take-out" commitment between the Company and an investor, but have not yet been purchased, may be sold to the investment bank with the accompanying trade assignment. This allows the Company to accelerate turnover and provide additional liquidity to fund additional mortgage loans. 56 The last of the Company's warehousing facilities is a $15.0 million warehouse line of credit with a major corporation. This agreement expires on October 31, 1998. At September 30, 1997, the Company had $1.6 million outstanding under this facility. The Company also has a $12.0 million operating line of credit from a group of commercial banks who are also lenders in the Warehouse Facility. This operating line of credit is secured by certain servicing contracts of the Company and is limited by the amount of servicing pledged as security. This operating line of credit, which has a conversion option to a three-year, amortizing term loan, is renewable from time to time and expires on November 4, 1998. At September 30, 1997, the Company had no outstandings under this line of credit. In addition to these financing sources, the Company also has various repurchase agreements with major investment banks which are collateralized by certificates reflecting interest in the Company's private securities. At September 30, 1997, the Company had $3.4 million outstanding under these agreements. The Company is required to comply with various operating and financial covenants as provided in the agreements as described above, the most restrictive of which are those relating to the Warehouse Facility as described above. The Company relies on securitizations and whole loan sales to generate cash proceeds for repayment of its warehouse facilities and to create availability to purchase additional mortgage loans. Several factors affect the Company's ability to complete securitizations of its loans, including conditions in the securities markets generally, conditions in the asset-backed securities market specifically, and the credit quality of the Company's portfolio of mortgage loans. Unanticipated delays in closing a securitization could also increase the Company's interest rate risk by increasing the warehousing period for its mortgage loans. COMPETITION The mortgage banking business is highly competitive. The Company competes with other wholesale and retail mortgage banking entities, mortgage brokers and financial institutions, many of which have substantially greater financial and other resources than the Company. The market for mortgage loan originations is also significantly influenced by interest rate levels and changes as well as demographic and other factors. The Company expects greater competition from its existing competitors. In addition, Fannie Mae and Freddie Mac are currently developing technologies and business practices that will expand the scope of mortgage loans eligible to be Agency mortgage loans to include some Alternative A and subprime mortgage loans. The foregoing factors may result in lower mortgage loan origination volume, compressed pricing margins or other challenging or adverse effects for the Company. Mortgage brokers compete on the basis of service, range of mortgage loan products and pricing. Retail mortgage banking companies have direct access to borrowers and generally are able to sell their mortgage loans to the same entities that purchase the Company's mortgage loans. The Company depends primarily on mortgage brokers for originating new mortgage loans. Competitors also seek to establish relationships with mortgage brokers who are not obligated by contract or otherwise to continue to do business with the Company. Although independent mortgage bankers may not possess the financial resources of those affiliated with larger financial institutions, management believes that such independent companies have the potential to be more adept at adjusting to changing market conditions. See "Risk Factors--Competition." EMPLOYEES As of September 30, 1997, the Company had 595 full-time employees, 18 part- time employees and 3 temporary employees on its payroll. Approximately 297 of the Company's employees were employed at the Company's headquarters in Larkspur, California. The Company's employees are not represented by any collective bargaining unit. The Company believes that it maintains good relations with its employees. 57 PROPERTIES The principal executive and administrative offices of the Company occupy approximately 49,600 square feet of commercial office space in Larkspur, California, under three separate leases expiring on various dates in 1997 and 1998. The Company leases approximately 13,000 square feet of additional space in Santa Rosa, California, for its Servicing Center under a lease expiring November 30, 1998, and an additional 46,100 square feet at various locations in connection with its branch offices, for lease terms expiring at various dates from 1997 through 2001. The Company does not own any real estate except for its interest in real estate held in the ordinary course of business (including real estate owned as a result of foreclosure). The Company intends to lease additional office space in connection with the expansion of its branch office system. See "--Business Strategy." LEGAL PROCEEDINGS The Company is not a party to any material litigation. Additionally, the Company's management is not aware of any pending or threatened claims against the Company that might materially adversely affect the Company's operating or financial results. REGULATION The Company is subject to the rules and regulations of, and examinations by, FNMA, FHLMC, VA, HUD and state and local regulatory and housing authorities with respect to originating, processing, underwriting, selling, securitizing and servicing mortgage loans. In addition, there are other federal and state statutes and regulations, as well as judicial decisions, affecting such activities. These rules, regulations and decisions may, 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 prospective borrowers, regulate payment features; and, in some cases, set maximum interest rates, fees and loan amounts. Among other federal consumer credit laws, mortgage loan origination activities are subject to the ECOA, Truth-in-Lending Act, RESPA, the Fair Housing Act, the Fair Credit Reporting Act, the Home Mortgage Disclosure Act, as well as the regulations promulgated thereunder. These laws prohibit certain types of discrimination, kickbacks and referral fees, and require the disclosure of certain information to borrowers concerning credit and settlement costs. Many of the regulatory requirements are designed to protect the interests of consumers, while others protect the owners or insurers of mortgage loans. Failure to comply with these requirements can lead to loss of approved status, termination of servicing contracts without compensation to the servicer, demands for indemnification or loan repurchases, class action lawsuits and administrative enforcement actions, which may involve civil money penalties and, in some instances, treble damages. Although the Company believes that it is in compliance in all material respects with applicable federal and state laws, rules and regulations, the requirements to which the Company is subject often are ambiguous and subject to differing interpretations. There can be no assurance that more restrictive laws, rules and regulations will not be adopted in the future or that existing laws, rules and regulations, or the provisions of the mortgage loan documents with mortgagors, will not be interpreted in a more restrictive manner, which could make compliance more difficult or expensive, restrict the Company's ability to originate, purchase, sell or service mortgage loans, further limit or restrict the amount of interest and other charges earned from loans originated, purchased or serviced by the Company, expose the Company to claims by mortgagors and administrative enforcement actions, or otherwise adversely affect the business, financial condition or prospects of the Company. See "Risk Factors--Regulation and Legislation." Certain conventional mortgage loans are subject to state usury statutes. Federally related first-lien mortgage loans are exempt from the effect of such statutes. Despite federal exemption of state usury limits, the Company must comply with usury statutes in those states that have opted out of the preemption. Various state laws affect the Company's mortgage banking operations. The Company is licensed to do business in those states where the Company's operations require such licensing. 58 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of the Company and their positions are as follows:
NAME POSITION - ---- -------- Peter T. Paul........... President, Chief Executive Officer and Director Becky S. Poisson........ Executive Vice President--Operations and Director Gilbert J. MacQuarrie... Executive Vice President, Chief Financial Officer and Secretary and Director Steven M. Abreu......... Executive Vice President, Production and Secondary Marketing
Directors and Executive Officers Peter T. Paul, age 53, has been President, founder and major stockholder of the Company since it began operations in 1986. He also holds the position of Chief Executive Officer. Prior to founding the Company, he was Vice President of United Century Mortgage in California and was responsible for wholesale mortgage lending in several western states. From 1977 to 1980, Mr. Paul was Executive Vice President and director of Lindsey & Co. in charge of all its mortgage banking activities. Mr. Paul's substantial experience in the secondary mortgage market includes positions in the Secondary Mortgage Marketing Departments for Ticor and IMI, mortgage insurance companies, and as a GNMA salesman for Weeden & Co. Mr. Paul received a B.A. degree in business administration from the University of New Hampshire in 1967 and was awarded an M.B.A. degree from Boston University in 1971. Mr. Paul has 25 years experience in the mortgage banking industry and is a Director of the California Mortgage Bankers Association. Becky S. Poisson, age 47, is Executive Vice President, Operations of the Company and has served in such capacity since January of 1994. From 1992 through 1993, Ms. Poisson was Senior Vice President, Operations. She oversees the day-to-day operations of the Company's underwriting, funding, branch operations, mortgage loan delivery, information services, servicing and Quality Assurance Department. Prior to joining the Company, Ms. Poisson was Vice President of Operations at Bank of San Francisco. From 1988 to 1990, Ms. Poisson was Vice President--Regional Underwriting Manager of Security Pacific National Bank, and from 1986 to 1988 she was Vice President of Asset Management of Unified Mortgage Company. From 1984 to 1986, Ms. Poisson was Vice President of Loan Acquisitions/Sales for Farmers' Savings Bank, and from 1974 to 1984, Ms. Poisson was responsible for all closing operations for Lindsey and Company, Inc. Ms. Poisson received a B.A. degree from the University of Wisconsin in 1971. Ms. Poisson has 23 years experience in the banking and mortgage banking industries. Gilbert J. MacQuarrie, age 42, is Executive Vice President, Chief Financial Officer and Secretary of the Company and has served in such capacities since 1997. From 1994 to 1997, Mr. MacQuarrie served as Senior Vice President, Chief Financial Officer and Secretary, and from 1987 to 1994 he served in both capacities of Controller and Assistant Controller of the Company. As head of the Company's Corporate Finance Group, Mr. MacQuarrie is responsible for accounting, treasury, finance and human resources. Mr. MacQuarrie received a B.A. degree from Sonoma State University and is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants. Steven M. Abreu, age 32, is Executive Vice President, Production and Secondary Marketing of the Company and has served in such capacity since 1997. Mr. Abreu has been elected to serve as a director of the Company effective upon the closing of the Offering. Mr. Abreu served as Senior Vice President, Production and Secondary Marketing since 1994 and 1996, respectively. He is responsible for all of the Company's production offices, national expansion and secondary marketing activities. Mr. Abreu served as Assistant Vice President of Secondary Marketing from 1988 to 1992. Prior to rejoining Headlands in 1994, Mr. Abreu was Vice President and Institutional Mortgage Bond Salesman for Donaldson, Lufkin & Jenrette. Mr. Abreu has a B.S. degree from the University of San Francisco. 59 Additional Directors The Company has elected three additional directors effective upon the completion of the Offering. Such directors will be "outside directors." An "outside director" is a director who is not (i) an employee of the Company, (ii) a 5% stockholder of the Company, (iii) a director, officer or general partner of a 5% stockholder of the Company, or (iv) a director, officer or general partner of a general partner of a 5% stockholder of the Company. Mark L. Korell, age 50, was elected to serve as a director of the Company effective upon the closing of the Offering. Mr. Korell is president and chief executive officer of Industrywide Mortgage Exchange ("IMX"), San Ramon, California, a recently formed software company which facilitates mortgage loan sales between loan originators and mortgage lenders. From 1995 to 1997, Mr. Korell served as group president and chief executive officer of Norwest Mortgage, Inc., Des Moines, Iowa, a nationwide mortgage lender and mortgage loan servicer. From 1993 to 1995, Mr. Korell served as president and chief executive officer of GMAC Mortgage Group, Minneapolis, Minnesota, and from 1986 to 1993, as president and chief executive officer of Residential Funding Corp., Minneapolis, Minnesota. Mr. Korell has a B.S. degree from the University of Wisconsin (Madison) and an M.B.A. degree from Stanford Business School. Leonard Auerbach, age 51, was elected to serve as a director of the Company effective upon the closing of the Offering. Mr. Auerbach is president of L, B, A and C, Inc., Orinda, California, which offers consulting services to mortgage lenders. From 1989 to 1997, Mr. Auerbach and L, B, A and C, Inc. served as general partners in Tuttle & Co., which offered consulting services in connection with the management of residential mortgage loan origination pipeline risk. Since 1987, Mr. Auerbach has served as a trustee of the Robertson Stephens Investment Trust, San Francisco, California, an investment trust of twelve publicly traded mutual funds. Mr. Auerbach has a Ph.D. degree from the University of California (Berkeley). Mark E. Lachtman, age 54, was elected to serve as a director of the Company effective upon the closing of the Offering. Mr. Lachtman is president of First Capital Group, Inc., San Rafael, California, a mortgage brokerage company that he founded in 1983. He previously served as director of production for Fair, Isaac & Co., San Rafael, California, from 1978 to 1982. He is a founding director and currently treasurer of the California Association of Mortgage Brokers, North Bay Chapter. Mr. Lachtman has a B.A. degree from the University of California (Berkeley) and a Ph.D. degree from the University of Maryland. COMMITTEES OF THE BOARD Audit Committee. The Company intends to establish an Audit Committee composed of Messrs. Korell, Auerbach, Lachtman and MacQuarrie and Ms. Poisson. The Audit Committee will make recommendations concerning the engagement of independent public accountants, review with the independent public accountants the plans and results of the audit engagement, approve professional services provided by the independent public accountants, review the independence of the independent public accountants, consider the range of audit and non-audit fees and review the adequacy of the Company's internal accounting controls. Compensation Committee. The Company intends to establish a Compensation Committee composed of the three outside directors. The Compensation Committee will determine the compensation of the Company's executive officers and administer the Company's stock option plan. Other Committees. The Board of Directors may establish other committees as deemed necessary or appropriate from time to time, including, but not limited to, an Executive Committee of the Board of Directors. COMPENSATION COMMITTEE INTERLOCKS No interlocking relationship exists between the Company's Board of Directors or officers responsible for compensation decisions and the board of directors or compensation committee of any other company, nor has any such interlocking relationship existed in the past. 60 COMPENSATION OF DIRECTORS Outside directors receive automatic stock options pursuant to the Company's Stock Option Plan. See "--Executive Compensation--Stock Option Plan--Automatic Grants to Non-Employee Directors." None of the directors of the Company has received any separate compensation for service on the Board of Directors or on any committee thereof. Following the consummation of the Offering, the Company expects to pay outside directors $10,000 per year. In addition, upon closing of the Offering, each outside director will be granted options to purchase 10,000 shares of Common Stock at the initial public offering price. All directors will receive reimbursement of reasonable out-of-pocket expenses incurred in connection with meetings of the Board of Directors. No director who is an employee of the Company will receive separate compensation for services rendered as a director. COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS Management of the Company receives annual base salaries. Mr. Paul, Ms. Poisson, Mr. MacQuarrie and Mr. Abreu currently receive base salaries of $90,000, $120,000, $120,000 and $120,000, respectively. The base salaries may be raised at the discretion of the Compensation Committee. In addition, the Board of Directors has established a bonus incentive compensation plan for executive officers of the Company. This program permits the Board of Directors, in their discretion, to award cash bonuses annually to executive officers of the Company. The following Summary Compensation Table sets forth information concerning compensation earned in the years ended December 31, 1994, 1995 and 1996 by the Company's Chief Executive Officer and its three other executive officers serving at the end of the last completed fiscal year. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION AWARDS ANNUAL COMPENSATION SECURITIES -------------------- UNDERLYING OTHER NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#)(1) COMPENSATION($) - --------------------------- ---- ---------- --------- ------------- --------------- Peter T. Paul..................... 1996 $ 90,000 $ 510,750 -- -- President and Chief Executive 1995 90,000 8,000 -- -- Officer 1994 90,000 9,375 -- -- Becky S. Poisson.................. 1996 $ 94,000 $ 30,000 -- -- Executive Vice President, 1995 82,520 35,459 -- -- Operations 1994 75,120 109,837 -- -- Gilbert J. MacQuarrie............. 1996 $ 94,000 $ 30,000 -- -- Executive Vice President, 1995 82,000 29,479 -- -- Chief Financial Officer and 1994 72,140 75,906 -- -- Secretary -- Steven M. Abreu................... 1996 $ 100,800 $ 30,000 -- -- Executive Vice President, 1995 104,800 -- -- -- Production and 1994 73,262 -- -- -- Secondary Marketing
- -------- (1) No options were granted during the years indicated. 61 Option Grants The following table sets forth information concerning stock options granted during the 1997 fiscal year to each of the executive officers, adjusted to give effect to the stock split. Each of the stock options to purchase Common Stock of the Company becomes exercisable as follows: 25% in July 1998 and 25% in each year thereafter.
POTENTIAL REALIZABLE INDIVIDUAL GRANTS VALUE AT ASSUMED --------------------------------------------------------- ANNUAL RATES OF NUMBER OF % OF TOTAL STOCK PRICE SECURITIES OPTIONS/SARS APPRECIATION UNDERLYING GRANTED TO FOR OPTION TERM OPTIONS/SARS EMPLOYEES IN EXERCISE OR EXPIRATION ----------------- NAME GRANTED(#)(1) FISCAL YEAR BASE PRICE($/SH)(2) DATE 5%($) 10%($) - ---- ------------- ------------ ------------------- ---------- -------- -------- Peter T. Paul........... -- -- -- -- -- -- Becky S. Poisson........ 70,000 13.51% $4.06 7/27/07 $178,500 $452,900 Gilbert J. MacQuarrie... 70,000 13.51% 4.06 7/27/07 178,500 452,900 Steven M. Abreu......... 70,000 13.51% 4.06 7/27/07 178,500 452,900
OPTION/SAR GRANTS IN CURRENT FISCAL YEAR - -------- (1) All options were granted without related DERs. (2) Estimated fair market value on the date of grant, as determined by independent third party appraisal. Option Exercises and Fiscal Year End Values The Company issued no options to acquire Common Stock prior to July 1997. EMPLOYMENT AGREEMENTS The Company entered into employment agreements with Mr. Paul, Ms. Poisson, Mr. MacQuarrie and Mr. Abreu. Each agreement provides for a term through December 31, 1999 and will be automatically extended for an additional year at the end of each year of the agreement, unless either party provides a prescribed prior written notice to the contrary. Each agreement provides for the annual base salary set forth under the caption "--Executive Compensation" above and for participation by the subject officer in the bonus incentive compensation plan. Each employment agreement provides for the subject officer to receive his or her base salary and bonus compensation to the date of the termination of employment by reason of death, disability or resignation and to receive base compensation to the date of the termination of employment by reason of a termination of employment for cause as defined in the agreement. Each employment agreement also provides for the subject officer to receive, in the event that the Company terminates the subject officer's employment without cause, or if the subject officer resigns for "good reason" (as defined in the agreement, including the occurrence of a "Change of Control" of the Company as defined in the agreement), an amount equal to two times the combined salary and bonus for the last fiscal year. Section 280G of the Code may limit the deductibility of such payments by the Company for federal income tax purposes. Each employment agreement also contains a "non-compete" provision prohibiting the subject officer from competing with the Company for a period of one year following termination of employment following the Company's termination of the subject officer without cause or resignation of the subject officer for "good reason" (including a "Change of Control"). In addition, all outstanding options and Awards (see "--Stock Options" below) granted to the subject officer under the Stock Option Plan shall immediately vest upon his or her termination without cause or termination for "good reason" (including upon a "Change of Control"). "Change of Control" for purposes of the agreements would include a merger or consolidation of the Company, a sale of all or substantially all of the assets of the Company, changes in the identity of a majority of the members of the Board of Directors of the Company (other than due to the death, disability or age of a director) or acquisitions of more than 25% of the Company's capital stock, subject to certain limitations. 62 STOCK OPTION PLAN General. The Company's 1997 Executive and Non-Employee Director Stock Option Plan (the "Stock Option Plan") provides for the grant of qualified incentive stock options ("ISOs") which meet the requirements of Section 422 of the Internal Revenue Code, stock options not so qualified ("NQSOs"), deferred stock, restricted stock, performance shares, stock appreciation and limited stock awards ("Awards") and dividend equivalent rights ("DERs"). Purpose. The Stock Option Plan is intended to provide a means of performance-based compensation in order to attract and retain qualified personnel and to afford additional incentive to others to increase their efforts in providing significant services to the Company. Administration. The Stock Option Plan will be administered by the Compensation Committee, which shall at all times be composed solely of "disinterested persons" as required by Rule 16b-3 under the Exchange Act. Members of the Compensation Committee are eligible to receive only NQSOs pursuant to automatic grants of stock options discussed below. Options and Awards. Options granted under the Stock Option Plan will become exercisable in accordance with the terms of grant made by the Committee. Awards will be subject to the terms and restrictions of the Awards made by the Committee. Option and Award recipients shall enter into a written stock option agreement with the Company. The Committee has discretionary authority to select participants from among eligible persons and to determine at the time an option or Award is granted when and in what increments shares covered by the option or Award may be purchased or will vest and, in the case of options, whether it is intended to be an ISO or a NQSO provided, however, that certain restrictions applicable to ISOs are mandatory, including a requirement that ISOs not be issued for less than 100% of the then fair market value of the Common Stock (110% in the case of a grantee who holds more than 10% of the outstanding Common Stock) and a maximum term of ten years (five years in the case of a grantee who holds more than 10% of the outstanding Common Stock). Fair market value means as of any given date, with respect to any option or Award granted, at the discretion of the Board of Directors or the Compensation Committee, (i) the closing sale price of the Common Stock on such date as reported in the Western Edition of the Wall Street Journal or (ii) the average of the closing price of the Common Stock on each day of which it was traded over a period of up to twenty trading days immediately prior to such date, or (iii) if the Common Stock is not publicly traded (e.g., prior to the Offering), the fair market value of the Common Stock as otherwise determined by the Board of Directors or the Compensation Committee in the good faith exercise of its discretion. Eligible Persons. Officers and directors and employees of the Company and other persons expected to provide significant services to the Company are eligible to participate in the Stock Option Plan. ISOs may be granted to the officers and key employees of the Company. NQSOs and Awards may be granted to the directors, officers, key employees, agents and consultants of the Company or any of its subsidiaries. Under current law, ISOs may not be granted to any director of the Company who is not also an employee, or to directors, officers and other employees of entities unrelated to the Company. No options or Awards may be granted under the Stock Option Plan to any person who, assuming exercise of all options held by such person, would own or be deemed to own more than 25% of the outstanding shares of equity stock of the Company. Shares Subject to the Plan. Subject to anti-dilution provisions for stock splits, stock dividends and similar events, the Stock Option Plan authorizes the grant of options to purchase, and Awards of, an aggregate of up to 700,000 shares of the Company's Common Stock. If an option granted under the Stock Option Plan expires or terminates, or an Award is forfeited, the shares subject to any unexercised portion of such option or Award will again become available for the issuance of further options or Awards under the Stock Option Plan. The maximum number of shares covered by the Stock Option Plan will increase to 10% of the Company's total outstanding shares at any time, provided that no more than 1,000,000 shares of Common Stock shall be cumulatively available for grant as Incentive Stock Options. 63 Term of the Plan. Unless previously terminated by the Board of Directors, the Stock Option Plan will terminate on September 15, 2007, and no options or Awards may be granted under the Stock Option Plan thereafter, but existing options or Awards remain in effect until the options are exercised or the options or Awards are terminated by their terms. Term of Options. Each option must terminate no more than ten years from the date it is granted (or five years in the case of ISOs granted to an employee who is deemed to own an excess of 10% of the combined voting power of the Company's outstanding equity stock). Options may be granted on terms providing for exercise either in whole or in part at any time or times during their restrictive terms, or only in specified percentages at stated time periods or intervals during the term of the option. DERs. The Plan provides for granting of dividend equivalent rights ("DERs") in tandem with any options granted under the Plan. Such DERs accrue for the account of the optionee shares of Common Stock upon the payment of dividends on outstanding shares of Common Stock. The number of shares accrued is determined by a formula and such shares may be made transferable to the optionee either upon exercise of the related option or on a "current-pay" basis so that payments would be made to the optionee at the same time as dividends are paid to holders of outstanding Common Stock. Holders of DERs may be made eligible to participate not only in cash distributions but also in distributions of stock or other property made to holders of outstanding Common Stock. Shares of Common Stock accrued for the account of the optionee are eligible to receive dividends and distributions. DERs may also be made "performance based" by conditioning the right of the holder of the DER to receive any dividend equivalent payment or accrual upon the satisfaction of specified performance objectives. Option Exercise. The exercise price of any option granted under the Stock Option Plan is payable in full in cash, or its equivalent as determined by the Committee. The Company may make loans available to options holders to exercise options evidenced by a promissory note executed by the option holder and secured by a pledge of Common Stock with fair value at least equal to the principal of the promissory note unless otherwise determined by the Committee. Automatic Grants to Non-Employee Directors. Following the closing of the Offering, each non-employee director of the Company will be automatically granted NQSOs to purchase 10,000 shares of Common Stock without DERs. Such automatic grants of stock options vest 25% on the anniversary date in the year following the date of the grant and 25% on each anniversary date thereafter. The exercise price for such automatic grants of stock options is the initial public offering price of the Common Stock in the Offering, and is required to be paid in cash. Amendment and Termination of Stock Option Plan. The Board of Directors may, without affecting any outstanding options or Awards, from time to time revise or amend the Stock Option Plan, and may suspend or discontinue it at any time. However, no such revision or amendment may, without stockholder approval, increase the number of shares subject to the Stock Option Plan, modify the class of participants eligible to receive options or Awards granted under the Stock Option Plan or extend the maximum option term under the Stock Option Plan. EMPLOYEE STOCK PURCHASE PLAN The 1998 Employee Stock Purchase Plan (the "ESPP") was adopted by the Board of Directors on October 20, 1997, to be effective upon the closing of this Offering. The ESPP provides employees of the Company with an opportunity to purchase shares of Common Stock at a discount and pay for their purchases through payroll deductions. All expenses incurred in connection with the implementation and administration of the ESPP will be paid by the Company. A pool of 300,000 shares of Common Stock has been reserved for issuance under the ESPP (subject to anti-dilution provisions). In general, each regular, full-time and part-time (non-seasonal) employee who has worked for at least three months and works an average of over 20 hours per week will be eligible to participate in the ESPP, provided the employee is employed as of the first day of the purchase period. 64 Eligible employees may elect to contribute up to 15% of their cash compensation to purchasing shares of Common Stock under the ESPP. At the end of each six-month purchase period, the Company will apply the amount contributed by the participant during that period to purchase shares of Common Stock for the participant. The purchase price will be equal to 85% of the lower of (a) the market price of Common Stock immediately before the beginning of the applicable "offering period" or (b) the market price of Common Stock on the last business day of the purchase period. The first offering period will commence upon the closing of this Offering and will extend through December 31, 1999. The value of the Common Stock purchased each calendar year (measured at the beginning of the offering period) may not exceed $25,000 per participant. Participants may withdraw their contributions at any time before the close of each purchase period. 65 PRINCIPAL AND SELLING SHAREHOLDERS BENEFICIAL OWNERSHIP OF COMMON STOCK BY LARGE AND SELLING SHAREHOLDERS The following table sets forth certain information known to the Company with respect to beneficial ownership of the Company's Common Stock as of September 30, 1997, and as adjusted to reflect the sale of Common Stock being offered hereby, by (i) each of the Selling Shareholders, and (ii) each person known to the Company to beneficially own more than five percent of the Company's Common Stock. The table reflects a 14,000-for-1 stock split to be effected immediately prior to the Offering.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED OWNED BEFORE OFFERING NUMBER OF AFTER OFFERING(1) ----------------------- SHARES ----------------------- NUMBER PERCENT BEING SOLD NUMBER PERCENT ------------ -------------------- ------------ ---------- Paul Family Group 1100 Larkspur Landing Circle, Suite 101 Larkspur, California 94939 Peter T. Paul(2)(3)..................... 14,000,000 100.0% 3,500,000 10,500,000 56.8% Jessica M. Paul(4)...................... 1,680,000 12.0% -- 1,680,000 9.1% Daniel W. Paul(4)....................... 840,000 6.0% -- 840,000 4.5% Gilbert J. MacQuarrie(4)................ 840,000 6.0% -- 840,000 4.5% Paul Family Group (exclusive of the Vot- ing Trust)............................. 8,400,000 60.0% -- 8,400,000 45.4% Hart Family Group 100 Larkspur Landing Circle, Suite 110 Larkspur, California 94939 Dennis M. Hart(5)....................... 1,400,000 10.0% -- 1,400,000 7.6% Kathryn E. Hart(5)...................... 1,400,000 10.0% 700,000 700,000 3.8% D. Michael Hart, Jr.(6)................. 933,333 6.67% 933,333 -- -- Elizabeth A. Hart(6).................... 933,333 6.67% 933,333 -- -- Christopher K. Hart(6).................. 933,333 6.67% 933,333 -- -- Hart Family Group(7).................... 5,600,000 40.0% 3,500,000 2,100,000 11.4%
- -------- (1) Assuming no exercise of the Underwriters' over-allotment option and no purchases by listed shareholders in the Offering. (2) Pursuant to a Voting Trust Agreement dated September 15, 1997, all of the outstanding shares of Common Stock of the Company have been transferred to Mr. Peter T. Paul, as Voting Trustee, 1100 Larkspur Landing Circle, Suite 101, Larkspur, California 94939, with certain voting and investment powers, including the power to act on behalf of each of the shareholders in connection with the Offering. The Voting Trust Agreement will terminate on September 30, 2000. (3) Peter T. Paul beneficially owns, through a living trust, 6,720,000 shares of Common Stock of the Company. (4) Jessica M. Paul, daughter of Peter T. Paul, beneficially owns 1,680,000 shares of Common Stock of the Company held in two trusts for her benefit. Daniel W. Paul, her uncle, and Gilbert J. MacQuarrie, the Company's Executive Vice President, Chief Financial Officer and Secretary, each serve as a trustee for one of those trusts, with sole voting and investment power with respect to the trust assets. (5) Dennis M. Hart and his wife Kathryn E. Hart each beneficially own 1,400,000 shares of Common Stock of the Company. Mr. Hart served as a director of the Company from April 1986 to September 1997. (6) D. Michael Hart, Jr., Elizabeth A. Hart and Christopher K. Hart, the adult children of Dennis M. and Kathryn E. Hart, each beneficially own 933,333 shares of Common Stock of the Company. (7) The 2,100,000 shares to be beneficially owned by the Hart Family after the closing of the Offering are pledged as collateral for certain bank loans unrelated to the Company. 66 BENEFICIAL OWNERSHIP OF COMMON STOCK BY DIRECTORS AND MANAGEMENT The following table sets forth certain information known to the Company with respect to beneficial ownership of the Company's Common Stock as of September 30, 1997, and as adjusted to reflect the sale of Common Stock offered hereby, by (i) each director, (ii) the Company's executive officers, and (iii) all directors and executive officers as a group. Unless otherwise indicated in the footnotes to the table, the beneficial owners named have, to the knowledge of the Company, sole voting and investment power with respect to the shares beneficially owned, subject to community property laws where applicable.
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP OF COMMON STOCK OF COMMON STOCK BEFORE OFFERING AFTER OFFERING(1) ------------------------------------------------ NAME OF BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT ------------------------ ------------- ----------------------- ---------- Peter T. Paul(2)........... 14,000,000 100% 10,500,000 56.8% Becky Poisson.............. 0 -- 0 -- Gilbert J. MacQuarrie(3)... 840,000 6.0% 840,000 4.5% Steve Abreu................ 0 -- 0 -- Directors and executive of- ficers as a group (7 per- sons)..................... 14,840,000 100% 9,940,000 53.7%
- -------- (1) Assuming no exercise of Underwriters' overallotment option and no purchases by any of the listed stockholders in the Offering. (2) See footnotes (2), (3) and (4) to previous table. (3) See footnote (4) to previous table. 67 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS HISTORY OF ARRANGEMENTS WITH FCMC The Company was incorporated in California and commenced its mortgage banking business in 1986. From inception of operations, the Company conducted certain of its business through a contractual arrangement with First California Mortgage Company ("FCMC"). This arrangement was embodied in an Agency Agreement dated December 11, 1992 (the "Agency Agreement"). Pursuant to the Agency Agreement, the Company arranged mortgage loans through its unaffiliated broker network that were funded by and in the name of FCMC. After funding the mortgage loans, FCMC warehoused the mortgage loans until the mortgage loans were sold (the "Warehouse Period"). The secondary marketing function for all mortgage loans arranged by the Company was performed by the Company. In performing the marketing function, the Company entered into sales commitments in the name of FCMC. During the Warehouse Period, the Company bore all marketing risks and rewards (resulting from interest rate volatility) associated with the mortgage loans. FCMC retained all cash received from the mortgage loans during the Warehouse Period. In addition, FCMC received a "production fee" for each mortgage loan funded, which was paid by the Company at the date of funding. Gains and losses realized on sales of mortgage loans arranged by the Company were received by or paid to the Company at the mortgage loan sale settlement date. Generally, the Company packaged all of the mortgage loans it arranged and sold them in the secondary market with servicing rights retained by the Company. FCMC performed all servicing functions for mortgage loans previously arranged by the Company. FCMC received certain servicing benefits and a servicing fee for each mortgage loan serviced by FCMC on behalf of the Company. The servicing income, net of the servicing fee charged by FCMC, was paid to the Company in arrears on a monthly basis and accounted for as mortgage loan administration income. The Company received all proceeds on the sale of mortgage loan servicing rights for mortgage loans previously arranged by the Company. In 1993, the Company took steps to conduct all of its business activities independently of FCMC through its own personnel and facilities in order to facilitate the full implementation of its business strategy. In particular, the Company wanted to establish and deal directly with its own sources of mortgage loan financing to permit it to arrange funding for the planned expansion of its origination activities and to realize net interest income on its portfolio of mortgage loans held for sale. In addition, the Company wanted to gain control over its servicing rights portfolio to permit it to arrange for planned increases in such portfolio, to improve customer service and to realize the resulting efficiencies in servicing costs and to be able to buy and sell servicing rights directly when market and other considerations warrant. Prior to June 30, 1993, the Company became an authorized seller/servicer for both Fannie Mae and Freddie Mac. As of July 1, 1993, the Company began originating mortgage loans in its own name and undertaking servicing responsibilities as the servicer of record. Pursuant to a Mortgage Loan Subservicing Agreement with FCMC dated July 1, 1993, FCMC agreed to act as subservicer for the Company with respect to all newly originated mortgage loans until such time as the Company elected to take over the servicing of such mortgage loans at its own facility. On October 25, 1993, the Company entered into the Warehouse Facility to enable it to fund its own originations. On the same date, the Company also entered into a Servicing Transfer Agreement (the "Servicing Transfer Agreement") with FCMC, The First National Bank of Chicago ("FNBC"), as agent under two FCMC credit facilities, and First Interstate Bank of California, as agent under the Warehouse Facility. Under the Servicing Transfer Agreement, FCMC confirmed (i) that the Company owned the servicing rights to mortgage loans being subserviced under the Subservicing Agreement by FCMC and that the Company had the right to terminate the Subservicing Agreement upon demand, and (ii) that FCMC would transfer for consideration to the Company the servicing rights to substantially all of the mortgage loans originated prior to July 1, 1993 in the name of FCMC upon demand by the Company. In addition, pursuant to the Servicing Transfer Agreement, FNBC released its security interest in the servicing rights described in the preceding sentence and FCMC and the Company terminated the Agency Agreement as of October 25, 1993. The transfer of servicing rights to the Company's Servicing Center was substantially completed in 1994, and the Subservicing Agreement was terminated. 68 SETTLEMENT AGREEMENTS Following completion of the steps described above permitting the Company to operate independently of FCMC, a number of disputes arose between the Company, FCMC and its successor in interest, Mortgage Service America Co. ("MSA"). In addition, at approximately the same time, litigation ensued between Peter T. Paul ("PTP") and Dennis M. Hart ("DMH") and between the Company and DMH in which the Company and PTP alleged that loans previously made to DMH by the Company and PTP (which loans were evidenced by the "Note to Headlands" and "Note to PTP" referenced below) were due and owing. The proceeds of such loans to DMH were to be used primarily for payment of personal income taxes and for investment in FCMC required by its lenders in connection with the separation of the Company's operations from FCMC. In the litigation, DMH questioned various actions by PTP as an officer and director of the Company in connection with PTP's ownership of Headlands Insurance Agency, Inc. ("HIA") and Marin Conveyancing Corporation ("MCC") and transactions between the Company and HIA and MCC. These disputes and the litigation were resolved pursuant to two settlement agreements (the "Settlement Agreements") which were finalized in July 1996 as described below. At the time of settlement, PTP and DMH were directors of the Company and PTP, DMH and the members of their respective families referred to below each beneficially owned, individually, in excess of 5% of the Company's outstanding Common Stock. Accordingly, the various payments and assignments effected pursuant to the Settlement Agreements constitute related transactions required to be described herein. FCMC and Headlands Settlement and Mutual Release Agreement. This agreement (the "FCMC-Headlands Agreement") was entered into on April 11, 1996 by the Company, FCMC (through MSA), PTP and DMH and his wife, Katherine E. Hart ("KEH"). In order to resolve a dispute between the Company and FCMC over the amounts and rights related to certain inter-company receivables and payables relating to services between the parties, as well as a dispute between the Company and certain of its shareholders, the FCMC-Headlands Agreement provided for the following: (1) Assignment of Inter-company Receivables and Payables. The Company agreed to assign to DMH and KEH the disputed receivables due to the Company from FCMC and the disputed payables due to FCMC from the Company, the net amount of which receivables and payables was agreed by the parties to equal $1.6 million due the Company from FCMC; and (2) Mutual Release. The parties to the FCMC-Headlands Agreement agreed to release each other (and certain related parties) from claims arising from the disputed matters. Headlands Shareholders Settlement and Mutual Release Agreement. This agreement (the "Headlands Shareholders Agreement") was entered into on April 11, 1996 by the Company, DMH, KEH, D. Michael Hart, Jr. ("DMH Jr."), Elizabeth A. Hart ("EAH"), Christopher K. Hart ("CKH") (DMH Jr., EAH and CKH being referred to collectively as the "Hart Children" and, together with DMH and KEH, the "Hart Family"), PTP and his daughter, Jessica M. Paul ("JMP"), HIA and MCC. The Company's common stock was at the time wholly owned by PTP, JMP and the Hart Family (collectively, the "Headlands Shareholders"). The Headlands Shareholders Agreement was entered into to resolve disputes arising out of (i) a promissory note of DMH to the Company evidencing indebtedness under an open line of credit in the face amount of $6.5 million (the "Note to Headlands"); (ii) a promissory note of DMH to PTP in face amount of $2,270,719 (the "Note to PTP"); (iii) actions by PTP in connection with his ownership of HIA and MCC and transactions between the Company and HIA and MCC; (iv) demand for payment of dividends from the Headlands Shareholders and for payment of his 1994 bonus from PTP; and (v) the need to approve an amended warehouse line of credit. To resolve these disputed matters, the Headlands Shareholders Agreement provided for the following: (1) Consent to Assignment of Inter-company Receivables and Payables. The Headlands Shareholders consented to the distribution upon the closing of the settlement transactions (the "closing") of the Company's receivables and payables relating to FCMC as a dividend pursuant to the FCMC-Headlands Agreement (see chart below illustrating such distribution). (2) Note to Headlands. The Headlands Shareholders agreed that the value to the Company of the Note to Headlands was $1,396,021, as of March 31, 1996 and approved of the distribution of the Note, plus accrued interest and related claims, to the Hart Children as a dividend upon the closing. 69 (3) Agreement on Share Ownership. The Headlands Shareholders confirmed the number of outstanding shares then held by each of them and agreed that throughout the period they held shares they received the proper amount of dividends and distributions to which they were entitled. (4) Cash Distributions. Dividends to the Headlands Shareholders were approved for distribution upon the closing in the following amounts: $638,948 each to DMH and KEH; $973,608 to each of the Hart Children; $719,474 to JMP; and $6,475,266 to PTP. (5) Compensation to PTP and Bank Lines of Credit. The following compensation was approved for payment to PTP: 1994 bonus, $500,000; 1995 salary, $90,000; 1995 bonus, $9,240; 1996 salary, $90,000; and 1996 bonus, $500,000. In addition, PTP was authorized to negotiate a renewal or amendment to the Company's warehouse lines of credit. (6) HIA and MCC Shares. PTP agreed to assign shares of HIA and MCC to the Headlands Shareholders such that the share ownership of HIA and MCC was the same as for the Company. (7) Note to PTP. The Hart Children agreed that the value of the Note to PTP as of March 31, 1996 was $2,479,735 and agreed to purchase the Note from PTP for that amount plus accrued interest and related claims. (8) PTP Loan to the Company. PTP agreed to make a loan to the Company, the repayment of which would be subordinated to the lenders under the warehouse lines of credit as required by such lenders. At the closing, PTP and JMP loaned the Company $9,670,000 pursuant to an unsecured promissory note. The terms of the note are described in note 13 to the consolidated financial statements. (9) Company Distribution Policy. The Company agreed to distribute to PTP and JMP as the holders of the unsecured promissory notes, so long as the Company continues to be an S corporation and no default would result under the warehouse line of credit, an amount equal to 60% of the Company's federal taxable income (less net gain under Section 1231 of the Code) and 40% of any net gain under Section 1231 of the Code until the notes have been repaid. (10) Mutual Release. The parties to the Headlands Shareholders Agreement agreed to release each other (and certain related parties) from claims arising from the disputed matters. In July 1996, the closing occurred and the various assignments and distributions under the Settlement Agreements were effected. The following chart illustrates the various cash and other distributions made by the Company according to the Settlement Agreements:
TYPE OF PURCHASE PROPERTY AMOUNT OF OF NOTE TO DISTRIBUTIONS NAME DISTRIBUTED DISTRIBUTION PTP FROM CLOSING ---- ------------- ------------ ---------- ------------- PTP.................. Cash $ 6,475,266 $2,479,735 $8,955,001* JMP.................. Cash 719,474 719,474* DMH.................. Inter-company Receivables 800,000 800,000 Cash 638,948 638,948 KEH.................. Inter-company Receivables 800,000 800,000 Cash 638,948 638,948 DMH Jr............... Note to Headlands 465,340 465,340 Cash 973,608 (826,578) 147,029 EAH.................. Note to Headlands 465,340 465,340 Cash 973,608 (826,578) 147,029 CKH.................. Note to Headlands 465,340 465,340 Cash 973,608 (826,578) 147,029 TOTAL $14,389,480
- -------- * Before deducting the amount of $9,670,000 loaned back to the Company at closing pursuant to the subordinated, unsecured promissory notes referred to in (8) above. 70 TAX INDEMNIFICATION AGREEMENT See "Termination of S Corporation Status." OTHER BUSINESS TRANSACTIONS WITH MANAGEMENT At December 31, 1995, the amount of the Note to Headlands referred to above was $1,365,389. This note was deemed repaid in full in 1996 pursuant to the Settlement Agreements. Also during 1996, the Company issued the note payable to stockholders evidencing the subordinated loan described above made to PTP and JMP. The initial principal amount of the note was $9,670,000 and the amount of interest accrued thereon during 1996 was $341,774. As of September 30, 1997, this note had been divided into two notes with principal balances of $8,901,000 and $769,000. These notes will be paid in full from proceeds of the Offering. At December 31, 1995, the gross amount of the receivables due from FCMC was $3.4 million. These receivables were assigned in 1996 pursuant to the Settlement Agreements. The Company had accounts receivable from HIA of $105,000, $56,000 and $45,000 at September 30, 1997 and December 31, 1996 and 1995, respectively. The Company had accounts payable due to MCC of $39,000 at September 30, 1997 and accounts receivable of $58,000 and $69,000 at December 31, 1996 and 1995, respectively. The Company provided administrative services to these related parties, and received fees (included in production income) of $195,000, $240,000 and $180,000 during the nine months ended September 30, 1997 and the years ended December 31, 1996 and 1995, respectively. 71 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 50,000,000 shares of Common Stock and 5,000,000 shares of Preferred Stock. At September 30, 1997, there were 14,000,000 shares of Common Stock outstanding (after giving effect to a 14,000-for-1 stock split to be effected immediately prior to the Offering) and no shares of Preferred Stock outstanding. Prior to this Offering, there has been no established trading market for the Company's Common Stock. No assurance can be made that an active public trading market for the Common Stock will develop after the Closing, or if developed, that it will be sustained. COMMON STOCK Each holder of Common Stock is entitled to one vote for each share held. California law generally permits holders of Common Stock to cumulate votes for the election of directors; however, the Company's Bylaws contain a prohibition on cumulative voting which prohibition will take effect, pursuant to California law, once the Common Stock is quoted on the Nasdaq National Market and is held by at least 800 holders of record on the record date for the Company's most recent annual meeting. The Common Stock is not convertible into any other security. Holders of Common Stock are entitled to receive ratably such dividends as may be declared by the Board of Directors out of funds legally available therefor. See "Dividend Policy." In the event of a liquidation, dissolution or winding up of the Company, holders of Common Stock would be entitled to share in the Company's assets remaining after the payment of liabilities and the satisfaction of any liquidation preference granted the holders of any outstanding shares of Preferred Stock. The Common Stock has no preemptive or other subscription rights. The outstanding shares of Common Stock are, and the Common Stock offered hereby will be when issued, fully paid and nonassessable. PREFERRED STOCK The Board of Directors has the authority, without further action by the shareholders of the Company, to issue up to 5,000,000 shares of Preferred Stock in one or more series, and to fix the designations, rights, preferences, privileges, qualifications and restrictions thereof including dividend rights, conversion rights, voting rights, rights and terms of redemption, liquidation preferences and sinking fund terms, any or all of which may be greater than the rights of the Common Stock. The Board of Directors, without shareholder approval, can issue Preferred Stock with voting, conversion and other rights which could adversely affect the voting power and other rights of the holders of Common Stock. Preferred Stock could thus be issued quickly with terms calculated to delay or prevent a change in control of the Company or to make removal of management more difficult. In certain circumstances, such issuance could have the effect of decreasing the market price of the Common Stock. The issuance of Preferred Stock may have the effect of delaying, deterring or preventing a change in control of the Company without any further action by the shareholders including, but not limited to, a tender offer to purchase Common Stock at a premium over then current market prices. The Company has no present plan to issue any shares of Preferred Stock. REGISTRATION RIGHTS Members of the Paul Family Group and the Hart Family Group, as holders of currently outstanding Common Stock (10,500,000 shares after the closing of the Offering), are entitled to certain rights with respect to registration under the Securities Act of such Common Stock. Under the terms of a Founders Registration Rights Agreement, such holders are entitled to include within any registration statement under the Securities Act proposed by the Company with respect to a firm commitment underwritten public offering of Common Stock (either for its own account or for the account of other security holders) shares of Common Stock held by such holders, subject to certain conditions and limitations, including the right of the underwriters to limit the number of shares included in the registration. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is The Bank of New York. 72 SHARES ELIGIBLE FOR FUTURE SALE Upon the closing of the Offering, the Company will have outstanding 18,500,000 shares of Common Stock (19,700,000 shares of Common Stock if the Underwriters' over-allotment option is executed in full). The 8,000,000 shares of Common Stock to be sold in the Offering, and any of the 1,200,000 shares that may be sold upon exercise of the Underwriters' over-allotment option, will be freely tradable by persons other than "affiliates" of the Company, as that term is defined in Rule 144, without restriction or registration or registration under the Securities Act. The remaining 10,500,000 shares (such shares being referred to herein as the "Restricted Shares") will be held by the Company's current shareholders. The Restricted Shares may not be sold unless they are registered under the Securities Act or sold pursuant to an applicable exemption from registration, including an exemption pursuant to Rule 144. As currently in effect, Rule 144 generally permits the public sale in ordinary trading transactions of "restricted securities" and of securities owned by "affiliates" beginning 90 days after the date of this Prospectus if the other restrictions enumerated in Rule 144 are met. Restricted securities are securities acquired directly or indirectly from an issuer or an affiliate of the issuer in an action not involving a public offering. In general, under Rule 144, if a period of at least one year has elapsed since the later of the date the restricted securities were acquired from the Company or an affiliate, as applicable, then the holder of such restricted securities (including an affiliate) is entitled, subject to certain conditions, to sell within any three-month period a number of shares which does not exceed the greater of: (i) 1% of the Company's then outstanding shares of Common Stock; or (ii) the share's average weekly trading volume during the four calendar weeks preceding such sale. Sales under Rule 144 are also subject to certain manner-of-sale provisions and requirements as to notice and the availability of current public information about the Company. Affiliates may sell shares not constituting restricted securities in accordance with the foregoing limitations and requirements but without regard to the one-year period. However, a person who is not and has not been an affiliate of the Company at any time during the 90 days preceding the sale of the shares, and who has beneficially owned restricted securities for at least two years, is entitled to sell such shares under Rule 144 with regard to the volume limitations, manner-of-sale provisions and notice and public information requirements of Rule 144. All of the Restricted Shares will become eligible for sale pursuant to Rule 144 beginning on the 90th day following the date of this Prospectus. Notwithstanding, the Company and each of its directors, executive officers and shareholders have agreed during the 180-day period immediately following the date of this Prospectus not to sell or otherwise dispose of any securities of the Company without the consent of the Representatives, subject to specific exceptions. The Company has reserved 700,000 shares of its Common Stock for issuance under the Stock Option Plan (subject to increase to 10% of the Company's total outstanding shares at any time) and 300,000 shares of its Common Stock for issuance under the Employee Stock Purchase Plan. All of the shares of Common Stock issued under the foregoing plans will also be restricted securities unless the Company files a registration statement under the Securities Act relating to the issuance of the shares. The Company currently intends to register the shares of Common Stock reserved under each of these employee benefit plans. Subject to compliance with Rule 144 by affiliates of the Company, any shares issued under such employee benefit plans will become freely tradable at the effective date of the registration statement for the shares reserved under such plan. Prior to the Offering, there has been no public market for the Common Stock, and no prediction can be made as to the effect, if any, that sales of shares or the availability of shares for sale will have on the market price prevailing from time to time. Nevertheless, sales of substantial amounts of Common Stock in the public market could adversely affect prevailing market prices. 73 UNDERWRITING The Underwriters named below represented by NationsBanc Montgomery Securities, Inc., BT Alex. Brown Incorporated and UBS Securities LLC (the "Representatives"), have severally agreed, subject to the terms and conditions set forth in the Underwriting Agreement, to purchase from the Company and the Selling Shareholders, the number of shares of Common Stock indicated below opposite their respective names at the initial public offering price less the underwriting discount set forth on the cover page of this Prospectus. The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions precedent and that the Underwriters are committed to purchase all of such shares if any are purchased.
UNDERWRITER NUMBER OF SHARES ----------- ---------------- NationsBanc Montgomery Securities, Inc. .................... BT Alex. Brown Incorporated................................. UBS Securities LLC.......................................... --------- Total..................................................... 8,000,000 =========
The Representatives have advised the Company and the Selling Shareholders that the Underwriters propose initially to offer the Common Stock to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow to selected dealers a concession of not more than $ per share, and the Underwriters may allow, and such dealers may reallow, a concession of not more than $ per share to certain other dealers. After this Offering, the offering price and other selling terms may be changed by the Representatives. The shares of Common Stock are offered subject to receipt and acceptance by the Underwriters, and to certain other conditions, including the right to reject orders in whole or in part. The Company has granted an option to the Underwriters, exercisable during the 30-day period after the date of this Prospectus, to purchase up to a maximum of 1,200,000 additional shares of Common Stock to cover over- allotments, if any, at the offering price less the Underwriting Discount set forth on the cover page of this Prospectus. To the extent the Underwriters exercise this option, each of the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the above table. The Underwriters may purchase such shares only to cover over-allotments made in connection with the Offering. The Underwriting Agreement provides that the Company and the Selling Shareholders will indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or will contribute to payments the Underwriters may be required to make in respect thereof. The Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. All of the Company's officers and directors and certain of the Company's shareholders have agreed that they will not, without the prior written consent of NationsBanc Montgomery Securities, Inc. (which consent may be withheld in its sole discretion) and subject to certain limited exceptions, directly or indirectly, sell, offer, contract or grant any option to sell, make any short sale, pledge, transfer, establish an open "put equivalent position" within the meaning of Rule 16a-1(h) under the Exchange Act, or otherwise dispose of any shares of Common Stock, options or warrants to acquire Common Stock, or securities exchangeable or exercisable for or convertible into Common Stock currently owned either of record or beneficially by them or announce the intention to do any of the foregoing, for a period commencing on the date of this Prospectus and continuing to a date 180 days after such date. NationsBanc Montgomery Securities, Inc. may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to these lock-up agreements. In addition, the Company has agreed that, for a period of 180 days after the date of this Prospectus, it will not, without the consent of NationsBanc Montgomery Securities, Inc., issue, offer, sell or grant options to purchase or otherwise dispose of any equity securities or securities convertible into or exchangeable for equity securities except for (i) the issuance of shares of Common Stock offered hereby, (ii) the issuance of shares of Common Stock pursuant to the exercise of outstanding options, and (iii) the grant of options to purchase shares of Common Stock pursuant to the Stock Option Plan. 74 Prior to the Offering, there has been no public market for the Common Stock. Consequently, the initial public offering price will be determined by negotiations among the Company, the Selling Shareholders and the Representatives. Among the factors to be considered in such negotiations are the history of, and prospects for, the Company and the industry in which it competes, an assessment of the Company management, its past and present operations and financial performance, the prospects for future earnings of the Company, the present state of the Company's development, the general condition of the securities markets at the time of the Offering, the market prices of and demand for publicly traded common stocks of comparable companies in recent periods and other factors deemed relevant. The Representatives have advised the Company that, pursuant to Regulation M under the Securities Act, certain persons participating in the Offering may engage in transactions, including stabilizing bids, syndicate covering transactions or the imposition of penalty bids, which may have the effect of stabilizing or maintaining the market price of the Common Stock at the level above that which might otherwise prevail in the open market. A "stabilizing bid" is a bid for or the purchase of the Common Stock on behalf of the Underwriters for the purpose of fixing or maintaining the price of the Common Stock. A "syndicate covering transaction" is the bid for or the purchase of the Common Stock on behalf of the Underwriters to reduce a short position incurred by the Underwriters in connection with the Offering. A "penalty bid" is an arrangement permitting the Representatives to reclaim the selling concession otherwise accruing to an Underwriter or syndicate member in connection with the Offering if the Common Stock originally sold by such Underwriter or syndicate member is purchased by the Representatives in a syndicate covering transaction and has therefore not been effectively placed by such Underwriter or syndicate member. The Representatives have advised the Company that such transactions may be effected on the Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. The Representatives have informed the Company that the Underwriters do not expect to make sales to accounts over which they exercise discretionary authority in excess of 5% of the number of shares of Common Stock offered hereby. LEGAL MATTERS The validity of the Common Stock to be offered hereby will be passed upon for the Company by Tobin & Tobin, a professional corporation, San Francisco, California. Certain legal matters in connection with the Offering will be passed upon for the Underwriters by O'Melveny & Myers LLP, San Francisco, California. EXPERTS The consolidated financial statements of Headlands Mortgage Company as of December 31, 1996 and 1995, and for each of the years in the three-year period ended December 31, 1996, have been included herein and in the registration statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. The report of KPMG Peat Marwick LLP dated March 21, 1997, except as to Note 21, which is as of December 10, 1997 refers to a change in the Company's method of accounting for originated mortgage servicing rights in 1995. 75 AVAILABLE INFORMATION The Company has filed with the Commission a Registration Statement on Form S-1 under the Securities Act, of which this Prospectus is a part, with respect to the Common Stock offered hereby. This Prospectus omits certain information contained in the Registration Statement, including exhibits thereto, and reference is made to the Registration Statement for further information with respect to the Company and the Common Stock offered hereby. Statements contained herein concerning the provisions of documents are necessarily summaries of such documents and when any such document is an exhibit to the Registration Statement, each such statement is qualified in its entirety by reference to the copy of such documents filed with the Commission. Copies of the Registration Statement, and exhibits thereto, may be acquired upon payment of the prescribed fees or examined without charge at the public reference facilities of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and may be accessed on the Commission's World Wide Web Site referred to below. Upon the closing of the Offering, the Company will be subject to the informational requirements of the Exchange Act and in accordance therewith will file reports and other information with the Commission. Reports and other information filed by the Company with the Commission pursuant to the information requirements of the Exchange Act may be inspected and copied at the public reference facilities maintained by the Commission at Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and at the following Regional Offices of the Commission: Seven World Trade Center, 13th Floor, New York, New York 10048 and Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies can be obtained at prescribed rates from the public reference facilities of the Commission at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. The Commission also maintains a World Wide Web Site that contains reports, proxy statements and other information regarding registrants, such as the Company, that file electronically with the Commission. The address of the site is http://www.sec.gov. 76 INDEX OF DEFINED TERMS
PAGE ------ Agencies................................................................. 4 Awards................................................................... 63 Change of Control........................................................ 62 CKH...................................................................... 69 Code..................................................................... 8 Common Stock............................................................. 1 Company.................................................................. 3, F-7 DERs..................................................................... 63, 64 DMH...................................................................... 69 DMH Jr................................................................... 69 EAH...................................................................... 69 ECOA..................................................................... 18 ESPP..................................................................... 64 Existing Shareholders.................................................... 8 FASB..................................................................... 37 FCMC..................................................................... 27, 68 FCMC-Headlands Agreement................................................. 69 FNBC..................................................................... 68 Hart Family Group........................................................ 66 Headlands................................................................ 3 HELOC.................................................................... 4 HIA...................................................................... 69 HMDA..................................................................... 18 HMSI..................................................................... 50 HUD...................................................................... 18 Interest-only Residual................................................... 7, 50 ISO...................................................................... 63 JMP...................................................................... 69 Jumbos................................................................... 4 KEH...................................................................... 69 locked pipeline loan..................................................... 12 MBA...................................................................... 8 MCC...................................................................... 69 Mortgage Sources......................................................... 4, 41 MSA...................................................................... 69 non-agency mortgage loans................................................ 12 NQSO..................................................................... 63 Offering................................................................. 1 Paul Family Group........................................................ 66 Principal Amount......................................................... 7, 50 PTP...................................................................... 69 QAD...................................................................... 49 Representatives.......................................................... 74 RESPA.................................................................... 18 Selling Shareholders..................................................... 1 Servicing Transfer Agreement............................................. 68 Settlement Agreement..................................................... 30 Settlement Agreements.................................................... 69
77
PAGE ---------- SFAS................................................................. 37 Shareholders Distribution Amount..................................... 8, 21 Stock Option Plan.................................................... 63 Tax Agreement........................................................ 19, 21 TILA................................................................. 17 Warehouse Facility................................................... 35, 56, 68
78 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- HEADLANDS MORTGAGE COMPANY Independent Auditors' Report............................................ F-2 Consolidated Balance Sheets as of December 31, 1996 and 1995 and Septem- ber 30, 1997 (unaudited)............................................... F-3 Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995 and 1994 and for the nine months ended September 30, 1997 and 1996............................................................... F-4 Consolidated Statements of Stockholders' Equity for the Years Ended De- cember 31, 1996, 1995 and 1994 and for the nine months ended September 30,1997................................................................ F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994 and for the nine months ended September 30, 1997 and 1996............................................................... F-6 Notes to Consolidated Financial Statements.............................. F-7
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors Headlands Mortgage Company: We have audited the accompanying consolidated balance sheets of Headlands Mortgage Company and subsidiary (the Company) as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statements presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects the financial position of Headlands Mortgage Company and subsidiary as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for originated mortgage servicing rights in 1995. KPMG Peat Marwick LLP San Francisco, California March 21, 1997, except as to Note 21, which is as of December 10, 1997 F-2 HEADLANDS MORTGAGE COMPANY CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ------------------------- SEPTEMBER 30, 1997 1996 1995 ------------------ ------------ ------------ (UNAUDITED) ASSETS Cash and cash equivalents......... $ 3,137,927 $ 2,701,332 $ 28,882,313 Retained interests in securitizations.................. 32,670,313 15,128,487 585,157 Accounts receivable............... 16,611,340 7,558,494 1,882,859 Accounts receivable from related parties.......................... 65,246 119,513 3,541,273 Note receivable from related par- ties............................. -- -- 1,365,389 Mortgage loans held for sale, pledged.......................... 262,295,839 238,171,841 97,088,392 Originated mortgage servicing rights, net...................... 25,208,735 20,275,593 7,083,271 Property, equipment and leasehold improvements, net................ 7,048,332 3,016,423 3,827,854 Mortgage loans held for invest- ment, net........................ 826,607 692,816 1,075,278 Real estate owned, net............ 462,330 880,462 1,705,449 Other assets...................... 1,671,660 445,510 394,953 ------------ ------------ ------------ TOTAL ASSETS.................. $349,998,329 $288,990,471 $147,432,188 ============ ============ ============ LIABILITIES AND STOCKHOLDERS' EQ- UITY Notes payable..................... $254,711,846 $241,343,055 $ 91,233,524 Bank line of credit .............. -- -- 25,000,000 Notes payable to stockholders..... 9,670,000 9,670,000 -- Accounts payable.................. 11,655,126 4,390,082 2,150,048 Accrued liabilities............... 7,880,786 4,443,093 3,174,495 ------------ ------------ ------------ Total liabilities............. 283,917,758 259,846,230 121,558,067 ------------ ------------ ------------ Commitments and contingencies Stockholders' equity: Common Stock (no par value; 14,700,000 shares authorized, 14,000,000 shares issued and outstanding)................... 1,000 1,000 1,000 Retained earnings............... 66,079,571 29,143,241 25,873,121 ------------ ------------ ------------ Total stockholders' equity.... 66,080,571 29,144,241 25,874,121 ------------ ------------ ------------ TOTAL LIABILITIES AND STOCK- HOLDERS' EQUITY.............. $349,998,329 $288,990,471 $147,432,188 ============ ============ ============
See notes to Consolidated Financial Statements. F-3 HEADLANDS MORTGAGE COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31, ----------------------- ----------------------------------- 1997 1996 1996 1995 1994 ----------- ----------- ----------- ----------- ----------- (UNAUDITED) INCOME: Net gain from sales of mortgage loans....... $45,009,683 $10,816,018 $25,598,792 $12,307,023 $ 6,130,900 Loan administration income............... 7,195,976 8,280,570 11,119,880 13,426,817 14,736,528 Gain from sale of mortgage servicing rights............... 9,374,526 11,040,823 11,083,549 8,836,293 7,449,425 Production income..... 6,223,237 4,442,060 5,830,170 3,831,938 6,043,680 Interest income, net of interest expense.. 8,826,202 3,496,519 5,624,446 1,813,858 2,709,314 Net unrealized gain in valuation of retained interests in securitizations...... 667,979 -- -- -- -- ----------- ----------- ----------- ----------- ----------- Total income ....... 77,297,603 38,075,990 59,256,837 40,215,929 37,069,847 EXPENSES: Personnel............. 20,799,293 14,669,504 20,545,181 15,514,731 19,609,940 General and adminis- trative.............. 10,978,295 8,659,357 13,458,281 10,899,708 10,584,162 Occupancy and rents... 1,658,899 1,435,839 1,940,920 2,136,050 2,591,042 Depreciation and amortization of property, equipment and leasehold improvements......... 1,983,178 2,245,399 2,919,314 3,483,647 2,964,493 Amortization and im- pairment of origi- nated mortgage ser- vicing rights........ 3,599,393 634,973 2,093,037 958,372 -- ----------- ----------- ----------- ----------- ----------- Total expenses...... 39,019,058 27,645,072 40,956,733 32,992,508 35,749,637 ----------- ----------- ----------- ----------- ----------- Income before income taxes.............. 38,278,545 10,430,918 18,300,104 7,223,421 1,320,210 Income taxes........ 1,342,215 414,539 640,504 252,820 50,215 ----------- ----------- ----------- ----------- ----------- Net Income.......... 36,936,330 10,016,379 17,659,600 6,970,601 1,269,995 =========== =========== =========== =========== =========== PRO FORMA INFORMATION (UNAUDITED): Income before pro forma data........... 38,278,545 10,430,918 18,300,104 7,223,421 1,320,210 Provision for pro forma income taxes (unaudited).......... 16,076,989 4,380,986 7,686,044 3,033,837 541,286 ----------- ----------- ----------- ----------- ----------- Pro forma net income (unaudited)........ $22,201,556 $ 6,049,932 $10,614,060 $ 4,189,584 $ 778,924 =========== =========== =========== =========== =========== Pro forma earnings per share of common stock (unaudited).. $ 1.42 $ 0.68
See notes to Consolidated Financial Statements. F-4 HEADLANDS MORTGAGE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON RETAINED STOCKHOLDERS' STOCK EARNINGS EQUITY ------- ------------- ------------- Balances at December 31, 1993........ $1,000 $ 26,900,485 $ 26,901,485 Net income........................... 0 1,269,995 1,269,995 Distribution to stockholders......... 0 (9,267,960) (9,267,960) ------- ------------- ------------- Balances at December 31, 1994........ 1,000 18,902,520 18,903,520 Net income........................... -- 6,970,601 6,970,601 ------- ------------- ------------- Balances at December 31, 1995........ 1,000 25,873,121 25,874,121 Net income........................... -- 17,659,600 17,659,600 Distribution to stockholders......... -- (14,389,480) (14,389,480) ------- ------------- ------------- Balances at December 31, 1996........ 1,000 29,143,241 29,144,241 Net income (unaudited)............... -- 36,936,330 36,936,330 ------- ------------- ------------- BALANCES AT SEPTEMBER 30, 1997 (UNAU- DITED).............................. $1,000 $ 66,079,571 $ 66,080,571 ======= ============= =============
See notes to Consolidated Financial Statements. F-5 HEADLANDS MORTGAGE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED FOR THE YEAR ENDED SEPTEMBER 30, DECEMBER 31, -------------------------------- ------------------------------------------------- 1997 1996 1996 1995 1994 --------------- --------------- --------------- --------------- --------------- (UNAUDITED) Cash flows from operat- ing activities: Net income............. $ 36,936,330 $ 10,016,379 $ 17,659,600 $ 6,970,601 $ 1,269,995 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization of property, equipment and leasehold improvements......... 1,983,178 2,245,399 2,919,314 3,483,647 2,964,493 Amortization and impairment of originated mortgage servicing rights..... 3,599,393 634,973 2,093,037 958,372 -- Gain from sale of mortgage servicing rights............... (9,374,526) (11,040,823) (11,083,549) (8,836,293) -- Net gain from sales of mortgage loans.... (45,009,683) (10,816,018) (24,550,108) (12,307,023) (6,130,900) Net (purchase of) proceeds from retained interests in securitizations... (17,541,826) (4,677,434) (14,543,330) 183,181 (768,338) (Increase) decrease in accounts receiv- able................. (9,052,846) (1,795,929) (5,675,635) 5,406,134 3,253,642 Decrease (increase) in accounts receiv- able from related parties.............. 54,267 3,333,722 3,421,760 (768,143) (2,773,130) Mortgage loans origi- nated................ (2,527,159,851) (1,643,848,993) (2,283,839,831) (1,355,603,902) (2,410,399,875) Proceeds from sale of mortgage loans....... 2,378,526,392 1,510,862,432 2,146,944,916 1,342,791,085 2,659,127,895 Principal payments received on mortgage loans held for sale................. 170,154,019 23,256,408 21,595,009 3,362,146 517,414 Decrease (increase) in deferred costs, net of fees.......... (634,875) (924,324) (1,233,435) (707,571) 3,798,822 Origination of mortgage servicing rights retained...... (18,372,237) (10,971,020) (16,251,858) (8,041,643) -- Proceeds from sale of mortgage servicing rights............... 19,214,228 12,007,323 12,050,048 8,836,293 -- (Increase) decrease in other assets...... (1,226,150) (416,506) (50,557) 539,825 (530,015) Increase (decrease) in accounts pay- able................. 7,265,044 966,687 2,240,034 728,685 (18,104) Decrease in accounts payable to related parties.............. -- -- -- -- (7,220,187) Increase (decrease) in accrued liabili- ties................. 3,437,693 (823,183) 1,268,598 1,047,544 (3,237,888) --------------- --------------- --------------- --------------- --------------- Net cash (used in) provided by operating activities......... (7,201,450) (121,990,907) (147,035,987) (11,957,062) 239,853,784 Net cash provided by (used in) investing ac- tivities: Decrease (increase) in note receivable from stockholder........... -- 1,365,389 1,365,389 (68,482) (837,751) Purchase of property, equipment and leasehold improvements.......... (6,015,087) (1,733,255) (2,107,883) (899,306) (5,137,542) Net proceeds from sale of mortgage loans held for investment... (133,791) 329,091 382,462 710,294 (782,195) Net proceeds from real estate investment..... -- -- -- -- 538,564 Net proceeds from sale (purchase of) real estate owned.......... 418,132 404,207 824,987 (794,560) (879,934) --------------- --------------- --------------- --------------- --------------- Net cash provided by (used in) investing activities......... (5,730,746) 365,432 464,955 (1,052,054) (7,098,858) Net cash provided by fi- nancing activities: Borrowing on the ware- house line............ 3,211,114,962 1,618,479,095 2,350,158,333 1,328,821,487 3,417,854,983 Payments on the ware- house line............ (3,198,848,503) (1,495,297,625) (2,202,308,567) (1,313,866,251) (3,649,142,795) Net proceeds from notes payable......... 1,102,332 -- 2,259,765 -- -- (Repayment of) pro- ceeds from line of credit with bank...... -- (19,400,000) (25,000,000) 25,000,000 -- Repayment of proceeds from note payable to stockholders.......... -- 9,670,000 9,670,000 -- (706,340) Distributions to stockholders.......... -- (14,389,480) (14,389,480) -- (9,267,960) --------------- --------------- --------------- --------------- --------------- Net cash provided by (used in) financing activities......... 13,368,791 99,061,990 120,390,051 39,955,236 (241,262,112) --------------- --------------- --------------- --------------- --------------- Net (decrease) increase in cash................ 436,595 (22,563,485) (26,180,981) 26,946,120 (8,507,186) Cash and cash equiva- lents beginning of year................... 2,701,332 28,882,313 28,882,313 1,936,193 10,443,379 --------------- --------------- --------------- --------------- --------------- Cash and cash equiva- lents end of year...... $ 3,137,927 $ 6,318,828 $ 2,701,332 $ 28,882,313 $ 1,936,193 =============== =============== =============== =============== =============== Supplemental disclosures of cash flow information: Cash paid for inter- est................... $ 21,754,430 $ 6,903,921 $ 11,946,721 $ 4,513,602 $ 9,400,000 Cash paid for income taxes................. 576,135 26,125 54,552 800 402,344
See notes to Consolidated Financial Statements. F-6 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED) 1. ORGANIZATION Headlands Mortgage Company (the "Company") is a closely-held S-corporation which was organized in 1981. The Company is a full service mortgage banking business, which consists of the origination, acquisition, sale and servicing of residential mortgage loans secured by one-to-four unit family residences, and the purchase and sale of mortgage servicing rights. The Company is headquartered in Northern California, and has production branches in California, Washington, Oregon, Nevada, Florida, New Jersey, Idaho, and Arizona. Loans are originated primarily on a wholesale basis, through a network of independent mortgage loan brokers approved by the Company. Other loan origination sources include correspondent and retail lending. The market for the Company's mortgage banking operations is predominantly California and the western United States. The consolidated financial statements include Headlands Mortgage Company ("HMC"), and its subsidiary Headlands Mortgage L.L.C. ("HMLLC") for the year ended December 31, 1996, and additionally HMLLC's successor Headlands Mortgage Securities Inc. ("HMSI") for the nine months ended September 30, 1997. The activity of the subsidiaries is related to the Company's securitizations. All material intercompany balances and transactions have been eliminated. In 1996, the Company diversified its residential mortgage loan sales activities to include the securitization of such loans into Real Estate Mortgage Investment Conduits ("REMICs") and Asset-Backed Securities ("ABS"). The REMICs, which consist of pooled fixed-rate first-lien mortgages, were issued by the Company to the public through the registration statement of the related underwriter during 1996, and through the registration statement of HMSI during the nine months ended September 30, 1997. The ABS, which consists of revolving home equity loans and closed-end second mortgages, was issued by the Company through HMLLC and the registration statement of the related underwriter. The Company operates a loan servicing center which it opened in January 1994. The Company's source of servicing is from mortgage loans it has originated and sold. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Cash and Cash Equivalents The Company considers all highly liquid investments with an original maturity of one month or less to be cash equivalents, including restricted cash and cash equivalents in the amount of $1,621,985 at December 31, 1996. (b) Mortgage Loans Held for Sale Mortgage loans held for sale consist of residential mortgage loans and home equity lines of credit. Residential mortgage loans have contractual maturities of up to 30 years, and home equity lines of credit have contractual maturities of up to 25 years. The real property of the borrower is pledged as collateral under either loan type. Mortgage loans held for sale are stated at the lower of cost or aggregate market value. The cost of a mortgage loan held for sale is the outstanding principal balance of the mortgage loan decreased by fees or discounts collected and increased by fees and certain direct costs. Fees and costs incurred net of discounts collected are deferred and recognized as adjustments to gain or loss when the related loans are sold. F-7 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company sells mortgage-backed and asset-backed securities through forward delivery contracts. Such forward delivery contracts that have not been completed at the end of an accounting period are used to determine the market value of unsold loans. The Company also enters into commitments with private and institutional investors. The market value of loans relating to such commitments are determined by the outstanding commitments from investors or current investor yield requirements. The fees paid for commitments are recognized over the term of the commitment or as the commitment is filled. Gains or losses realized from mortgage loan sales are recognized at time of settlement with investors based upon the difference between the proceeds from sale and the carrying value of the mortgage loans sold, net of commitment fees paid. Such sales ordinarily provide for a pass-through yield to the investor and a yield retained by the Company for servicing. For mortgage loan sales other than pursuant to securitizations, the yield retained for servicing has not exceeded in material respect contractually specified servicing fees or adequate servicing compensation and hence no excess servicing value has been recognized. If the mortgage loans are sold with the servicing rights released to the purchaser, the Company reflects the difference between the value paid by the investor for the servicing rights and the carrying value of such servicing rights in net gain from sales of mortgage loans. If the mortgage loans are sold with the servicing rights retained by the Company, the Company determines the relative fair value of the servicing rights and includes such amount in the calculation of net gain from sales of mortgage loans. (c) Originated Mortgage Servicing Rights On May 12, 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights, an amendment to Statement No. 65" ("SFAS 122"). This statement provides guidance for the recognition of mortgage servicing rights as an asset when a mortgage loan is sold and servicing rights are retained. SFAS 122 requires that a portion of the cost of originating a mortgage loan be allocated to the mortgage servicing rights based on its relative fair value. The Company elected to adopt this standard effective January 1, 1995. Originated mortgage servicing rights are stated at the lower of amortized relative fair value or market value as determined by quoted market prices for similar assets. The Company stratifies originated mortgage servicing rights based on the loan type and note rate of the underlying loans. It is the policy of the Company to amortize originated mortgage servicing rights in proportion to and over the period of estimated net servicing income. To achieve this, the Company computes amortization on a loan by loan basis using a cash flow model. This method allocates the amortization expense over the servicing life of each loan in the servicing portfolio in proportion to the corresponding net servicing income. Valuation adjustments are charged to impairment expense on an aggregate stratum basis. The Company recognizes gain or loss from the sale of mortgage servicing rights when the purchase/sales contract has been executed and the risks and rewards of ownership are determined to have passed to the purchaser. The gain recognized reflects the difference between the carrying value of the servicing rights sold and the proceeds from sale, net of selling expenses. (d) Retained Interests in Securitizations Retained interests in securitizations consist of subordinate certificates in REMICs and ABS which were issued by the Company. All of the Company's securities are classified as trading and stated at market value in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company pools mortgage loans that it has originated or purchased and issues securities. The Company generally sells the more senior classes of the securities for cash and retains one or more of the subordinated classes. F-8 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The subordinate classes of the REMIC securities consist of classes with less than an AAA rating due to reduced credit enhancement. Theses classes generally have a stated principal amount and earn a fixed interest rate. Management believes that it has made reasonable estimates of the market value of the subordinated interests of market securities on its balance sheet, based on market prices for similar securities. In an asset-backed securitization, the Company retains as an investment a subordinate principal interest and the interest-only residual interest created as a result of such securitization. A significant portion of the Company's total income is recognized as net gain on sale of mortgage loans, which partially represents the present value of the interest-only residual interests and mortgage servicing rights. The Company recognizes such net gain on sale of mortgage loans in the period in which such loans are sold, although cash is received by the Company over the life of the loans. Management believes that it has made reasonable estimates of the present value of the interest-only residual interests of the home equity loan securities on its balance sheet. The Company projects the expected cash flows over the life of the retained interests, using prepayment and default assumptions that market participants would use for similar financial instruments that are subject to prepayment, credit and interest rate risks. The Company then determines the present value of these cash flows using an interest rate which it believes is commensurate with the risks involved. (e) Mortgage Loans held for Investment Mortgage loans held for investment are stated at the lower of aggregate cost or fair value. (f) Real Estate Owned Real estate owned includes property acquired through foreclosure or deed taken in lieu of foreclosure. The properties are predominantly located in California, and are carried at the lower of cost or fair value less estimated selling expenses. (g) Property, Equipment and Leasehold Improvements Property, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation on property and equipment is calculated using the straight-line method over the estimated useful lives of the assets, generally 3 to 5 years. Amortization of leasehold improvements is calculated using the straight-line method over the shorter of the lease term or estimated useful life of the asset. (h) Fannie Mae Stock The Company is the owner of record of Federal National Mortgage Association ("Fannie Mae") shares in excess of the minimum requirement. The Fannie Mae shares are held in accordance with the FNMA servicing agreement, and are included in other assets in the accompanying financial statements. F-9 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (i) Financial Statement Presentation The Company prepares its financial statements using an unclassified balance sheet presentation as is customary in the mortgage banking industry. A classified balance sheet presentation would have aggregated current assets, current liabilities and net working capital as follows:
DECEMBER 31, ---------------------------- 1996 1995 ------------- ------------- Current assets............................. $ 263,560,678 $ 135,311,967 Current liabilities........................ (249,395,038) (121,310,153) ------------- ------------- Net working capital........................ $ 14,165,640 $ 14,001,814 ============= =============
(j) Loan Administration Income Loan administration income represents fees earned as master servicer for residential mortgage loans owned by investors. The fees are calculated based on a contractual percentage of the outstanding principal balances of the loans serviced, and recognized when collected. Loan Administration income also includes ancillary fees collected in conjunction with the servicing operation. (k) Production Income Production income consists of fees paid to the Company by borrowers for the preparation, documentation and underwriting of loans. These fees and related lending transaction costs are deferred until the related loan is sold. Upon sale of the loan, the deferred fees are recognized as production income and deferred costs are recognized in the applicable expense classification. (l) Income Taxes The Company has elected for both Federal and State income tax purposes to be treated as an S corporation. Consequently, the net earnings of the Company are taxed directly to the stockholders, rather than the Company. Income taxes are based on an asset and liability approach for financial accounting and reporting for income taxes. Deferred income taxes arise from temporary differences in reporting income and expense for tax and financial reporting purposes. The primary temporary differences relating to Company operations stem from the recognition of additional net gain on sales of mortgage loans required under SFAS No. 122, and the tax treatment of the Company's loan securitizations. (n) Unaudited Interim Financial Data The interim financial data as of September 30, 1997 and for the nine months ended September 30, 1997 and 1996 are unaudited. However, in the opinion of the Company's management, the interim data includes all adjustments, consisting of only normal recurring accruals, necessary for a fair statement of the results for the interim periods. The results for the nine months ended September 30, 1997 are not necessarily indicative of the results to be expected for the full year or for any other interim period. (o) Reclassifications Certain reclassifications were made to the prior balances to conform with the current presentation. F-10 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (p) Use of Management 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 on the balance sheets at September 30, 1997 and 1996, and at December 31, 1996 and 1995 and the statements of operations for the periods then ended. Actual results could differ significantly from those estimates. (q) Adoption of New Accounting Pronouncement On January 1, 1997, the Company adopted Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 125 ("SFAS 125"), "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." This Statement provides guidelines for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS 125 supersedes SFAS 76, 77 and 122, while amending both SFAS 65 and 115. The Statement is to be applied prospectively, however, portions of SFAS No. 125 were deferred under SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125" until January 1, 1998. Earlier implementation is not permitted. Under SFAS 125, a transfer of financial assets in which control is surrendered is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in the exchange. Liabilities and derivatives incurred or obtained by the transfer of financial assets are required to be measured at fair value, if practicable. Also, servicing assets and other retained interests in the transferred assets must be measured by allocating the previous carrying value between the asset sold and the interest retained, if any, based on their relative fair values at the date of transfer. For each servicing contract in existence before January 1, 1997, previously recognized servicing rights that do not exceed contractually specified servicing are required to be combined, net of any previously recognized servicing obligations under that contract, as a servicing asset or liability. SFAS 125 also requires an assessment of interest-only strips, loans, other receivables and retained interests in securitizations. If these assets can be contractually prepaid or otherwise settled such that the holder would not recover substantially all of its recorded investment, the asset will be measured like trading securities. This assessment is required for financial assets held on or acquired after January 1, 1997. 3. NOTE RECEIVABLE FROM STOCKHOLDER Note receivable from stockholder at December 31, 1995 and 1994 consisted of the principal balance including accrued interest outstanding due from a stockholder. This note earned interest at the Bank of America reference rate, which was 8.65% and 8.5% at December 31, 1995 and 1994, respectively. The note was due December 31, 1994, and fully repaid during 1996. 4. MORTGAGE LOANS HELD FOR SALE Mortgage loans held for sale included net deferred fees and costs, and consisted of the following at December 31:
1996 1995 ------------ ----------- Mortgage loans.................................. $217,297,135 $96,187,050 Home equity lines of credit..................... 18,739,929 -- Deferred costs, net of fees..................... 2,134,777 901,342 ------------ ----------- $238,171,841 $97,088,392 ============ ===========
F-11 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 5. ORIGINATED MORTGAGE SERVICING RIGHTS Originated mortgage servicing rights (OMSR) consist of the following:
ACCUMULATED IMPAIRMENT NET OMSR AMORTIZATION ALLOWANCE OMSR ----------- ------------ ----------- ----------- Balance at December 31, 1994..................... $ -- $ -- $ -- $ -- Current year additions.... 8,041,643 (32,985) (925,387) 7,083,271 Write-downs due to prepay- ments.................... (706,316) -- 706,316 -- ----------- --------- ----------- ----------- Balance at December 31, 1995..................... 7,335,327 (32,985) (219,071) 7,083,271 Current year additions.... 16,251,858 (225,794) (1,867,243) 14,158,821 Servicing sold............ (1,021,175) 12,638 42,038 (966,499) Write-downs due to prepay- ments.................... (286,354) -- 286,354 -- ----------- --------- ----------- ----------- Balance at December 31, 1996..................... $22,279,656 $(246,141) $(1,757,922) $20,275,593 =========== ========= =========== ===========
The capitalized mortgage servicing rights were reported at fair value at December 31, 1996 and 1995, which was lower than amortized relative fair value at the time of loan sale. The fair value was estimated based on prepayment speeds consistent with those published by various Wall Street securities dealers for securities with similar characteristics to those in the Company's portfolio, delinquency rates consistent with other California concentrated portfolios, and estimated escrow, principal, interest and payoff float. The unpaid principal balance of mortgage loans for which the Company has capitalized mortgage servicing rights was approximately $2,017 million and $730 million at December 31, 1996 and 1995, respectively. The Company held off balance sheet originated mortgage servicing rights with an estimated fair value of approximately $22.9 million and $34.2 million at December 31, 1996 and 1995, respectively. These estimated fair values may not represent actual amounts that would be realized upon any sale or liquidation of the asset. 6. RETAINED INTERESTS IN SECURITIZATIONS Retained interests in securitizations consist of assets generated by the Company's loan securitizations. These assets were as follows at December 31:
1996 1995 ----------- -------- REMIC subordinate certificates...................... $ 3,953,659 $585,157 Interest-only residual interest..................... 7,689,529 -- ABS transferor interest............................. 2,563,177 -- ABS overcollateralization........................... 922,122 -- ----------- -------- $15,128,487 $585,157 =========== ========
The Company classifies REMIC and ABS securities as trading securities in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and carries them as current assets at market value. The Company is contractually bound by the Headlands Home Equity Loan (HHEL) ABS Trust to retain it's transferor interest and overcollateralization. While the Company can sell these certificates, it would be considered a "Rapid Amortization Event" under the terms of the trust, and would trigger rapid amortization of the trust senior certificates. The interest-only residual interest is recorded as a result of the Company's securitization of home equity lines of credit through the HHEL trust. The Company is subject to certain recourse provisions in connection with F-12 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) its securitization and presents its obligation under these provisions as a reduction in the carrying value of the asset. The Company estimates future cash flows from this interest-only residual interest and values them utilizing assumptions that it believes are consistent with those that would be utilized by an unaffiliated third party purchaser. The interest-only residual interest is recorded as a trading security at fair value. To the Company's knowledge, there is no active market for the sale of this interest-only residual interest. The fair value of the interest-only residual interest is determined by computing the present value of the excess of the weighted average coupon on the loans sold over the sum of: (1) the coupon on the senior interests, (2) the contracted servicing fee, (3) expected losses to be incurred on the portfolio of loans sold over the lives of the loans, (4) overcollateralization and (5) fees payable to the trustee and the monoline insurer. Prepayment assumptions used in the present value computation are based on market prepayment rates for similar loans. The cash flows expected to be received by the Company are discounted at an interest rate that the Company believes an unaffiliated third-party purchaser would require as a rate of return on such a financial instrument. To the extent that actual future excess cash flows are different from estimated excess cash flows, the fair value of the Company's interest-only residual certificate will be adjusted quarterly with corresponding adjustments made to earnings in that period. The Company provided an initial overcollateralization on the security sold and builds overcollateralization from the excess cash flows. The overcollateralization reduces the certificate balance of the securities sold by the amount required by the monoline insurer. The current amount of such overcollateralization built through cash flows is recorded by the Company as part of securities. The initial overcollateralization paid by the Company is included in restricted cash and cash equivalents. 7. MORTGAGE LOANS HELD FOR INVESTMENT During the normal course of business, the Company is required from time to time to repurchase certain loans from investors. Mortgage loans held for investment consisted of residential real estate mortgage loans at December 31, 1996 and 1995. All properties are located in the state of California. Interest rates on these mortgage loans are at variable and fixed rates which range from 6.94% to 8.875% at December 31, 1996, and from 7.25% to 10.25% at December 31, 1995. The maturities range from 1 year to 26 years at December 31, 1996, and from 1 to 28 years at December 31, 1995. 8. REAL ESTATE OWNED Real estate owned, net, consists of the following at:
DECEMBER 31, ---------------------- 1996 1995 ---------- ---------- Residential real estate at cost................... $ 932,717 $2,250,600 Less valuation allowance: Balance at beginning of year.................... (545,151) (211,000) Additions to allowance.......................... (645,279) (723,501) Deductions related to real estate sold.......... 1,138,175 389,350 ---------- ---------- Real estate owned, net............................ $ 880,462 $1,705,449 ========== ==========
F-13 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 9. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Property, equipment and leasehold improvements, net, consist of the following at :
DECEMBER 31, ------------------------ 1996 1995 ------------ ---------- Furniture and fixtures.......................... $ 1,253,607 $1,247,556 Office equipment................................ 11,713,822 10,039,045 Leasehold improvements.......................... 728,474 666,725 Automobiles..................................... 47,911 47,911 ------------ ---------- 13,743,814 12,001,237 Less accumulated depreciation and amortization................................... (10,727,391) (8,173,383) ------------ ---------- $ 3,016,423 $3,827,854 ============ ==========
10. NOTES PAYABLE Notes payable consist of the following at:
DECEMBER 31, ------------------------ 1996 1995 ------------ ----------- Warehouse line of credit with banks, expiring on November 4, 1998, $185 million at December 31, 1996 and $110 million at December 31, 1995, and bearing variable rates, including a rate adjusted for compensating balances............................... $166,457,268 $91,233,524 Warehouse line of credit with an investment banker expiring September 29, 1997, $250 million at December 31, 1996, bearing variable interest rates based on the LIBOR.................................. 57,973,407 -- Warehouse line of credit with a major corporation, expiring October 31, 1997, $5 million at December 31, 1996 and 1995, and bearing variable interest rates based on the LIBOR............................ 2,652,615 -- Servicing secured working capital line of credit, ex- piring on November 4, 1997, $12 million at December 31, 1996 and 1995, and bearing a variable interest rate based on the open Federal Funds rate or the LI- BOR including a rate adjusted for compensating bal- ances............................................... 12,000,000 -- Master repurchase line of credit with an investment banker, bearing a variable interest rate based on the LIBOR........................................... 2,259,765 -- ------------ ----------- $241,343,055 $91,233,524 ============ ===========
The warehouse lines of credit are collateralized by mortgage loans held for sale, the master repurchase lines of credit are collateralized by marketable securities, and the servicing secured line of credit is collateralized by a portion of the Company's servicing portfolio. The weighted average cost of funds for the years ended December 31, 1996 and 1995 was 5.17 and 5.19 percent, respectively. Compensating balances averaged $24.6 million and $28.9 million for the years ended December 31, 1996 and 1995, respectively, and were comprised of corporate and custodial accounts. Warehouse interest expense of $12.8 million and $3.6 million for the years ended December 31, 1996 and 1995, respectively, has been netted with interest income in the statement of operations. The Company must comply with certain covenants provided in its loan agreements, including requirements relating to net worth, working capital, outstanding indebtedness, and the loan servicing portfolio. At December 31, 1996 and 1995, the Company was in compliance with the aforementioned loan covenants. F-14 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 11. BANK LINE OF CREDIT The Company entered into a line of credit agreement with a bank during 1995. The agreement provided the Company with borrowings for the sole purpose of investing in cash equivalents. These borrowings were at a nominal interest rate and were supported by compensating balances. The balance outstanding at December 31, 1995 was $25,000,000. The line of credit was paid in full during 1996, and the agreement was dissolved. 12. NOTE PAYABLE TO STOCKHOLDERS The Company issued a note during 1996 to two of its stockholders in the amount of $9,670,000. The note bears interest at a variable rate based on the LIBOR, and matures on June 29, 2000. Principal and accrued interest are payable annually. Any rights of the stockholders under the note agreement are subordinate to the Company's warehouse lenders. 13. RELATED PARTY TRANSACTIONS The Company had a receivable from a related party of approximately $3.4 million at December 31, 1995. The sole owner of the related party is a stockholder of the Company. The Company and the related party reached a settlement agreement during 1996 to facilitate the receipt of the outstanding receivable. The Company has loans receivable from employees (included in accounts receivable) of $19,000 and $39,000 at December 31, 1996 and 1995, respectively. The Company also has accounts receivable from Headlands Insurance Agency, a related party, of approximately $56,000 and $45,000 at December 31, 1996 and 1995, respectively. The Company has accounts receivable from Marin Conveyance Corporation, another related party, at December 31, 1996 and 1995 of $58,000 and $69,000, respectively. The Company provided administrative services to these related parties, and received fees (included in production income) of $240,000 and $180,000 during 1996 and 1995, respectively. 14. LOAN ADMINISTRATION The Company's portfolio of residential mortgage loans serviced aggregated approximately $4.4 billion and $4.1 billion at December 31, 1996 and 1995, respectively. Of the Company's portfolio at December 31, 1996, 81% of the loans serviced were located in California with 19% in other states. At December 31, 1995, 96% of the loans serviced were located in California with 4% in other states. The delinquency ratio of the portfolio was 1.52% and 1.44% as of December 31, 1996 and 1995, respectively. Principal balances serviced were as follows at:
DECEMBER 31, ----------------------------- 1996 1995 -------------- -------------- Fannie Mae....................................... $1,367,000,000 $1,239,000,000 Freddie Mac...................................... 674,000,000 682,000,000 HMC securities................................... 489,000,000 224,000,000 Home equity lines of credit...................... 148,000,000 -- Other investors.................................. 1,709,000,000 2,004,000,000 -------------- -------------- $4,387,000,000 $4,149,000,000 ============== ==============
The Company is required to advance corporate funds for principal, interest, escrow and foreclosure costs relating to loans for which it services. These advances (included in accounts receivable) were approximately $4.6 million and $1.3 million at December 31, 1996 and 1995, respectively. A portion of these advances is non-recoverable. The Company had reserved approximately $511,000 and $416,000 for unrecoverable advances and future foreclosure losses at December 31, 1996 and 1995, respectively. F-15 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Related trust funds on deposit in trustee bank accounts were approximately $7.7 million at December 31, 1996 and $7.1 million at December 31, 1995, and are not included in the accompanying balance sheets. Separate bank accounts are maintained and such funds are not commingled with those of the Company. The Company maintained errors and omissions and employee fidelity bond insurance policies in the amount of $5 million at December 31, 1996 and 1995. 15. FAIR VALUE OF FINANCIAL INSTRUMENTS Because no market exists for certain of the Company's assets and liabilities, fair value estimates are based on judgments regarding credit risk, investor expectations of future economic conditions, normal cost of administration and other risk characteristics, including interest rate and prepayment risk. These estimates are subjective in nature and involve uncertainties and matters of judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the fair value estimates presented do not include the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. The estimated fair values of the Company's balance sheet financial instruments at:
DECEMBER 31, ------------------------------------------------- 1996 1995 ----------------------- ------------------------- CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE ----------- ----------- ------------ ------------ Financial assets Cash and cash equivalents.. $ 2,701,332 $ 2,701,332 $ 28,882,313 $ 28,882,313 Retained interests in securitizations........... 15,128,487 15,128,487 585,157 585,157 Mortgage loans held for sale...................... 238,171,841 241,883,738 97,088,392 98,051,417 Mortgage loans held for in- vestment.................. 692,816 692,816 1,075,278 1,075,278 Financial liabilities: Notes payable.............. 241,343,055 241,343,055 91,233,524 91,233,524 Line of credit with bank... -- -- 25,000,000 25,000,000 Note payable to stockhold- ers....................... 9,670,000 9,670,000 -- --
These estimated fair values do not represent actual amounts that may be realized upon any sale or liquidation of the related assets or liabilities. In addition, these values do not give effect to discounts to fair value which may occur when financial instruments are sold in large quantities. The fair values presented above represent the Company's best estimate of fair value using the methodologies discussed below: (a) Cash and Cash Equivalents The carrying value is a reasonable estimate of fair value. (b) Retained Interests in Securitizations The fair value of subordinate interests is determined based on the market price obtained for similar securities. The fair value of interest-only residual interests is determined using estimated discounted future cash flows taking into consideration anticipated prepayment rates and loss experience. F-16 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (d) Mortgage Loans Held for Sale, Mortgage Loans Held for Investment, Loan Sale Commitments, and Locked Loan Origination Commitments Fair value of mortgage loans held for sale, mortgage loans held for investment, commitments to originate mortgage loans and commitments to sell mortgage loans are estimated using quoted market prices for mortgage-backed securities backed by similar loans or by prices obtained by the Company in forward delivery contracts. The fair value of commitments to originate mortgage loans includes a portion of the unrealized gain or loss calculated using quoted market prices based on a historical estimate of the percentage of such commitments that will actually result in mortgage loans originated. (e) Financial Liabilities The fair value of financial liabilities is believed to be equal to the carrying amount because the terms of the debt are similar to terms currently offered by lenders, and the interest rates are variable based on current market rates. (f) Off Balance Sheet Financial Instruments At December 31, 1996, the locked pipeline was $103.9 million with a related fair value of $106.2 million, and, net of related mandatory forward commitments, had unrecognized gains of approximately $1.8 million. At December 31, 1995, the locked pipeline was $84.0 million with a related fair value of $84.8 million, and, net of related mandatory forward commitments, had unrecognized gains of approximately $0.4 million. Mortgage servicing rights retained relating to loans sold prior to January 1, 1995 are not financial instruments and, accordingly, are not included in the above fair values. These servicing rights contribute substantial value to the Company and are not reflected in the accompanying financial statements. 16. PROFIT SHARING PLAN On December 31, 1993, the Company adopted a new profit sharing plan. The new plan has entry dates of July 1st and January 1st and any employee who has completed 6 months of employment on those dates is automatically a member of the plan. To participate in the current year's profit sharing, an employee must be a member of the plan, must have worked 1,000 hours during the fiscal year and must be employed as of the profit sharing plan year end. The plan provides vesting ratably over two to six years. Contributions are at the discretion of the Board of Directors. When made, contributions are credited to each member's account in proportion to their annual compensation and time of service. The Company did not contribute to the profit sharing plan during the two years ended December 31, 1996. 17. COMMITMENTS AND CONTINGENCIES (a) Leases The Company leases office space under various operating leases. Minimum rental commitments under these operating leases with an initial or remaining noncancelable lease term in excess of one year as of December 31, 1996 were as follows:
RELATED LEASE SUBLEASE NET LEASE COMMITMENT INCOME COMMITMENT ---------- --------- ---------- 1997..................................... $ 739,740 $(160,787) $578,953 1998..................................... 399,308 (149,187) 250,121 1999..................................... 140,499 (47,661) 92,838 ---------- --------- -------- $1,279,547 $(357,635) $921,912 ========== ========= ========
F-17 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Rent expense recorded by the Company for the years ended December 31, 1996 and 1995 was $1.9 million and $2.1 million, respectively. In addition to the office leases described above, the Company entered into operating leases for certain office equipment during 1996. The future minimum payments under these noncancelable lease terms as of December 31, 1996 were as follows: 1997............................................................. $ 69,741 1998............................................................. 69,741 1999............................................................. 58,118 -------- $197,600 ========
Expense recorded by the Company under these equipment leases for the year ended December 31, 1996 was approximately $12,000. (b) Loan Commitments The Company made commitments to deliver loans to various investors. The mandatory commitments outstanding were $276.2 million and $78.9 million at December 31, 1996 and 1995, respectively, with a related market cost of $.5 million at December 31, 1996 and 1995. The Company had prepaid commitment fees of approximately $58,000 and $-0- related to these commitments at December 31, 1996 and 1995, respectively. The Company uses mandatory sell forward delivery commitments to buy and sell whole loans, to issue private securities and to issue Fannie Mae and Freddie Mac securities. These commitments, which are used as a hedge against locked loan origination commitments whereby the Company has extended an interest rate lock to the borrower, were included in the lower of cost or market valuation of mortgage loans held for sale. The Company is subject to interest rate risk on open commitments. This risk results from differences between the market interest rate and the commitment interest rate. The Company is contractually committed to fund the undrawn portion of home equity lines of credit (HELOCs) which it has originated. This commitment extends to HELOCs which are currently held for sale by the Company, and HELOCs sold by the Company into the Headlands Home Equity Loan Trust. As of December 31, 1996, this unfunded commitment was approximately $38.2 million. Additionally, the Company is contractually committed to fund the undrawn portion of mortgage loans originated under it's land/home program. The terms of these loans allow borrowers to draw funds under their mortgage loans in installments. As of December 31, 1996, this unfunded commitment was approximately $1.1 million. (c) Contingencies The Company is a defendant to a number of claims arising in the ordinary course of business. Management is of the view that these matters will not have a material adverse effect on the Company's financial position, net income or liquidity. 18. STOCK OPTION PLAN The Company's 1997 Executive and non-employee Director Stock Option Plan (the Plan) provides for the grant of qualified incentive stock options (ISOs), stock options not so qualified (NQSOs), deferred stock, restricted stock, F-18 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) performance shares, stock appreciation rights, limited stock appreciation rights, and dividend equivalent rights (DERs). ISOs may be granted to the officers and key employees of the Company. NQSOs and awards may be granted to the directors, officers, key employees, agents and consultants of the Company or any subsidiaries. Unless previously terminated by the Board of Directors, the Plan will terminate on September 15, 2007. In September 1997, options to acquire 518,000 shares of common stock were granted to certain officers with an exercise price of $4.06 per share. The Company used an independent appraisal firm to value the options granted in 1997. The independent appraisal firm considered three valuation approaches in developing a value for the options, including (1) market comparison using comparable public companies, (2) underlying asset method using the Company's individual assets, and (3) discounted future returns analysis based on an expected value discount model. The Board of Directors determined the estimated fair value of the option shares at the time of grant by adjusting the independent appraisal upward to take into consideration the probability of a successful initial public offering. The options, along with the options granted to non-officer directors, vest over 4 years and have ten year terms. As of September 30, 1997, no options have been exercised or are eligible to be exercised. In accordance with the provisions of APB Opinion No. 25, the Company will recognize compensation expense over the vesting period for the difference between such exercise price and the estimated fair value of the underlying shares at time of grant, aggregating approximately $3.3 million. 19. PREFERRED STOCK The Company has authorized 5,000,000 shares of Preferred Stock. As of September 30, 1997, none of the authorized shares have been issued. 20. UNAUDITED PRO FORMA INFORMATION Pro forma information has been presented to show what the significant effects on the historical financial information might have been based upon the revocation of the S corporation status. The number of shares used in all calculations has been adjusted to reflect a 14,000-for-one stock split. Pro forma net income represents the results of operations adjusted to reflect a change in the Company's income tax status from an S corporation to a C corporation, using a pro forma income tax rate of 41% for 1992 and 1994, and 42% for 1993 and 1995 through 1997. If the S corporation status had been terminated as of September 30, 1997, the amount of the deferred tax liability and corresponding reduction in retained earning would have been approximately $18.7 million. Any remaining retained earnings after adjustments attributable to termination of S corporation status will be reclassified as common stock. Pro forma net income per share is computed by dividing pro forma net income by the weighted average number of shares of common stock and dilutive common stock equivalents. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, common and common equivalent shares issued below the estimated initial public offering price during the twelve month period prior to the date of the initial filing of the Company's Registration Statement have been included in the calculation, using the treasury stock method, as if they were outstanding for all periods presented. For purposes of this calculation, outstanding stock options are considered common stock equivalents and totaled 377,795 shares for all periods presented under the treasury stock method. The pro forma weighted average number of shares also includes the effect of the assumed issuance of 1,253,334 shares of common stock to generate sufficient cash to pay to shareholders upon termination of the Company's S corporation status the amount of previously earned and undistributed taxable income ($18.8 million at September 30, 1997). The assumed issuance of common stock was based on an assumed price of $15.00, the midpoint of the estimated range of the initial public offering price. The weighted average shares outstanding for computing primary earnings per share were 15,631,129 for the nine months ended September 30, 1997 and the year ended December 31, 1996. F-19 HEADLANDS MORTGAGE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Supplemental pro forma earnings per share of $1.38 and $0.68 for the periods ended September 30, 1997 and December 31, 1996, respectively, reflects further adjustment for the effect of the add back, net of tax, of interest expense recorded since July 1996, the inception of the Notes, to be repaid from the proceeds of the offering. In that calculation, weighted average shares outstanding of 16,331,129 include the effect of the assumed issuance of 700,000 shares of common stock in July 1996 to retire the Notes payable to stockholders ($10.5 million at September 30, 1997). 21. SUBSEQUENT EVENTS On December 10, 1997, the company authorized an additional 35,300,000 shares of common stock and authorized a 14,000-to-1 share stock split to become effective prior to the effectiveness of the Registration Statement for the Company's initial public offering. In accordance with SEC Staff Accounting Bulletin Topic 4(c), the stock split has been retroactively reflected in the accompanying consolidated balance sheet. F-20 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE- SENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDER- WRITERS. 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 OR THAT THE INFOR- MATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RE- LATES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL. ---------------- TABLE OF CONTENTS ----------------
PAGE ---- Prospectus Summary....................................................... 1 Risk Factors............................................................. 12 Termination of S Corporation Status...................................... 21 Use of Proceeds.......................................................... 22 Dividend Policy.......................................................... 22 Capitalization........................................................... 23 Dilution................................................................. 24 Selected Consolidated Financial Data..................................... 25 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................... 27 Business................................................................. 40 Management............................................................... 59 Executive Compensation................................................... 61 Principal and Selling Shareholders....................................... 66 Certain Relationships and Related Business Transactions.................. 68 Description of Capital Stock............................................. 72 Shares Eligible for Future Sale.......................................... 73 Underwriting............................................................. 74 Legal Matters............................................................ 75 Experts.................................................................. 75 Available Information.................................................... 76 Index of Defined Terms................................................... 77 Index to Financial Statements............................................ F-1
UNTIL , 1997 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICI- PATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER TO PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 8,000,000 SHARES HEADLANDS MORTGAGE COMPANY ---------------- PROSPECTUS ---------------- NATIONSBANC MONTGOMERY SECURITIES, INC. BT ALEX. BROWN UBS SECURITIES , 1997 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The expenses expected to be incurred in connection with the issuance and distribution of the securities being registered, other than underwriting compensation, are as set forth below. All such expenses, except for the SEC registration and filing fees, are estimated: SEC Registration................................................... $ 47,484 Legal Fees and Expenses............................................ $ * Accounting Fees and Expenses....................................... $ * NASD Fees.......................................................... $ * Blue Sky Qualification Fees and Expenses........................... $ * Printing and Engraving Fees........................................ $ * Transfer Agent and Custodian Fees.................................. $ * Miscellaneous...................................................... $ * -------- Total............................................................ $800,000 ========
- -------- * To be provided by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Section 204(a)(10)(A) of the General Corporation Law of the State of California ("GCL") allows a corporation to eliminate the personal liability of a director for monetary damages in an action brought by or in the right of the corporation for breach of a director's duties to the corporation and its stockholders, except that such provision may not eliminate or limit the liability of directors for (i) acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) acts or omissions that a director believes to be contrary to the best interests of the corporation or its stockholders or that involve the absence of good faith on the part of the director, (iii) any transaction from which a director derived an improper personal benefit, (iv) acts or omissions that show a reckless disregard for the director's duty to the corporation or its stockholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the corporation or its stockholders, (v) acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the corporation or its stockholders, (vi) certain liabilities arising from contracts with the corporation in which the director has a material financial interest, (vii) the making of any distributions to stockholders contrary to the law, (viii) the distribution of assets to shareholders after dissolution proceedings without paying or adequately providing for all known liabilities of the corporation within certain time limits, and (ix) the making of any loan or guaranty contrary to law. The Registrant's Articles of Incorporation contains a provision which eliminates directors' personal liability as set forth above, except, as required by Section 204(a)(10)(B) and (C) of the GCL, any liability of a director for any act or omission occurring prior to the date of the provision's effectiveness, or any liability for an officer's acts or omissions, notwithstanding that the officer is also a director or that the officer's actions, if negligent or improper, have been ratified by the directors. Section 317 of the GCL ("Section 317") empowers a corporation to indemnify any person who was or is a party or is threatened to be made a party to any proceeding (other than an action by or in the right of the corporation to procure a judgment in its favor) by reason of the fact that he or she is or was a director, officer, employee or agent of the corporation, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with the proceeding if that person acted in good faith and in a manner the person reasonably believed to be in the best interests of the corporation and, in the case of a criminal proceeding, had no reasonable cause to believe the conduct of the person was unlawful. The termination of any proceeding II-1 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 the person reasonably believed to be in the best interests of the corporation or that the person had reasonable cause to believe that the person's conduct was unlawful. Section 317 empowers the corporation 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 by or in the right of the corporation to procure a judgment in its favor by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, against expenses actually and reasonably incurred by that person in connection with the defense or settlement of the action if the person acted in good faith, in a manner the person believed to be in the best interests of the corporation and its stockholders, provided that (i) the person is successful on the merits or (ii) such amounts are paid with court approval. Section 317 also provides that, unless a person is successful on the merits in defense of any proceeding referred to above, indemnification may be made only if authorized in the specific case, upon a determination that indemnification is proper in the circumstances because the indemnified person met the applicable standard of conduct described above by one of the following: (1) a majority vote of a quorum consisting of directors who are not parties to such proceedings; (2) if such quorum is not obtainable, by independent legal counsel in a written opinion; (3) by approval of stockholders with such indemnified person's shares not being entitled to vote thereon; or (4) by the court in which the proceeding is or was pending upon application by or on behalf of the person. Such indemnification may be advanced to the indemnified person upon the receipt of the corporation of an undertaking by or on behalf of the indemnified person to repay such amount in the event it shall be ultimately determined that such indemnified person is not entitled to indemnification. Section 317 also allows the corporation, by express provision in its articles, to authorize additional rights for indemnification pursuant to Section 204(a)(ii). The Bylaws of the Registrant provide that the Registrant shall indemnify its directors and officers against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceeding arising by reason of such person being or having been a director or officer of the corporation and shall advance to such director or officer expenses incurred in defending any such proceeding to the fullest extent permissible under California law. The Bylaws also provide that the Registrant may indemnify its employees and agents for such expenses by resolution of the Board of Directors. Reference is also made to the Form of Underwriting Agreement filed as Exhibit 1.1 to this Registration Statement for provisions relating to the indemnification of directors, officers and controlling persons against certain liabilities including liabilities under the Securities Act of 1933, as amended. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. None. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits: 1.1* Form of Underwriting Agreement 3.1 Composite Articles of Incorporation of the Registrant 3.2 Amended and Restated Bylaws of the Registrant 4.1 Specimen Common Stock Certificate 5.1* Opinion of Tobin & Tobin as to legality (including consent of such firm) 9.1 Voting Trust Agreement dated September 15, 1997, as amended 10.1.1 Employment Agreement of Peter T. Paul 10.1.2 Employment Agreement of Becky S. Poisson 10.1.3 Employment Agreement of Gilbert J. MacQuarrie 10.1.4 Employment Agreement of Steven M. Abreu 10.2 1997 Executive and Non-Employee Director Stock Option Plan dated July 22, 1997 10.3 Description of Bonus Incentive Compensation Plan 10.4 Amended and Restated Mortgage Loan Capital Loan Warehousing, dated as of August 29, 1997, among the Registrant and the Lenders therein named, as amended
II-2 10.5 Amended and Restated Servicing Secured Credit Agreement, dated as of August 29, 1997, among the Registrant and the Lender named therein, as amended 10.6 Master Repurchase Agreement dated as of September 11, 1996 among Merrill Lynch Mortgage Capital, Inc., Merrill Lynch Credit Corporation and the Registrant, as amended 10.7 Tax Indemnification Agreement among the Registrant and the Registrant's shareholders prior to termination of S corporation status. 10.8 Founders Registration Rights Agreement 11.1 Statement regarding computation of per share earnings 21.1** List of Subsidiaries of the Registrant 23.1* Consent of Tobin & Tobin (included in Exhibit 5.1) 23.2 Consent of KPMG Peat Marwick LLP 24.1** Power of Attorney (set forth on the signature page) 27.1 Financial Data Schedule 99.1 Consent of Director pursuant to Rule 438 for Mark L. Korell 99.2 Consent of Director pursuant to Rule 438 for Leonard Auerbach 99.3 Consent of Director pursuant to Rule 438 for Mark E. Lachtman 99.4 Consent of Director pursuant to Rule 438 for Steven M. Abreu
- -------- * To be filed by amendment. ** Previously filed (b) Financial Statement Schedules: All other schedules are either inapplicable or the information is included in the Company's financial statements and therefor have been omitted. ITEM 17. UNDERTAKINGS. The undersigned registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. 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, 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, less 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. 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 of 1933 shall be deemed to be part of this Registration Statement as of the time it was declared effective; and (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 and the undersigned registrant hereby undertakes to file an application for the purpose of determining the eligibility of the trustee to act under subsection (a) of Section 310 of the Trust Indenture Act in accordance with the rules and regulations prescribed by the Commission under Section 305(b)(2) of the Act. II-3 SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT HAS DULY CAUSED THIS AMENDMENT NO. 1 TO THE REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF LARKSPUR, STATE OF CALIFORNIA, ON DECEMBER 4, 1997. HEADLANDS MORTGAGE COMPANY /s/ Peter T. Paul By: _________________________________ PETER T. PAUL PRESIDENT PURSUANT TO TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT NO. 1 TO REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED:
SIGNATURE TITLE DATE /s/ Peter T. Paul President and - ------------------------------------- Director (Principal December 4, 1997 PETER T. PAUL Executive Officer) /s/ Becky S. Poisson Executive Vice President-- - ------------------------------------- Operations and Director December 4, 1997 BECKY S. POISSON Executive Vice President, /s/ Gilbert J. MacQuarrie Chief Financial Officer, - ------------------------------------- Secretary and Director December 4, 1997 GILBERT J. MACQUARRIE (Principal Financial Officer) /s/ Kristen Decker Senior Vice President - ------------------------------------- President and Controller December 4, 1997 KRISTEN DECKER (Principal Accounting Officer)
II-4 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF DOCUMENT ----------- ----------------------- 1.1* Form of Underwriting Agreement 3.1 Composite Articles of Incorporation of the Registrant 3.2 Amended and Restated Bylaws of the Registrant 4.1 Specimen Common Stock Certificate 5.1* Opinion of Tobin & Tobin as to legality (including consent of such firm) 9.1 Voting Trust Agreement dated September 15, 1997, as amended 10.1.1 Employment Agreement of Peter T. Paul 10.1.2 Employment Agreement of Becky S. Poisson 10.1.3 Employment Agreement of Gilbert J. MacQuarrie 10.1.4 Employment Agreement of Steven M. Abreu 10.2 1997 Executive and Non-Employee Director Stock Option Plan dated July 22, 1997 10.3 Description of Bonus Incentive Compensation Plan 10.4 Amended and Restated Mortgage Loan Capital Loan Warehousing, dated as of August 29, 1997, among the Registrant and the Lenders therein named, as amended 10.5 Amended and Restated Servicing Secured Credit Agreement, dated as of August 29, 1997, among the Registrant and the Lender named therein, as amended 10.6 Master Repurchase Agreement dated as of September 11, 1996 among Merrill Lynch Mortgage Capital, Inc., Merrill Lynch Credit Corporation and the Registrant, as amended 10.7 Tax Indemnification Agreement among the Registrant and the Registrant's shareholders prior to termination of S corporation status. 10.8 Founders Registration Rights Agreement 11.1 Statement regarding computation of per share earnings 21.1** List of Subsidiaries of the Registrant 23.1* Consent of Tobin & Tobin (included in Exhibit 5.1) 23.2 Consent of KPMG Peat Marwick LLP 24.1** Power of Attorney (set forth on the signature page) 27.1 Financial Data Schedule 99.1 Consent of Director pursuant to Rule 438 for Mark L. Korell 99.2 Consent of Director pursuant to Rule 438 for Leonard Auerbach 99.3 Consent of Director pursuant to Rule 438 for Mark E. Lachtman 99.4 Consent of Director pursuant to Rule 438 for Steven M. Abreu
- -------- * To be filed by amendment. ** Previously filed II-5 EX-3.1 2 ARTICLES OF INCORPORATION EXHIBIT 3.1 ----------- ARTICLES OF INCORPORATION OF HEADLANDS MORTGAGE COMPANY The undersigned incorporator, for the purpose of forming a corporation under the General Corporation Law of the State of California, hereby certifies: ONE. The name of the corporation is HEADLANDS MORTGAGE COMPANY. TWO. The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code. THREE. (a) The liability of directors of the Corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. (b) The Corporation is authorized to provide indemnification of agents (as defined in Section 317 of the California Corporations Code) through Bylaw provisions, agreements and agents, vote of shareholders or disinterested directors, or otherwise, to the fullest extent permissible under California law. (c) Any amendment, repeal or modification of any provision of this Article THREE shall not adversely affect any right or protection of an agent of this Corporation existing at the time of such amendment, repeal or modification. FOUR. (a) The Corporation is authorized to issue two classes of shares designated "Preferred Stock" and "Common Stock," respectively. The number of shares of Preferred Stock authorized to be issued is five million (5,000,000) and the number of shares of Common Stock authorized to be issued is fifty million (50,000,000). Upon amendment of this article to read as herein set forth, each outstanding share of Common Stock is split and converted into fourteen thousand (14,000) shares of Common Stock. (b) The Preferred Stock may be divided into such number of series as the Board of Directors may determine. The Board of Directors is authorized to determine and alter the rights, preferences, privileges and restrictions granted to and imposed upon any wholly 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 of Preferred Stock. The Board of Directors, within the limits and restrictions stated in any resolution or resolutions of the Board of Directors originally fixing the number of shares constituting any series, may increase or decrease (but not 1 below the number of shares of such series then outstanding) the number of shares of any series subsequent to the issue of shares of that series. IN WITNESS WHEREOF, the undersigned has executed these Articles of Incorporation. _________________________________ Incorporator I declare that I am the person who executed the foregoing Articles of Incorporation and said instrument is my act and deed. Executed this ____ day of December, 1997, at San Francisco, California. _________________________________ 2 EX-3.2 3 AMENDED & RESTATED BYLAWS EXHIBIT 3.2 ----------- AMENDED AND RESTATED BYLAWS OF HEADLANDS MORTGAGE COMPANY TABLE OF CONTENTS ARTICLE I. CORPORATE OFFICES................................................ 1.1 PRINCIPAL OFFICE................................................. 1.2 OTHER OFFICES.................................................... ARTICLE II. MEETINGS OF SHAREHOLDERS........................................ 2.1 PLACE OF MEETINGS................................................ 2.2 ANNUAL MEETING................................................... 2.3 SPECIAL MEETINGS................................................. 2.4 NOTICE OF SHAREHOLDERS' MEETINGS................................. 2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE..................... 2.6 QUORUM........................................................... 2.7 ADJOURNED MEETING; NOTICE........................................ 2.8 VOTING........................................................... 2.9 VALIDATION OF MEETINGS; WAIVER OF NOTICE; CONSENT................ 2.10 SHAREHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING...................................................... 2.11 RECORD DATE FOR SHAREHOLDER NOTICE; VOTING; GIVING CONSENTS................................................ 2.12 PROXIES.......................................................... 2.13 INSPECTORS OF ELECTION........................................... ARTICLE III. DIRECTORS...................................................... 3.1 POWERS........................................................... 3.2 NUMBER OF DIRECTORS.............................................. 3.3 ELECTION AND TERM OF OFFICE OF DIRECTORS......................... 3.4 REMOVAL.......................................................... 3.5 RESIGNATION AND VACANCIES........................................ 3.6 PLACE OF MEETINGS; MEETINGS BY TELEPHONE, ELECTRONIC VIDEO SCREEN COMMUNICATION, ETC....................... 3.7 REGULAR MEETINGS................................................. 3.8 SPECIAL MEETINGS; NOTICE......................................... 3.9 QUORUM........................................................... 3.10 WAIVER OF NOTICE................................................. 3.11 ADJOURNMENT...................................................... 3.12 NOTICE OF ADJOURNMENT............................................ 3.13 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING................ 3.14 FEES AND COMPENSATION OF DIRECTORS............................... 3.15 APPROVAL OF LOANS TO OFFICERS....................................
i ARTICLE IV. COMMITTEES...................................................... 4.1 COMMITTEES OF DIRECTORS.......................................... 4.2 MEETINGS AND ACTION OF COMMITTEES................................ ARTICLE V. OFFICERS......................................................... 5.1 OFFICERS......................................................... 5.2 APPOINTMENT OF OFFICERS.......................................... 5.3 SUBORDINATE OFFICERS............................................. 5.4 REMOVAL AND RESIGNATION OF OFFICERS.............................. 5.5 VACANCIES IN OFFICES............................................. 5.6 CHAIRMAN OF THE BOARD............................................ 5.7 PRESIDENT........................................................ 5.8 VICE PRESIDENTS.................................................. 5.9 SECRETARY........................................................ 5.10 CHIEF FINANCIAL OFFICER.......................................... ARTICLE VI. INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES, AND OTHER AGENTS..................................... 6.1 INDEMNIFICATION OF DIRECTORS..................................... 6.2 INDEMNIFICATION OF OTHERS........................................ 6.3 PAYMENT OF EXPENSES IN ADVANCE................................... 6.4 INDEMNITY NOT EXCLUSIVE.......................................... 6.5 INSURANCE INDEMNIFICATION........................................ 6.6 CONFLICTS........................................................ 6.7 RIGHT TO BRING SUIT.............................................. 6.8 INDEMNITY AGREEMENTS............................................. 6.9 AMENDMENT, REPEAL OR MODIFICATION................................ ARTICLE VII. RECORDS AND REPORTS............................................ 7.1 MAINTENANCE AND INSPECTION OF SHARE REGISTER..................... 7.2 MAINTENANCE AND INSPECTION OF BYLAWS............................. 7.3 MAINTENANCE AND INSPECTION OF OTHER CORPORATE RECORDS................................................ 7.4 INSPECTION BY DIRECTORS.......................................... 7.5 ANNUAL REPORT TO SHAREHOLDERS; WAIVER............................ 7.6 FINANCIAL STATEMENTS............................................. 7.7 REPRESENTATION OF SHARES OF OTHER CORPORATIONS................... ARTICLE VIII. GENERAL MATTERS 8.1 RECORD DATE FOR PURPOSES OTHER THAN NOTICE AND VOTING....................................................... 8.2 CHECKS; DRAFTS; EVIDENCES OF INDEBTEDNESS........................ 8.3 CORPORATE CONTRACTS AND INSTRUMENTS:
ii HOW EXECUTED..................................................... 8.4 CERTIFICATES FOR SHARES.......................................... 8.5 LOST CERTIFICATES................................................ 8.6 CONSTRUCTION; DEFINITIONS........................................ ARTICLE IX. AMENDMENTS...................................................... 9.1 AMENDMENT BY SHAREHOLDERS........................................ 9.2 AMENDMENT BY DIRECTORS........................................... 9.3 RECORD OF AMENDMENTS............................................. ARTICLE X. INTERPRETATION...................................................
iii AMENDED AND RESTATED BYLAWS OF HEADLANDS MORTGAGE COMPANY ARTICLE I. CORPORATE OFFICES ----------------- 1.1 PRINCIPAL OFFICE ---------------- The Board of Directors shall fix the location of the principal executive office of the corporation at any place within or outside the State of California. If the principal executive office is located outside California and the corporation has one or more business offices in California, then the Board of Directors shall fix and designate a principal business office in California. 1.2 OTHER OFFICES ------------- The Board of Directors may at any time establish branch or subordinate offices at any place or places. ARTICLE II. MEETINGS OF SHAREHOLDERS ------------------------ 2.1 PLACE OF MEETINGS ----------------- Meetings of shareholders shall be held at any place within or outside the State of California designated by the Board of Directors. In the absence of any such designation, shareholders' meetings shall be held at the principal executive office of the corporation or at any place consented to in writing by all persons entitled to vote at such meeting, given before or after the meeting and filed with the Secretary of the corporation. 2.2 ANNUAL MEETING -------------- An annual meeting of the shareholders shall be held each year on the date and time designated by the Board of Directors. At that meeting, directors shall be elected. Any other proper business within the power of the shareholders may be transacted. 2.3 SPECIAL MEETINGS ---------------- Special meetings of the shareholders may be called at any time, subject to the provisions of Sections 2.4 and 2.5 of these Bylaws, by the Board of Directors, the Chairman of 1 the Board, the President or the holders of shares entitled to cast not less than ten percent (10%) of the votes at that meeting. If a special meeting is called by anyone other than the Board of Directors or the President or the Chairman of the Board, then the request shall be in writing, specifying the time of such meeting and the general nature of the business proposed to be transacted, and shall be delivered personally or sent by registered mail or by other written communication to the Chairman of the Board, the President, any Vice President or the Secretary of the corporation. The officer receiving the request forthwith shall cause notice to be given to the shareholders entitled to vote, in accordance with the provisions of Sections 2.4 and 2.5 of these Bylaws, that a meeting will be held at the time requested by the person or persons calling the meeting, so long as that time is not less than thirty-five (35) nor more than sixty (60) days after the receipt of the request. If the notice is not given within twenty (20) days after receipt of the request, then the person or persons requesting the meeting may give the notice. Nothing contained in this paragraph of this Section 2.3 shall be construed as limiting, fixing or affecting the time when a meeting of shareholders called by action of the Board of Directors may be held. 2.4 NOTICE OF SHAREHOLDERS' MEETINGS -------------------------------- All notices of meetings of shareholders shall be sent or otherwise given in accordance with Section 2.5 of these Bylaws not less than ten (10) (or, if sent by third-class mail pursuant to Section 2.5 of these Bylaws, not less than thirty (30)) nor more than sixty (60) days before the date of the meeting to each shareholder entitled to vote thereat. Such notice shall state the place, date, and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted, and no business other than that specified in the notice may be transacted, or (ii) in the case of the annual meeting, those matters which the Board of Directors, at the time of the mailing of the notice, intends to present for action by the shareholders, but, subject to the provisions of the next paragraph of this Section 2.4, any proper matter may be presented at the meeting for such action. The notice of any meeting at which Directors are to be elected shall include the names of nominees intended at the time of the notice to be presented by the Board for election. If action is proposed to be taken at any meeting for approval of (i) a contract or transaction in which a director has a direct or indirect financial interest, pursuant to Section 310 of the California Corporations Code (the "Code"), (ii) an amendment of the Articles of Incorporation, pursuant to Section 902 of the Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of the Code, (iv) a voluntary dissolution of the corporation, pursuant to Section 1900 of the Code, or (v) a distribution in dissolution other than in accordance with the rights of any outstanding preferred shares, pursuant to Section 2007 of the Code, then the notice shall also state the general nature of that proposal. 2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE -------------------------------------------- Notice of a shareholders' meeting shall be given either personally or by first-class mail, or, if the corporation has outstanding shares held of record by five hundred (500) or more persons (determined as provided in Section 605 of the Code) on the record date for the shareholders' meeting, notice may be sent by third-class mail, or other means of written communication, addressed to the shareholder at the address of the shareholder appearing on the 2 books of the corporation or given by the shareholder to the corporation for the purpose of notice; or if no such address appears or is given, at the place where the principal executive office of the corporation is located or by publication at least once in a newspaper of general circulation in the county in which the principal executive office is located. The notice shall be deemed to have been given at the time when delivered personally or deposited in the mail or sent by other means of written communication. If any notice (or any report referenced in Article VII of these Bylaws) addressed to a shareholder at the address of such shareholder appearing on the books of the corporation is returned to the corporation by the United States Postal Service marked to indicate that the United States Postal Service is unable to deliver the notice to the shareholder at that address, all future notices or reports shall be deemed to have been duly given without further mailing if the same shall be available to the shareholder upon written demand of the shareholder at the principal executive office of the corporation for a period of one (1) year from the date of the giving of the notice. An affidavit of mailing of any notice or report in accordance with the provisions of this Section 2.5, executed by the Secretary, Assistant Secretary or any transfer agent, shall be prima facie evidence of the giving of the notice or report. 2.6 QUORUM ------ Unless otherwise provided in the Articles of Incorporation of the corporation, a majority of the shares entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of the shareholders. The shareholders present at a duly called or held meeting at which a quorum is present may continue to transact business until adjournment notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. In the absence of a quorum, any meeting of shareholders may be adjourned from time to time by the vote of a majority of the shares represented either in person or by proxy, but no other business may be transacted, except as provided in the last sentence of the preceding paragraph. 2.7 ADJOURNED MEETING; NOTICE ------------------------- Any shareholders' meeting, annual or special, whether or not a quorum is present, may be adjourned from time to time by the vote of the majority of the shares represented at that meeting, either in person or by proxy. When any meeting of shareholders, either annual or special, is adjourned to another time or place, notice need not be given of the adjourned meeting if its time and place are announced at the meeting at which the adjournment is taken. However, if the adjournment is for more than forty-five (45) days from the date set for the original meeting or if a new record date for the adjourned meeting is fixed, a notice of the adjourned meeting shall be given to each shareholder of record entitled to vote at the adjourned meeting in accordance with the provisions 3 of Sections 2.4 and 2.5 of these Bylaws. At any adjourned meeting the corporation may transact any business which might have been transacted at the original meeting. 2.8 VOTING ------ The shareholders entitled to vote at any meeting of shareholders shall be determined in accordance with the provisions of Section 2.11 of these Bylaws, subject to the provisions of Sections 702 through 704 of the Code (relating to voting shares held by a fiduciary, in the name of a corporation, or in joint ownership). Elections for directors and voting on any other matter at a shareholders' meeting need not be by ballot unless a shareholder demands election by ballot at the meeting and before the voting begins. Except as provided in the last paragraph of this Section 2.8, or as may be otherwise provided in the Articles of Incorporation, each outstanding share, regardless of class, shall be entitled to one vote on each matter submitted to a vote of the shareholders. Any holder of shares entitled to vote on any matter may vote part of the shares in favor of the proposal and refrain from voting the remaining shares or may vote them against the proposal other than elections to office, but, if the shareholder fails to specify the number of shares such shareholder is voting affirmatively, it will be conclusively presumed that the shareholder's approving vote is with respect to all shares which the shareholder is entitled to vote. The affirmative vote of the majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum) shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required by the Code or by the Articles of Incorporation. Subject to the following paragraph, a shareholders' meeting at which directors are to be elected, a shareholder shall be entitled to cumulate votes either (i) by giving one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which that shareholder's shares are normally entitled or (ii) by distributing the shareholder's votes on the same principle among as many candidates as the shareholder thinks fit, if the candidate or candidates' names have been placed in nomination prior to the voting and the shareholder has given notice prior to the voting of the shareholder's intention to cumulate the shareholder's votes. If any one shareholder has given such a notice, then every shareholder entitled to vote may cumulate votes for candidates in nomination. The candidates receiving the highest number of affirmative votes, up to the number of directors to be elected, shall be elected; votes against any candidate and votes withheld shall have no legal effect. Notwithstanding the preceding paragraph, effective at the time the corporation becomes a listed corporation, cumulative shall be eliminated and no shareholder shall be entitled to cumulate votes at any meeting held thereafter. This provision shall become effective only when the corporation becomes a listed corporation within the meaning of Section 301.5 of the Code. 4 2.9 VALIDATION OF MEETINGS; WAIVER OF NOTICE; CONSENT ------------------------------------------------- The transactions of any meeting of shareholders, either annual or special, however called and noticed, and wherever held, are as valid as though they had been taken at a meeting duly held after regular call and notice, if a quorum be present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by proxy, signs a written waiver of notice or a consent to the holding of the meeting or an approval of the minutes thereof. Neither the business to be transacted at nor the purpose of any annual or special meeting of shareholders need be specified in any written waiver of notice or consent to the holding of the meeting or approval of the minutes thereof, except that if action is taken or proposed to be taken for approval of any of those matters specified in the second paragraph of Section 2.4 of these Bylaws, the waiver of notice or consent or approval shall state the general nature of the proposal. All such waivers, consents, and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance of a person at a meeting shall constitute a waiver of notice of and presence at that meeting, except when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened and except that attendance at a meeting is not a waiver of any right to object to the consideration of matters required by the Code to be included in the notice of such meeting but not so included, if such objection is expressly made at the meeting. 2.10 SHAREHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING ------------------------------------------------------- Any action which may be taken at any annual or special meeting of shareholders may be taken without a meeting and without prior notice, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Directors may not be elected by written consent except by unanimous written consent of all shares entitled to vote for the election of directors. However, a director may be elected at any time to fill any vacancy on the Board of Directors, provided that it was not created by removal of a director and that it has not been filled by the directors, by the written consent of the holders of a majority of the outstanding shares entitled to vote for the election of directors. All such consents shall be maintained in the corporate records. Any shareholder giving a written consent, or the shareholder's proxy holders, or a transferee of the shares, or a personal representative of the shareholder, or their respective proxy holders, may revoke the consent by a writing received by the Secretary of the corporation before written consents of the number of shares required to authorize the proposed action have been filed with the Secretary. If the consents of all shareholders entitled to vote have not been solicited in writing, the Secretary shall give prompt notice of any corporate action approved by the shareholders without a meeting by less than unanimous written consent to those shareholders entitled to vote who have not consented in writing. Such notice shall be given in the manner specified in Section 2.5 of these Bylaws. In the case of approval of (i) a contract or transaction in which a 5 director has a direct or indirect financial interest, pursuant to Section 310 of the Code, (ii) indemnification of a corporate "agent," pursuant to Section 317 of the Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of the Code, and (iv) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares, pursuant to Section 2007 of the Code, the notice shall be given at least ten (10) days before the consummation of any action authorized by that approval, unless the consents of all shareholders entitled to vote have been solicited in writing. 2.11 RECORD DATE FOR SHAREHOLDER NOTICE; VOTING; GIVING CONSENTS ----------------------------------------------------------- In order that the corporation may determine the shareholders entitled to notice of any meeting or to vote, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) days nor less than ten (10) days prior to the date of such meeting nor more than sixty (60) days before any other action. Shareholders at the close of business on the record date are entitled to notice and to vote, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date, except as otherwise provided in the Articles of Incorporation or the Code. A determination of shareholders of record entitled to notice of or to vote at a meeting of shareholders shall apply to any adjournment of the meeting unless the Board of Directors fixes a new record date for the adjourned meeting, but the Board of Directors shall fix a new record date if the meeting is adjourned for more than forty-five (45) days from the date set for the original meeting. If the Board of Directors does not so fix a record date: (a) The record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. (b) The record date for determining shareholders entitled to give consent to corporate action in writing without a meeting, (i) when no prior action by the Board has been taken, shall be the day on which the first written consent is given, or (ii) when prior action by the Board has been taken, shall be at the close of business on the day on which the Board adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such other action, whichever is later. The record date for any other purpose shall be as provided in Section 8.1 of these Bylaws. 2.12 PROXIES ------- Every person entitled to vote for directors, or on any other matter, shall have the right to do so either in person or by one or more agents authorized by a written proxy signed by the person and filed with the Secretary of the corporation. A proxy shall be deemed signed if the shareholder's name or other authorization is placed on the proxy (whether by manual signature, 6 typewriting, telegraphic or electronic transmission or otherwise) by the shareholder or the shareholder's attorney-in-fact. A validly executed proxy which does not state that it is irrevocable shall continue in full force and effect unless (i) the person who executed the proxy revokes it prior to the time of voting by delivering a writing to the corporation stating that the proxy is revoked or by executing a subsequent proxy and presenting it to the meeting or by attendance at such meeting and voting in person, or (ii) written notice of the death or incapacity of the maker of that proxy is received by the corporation before the vote pursuant to that proxy is counted; provided, however, that no proxy shall be valid after the expiration of eleven (11) months from the date thereof, unless otherwise provided in the proxy. The dates contained on the forms of proxy presumptively determine the order of execution, regardless of the postmark dates on the envelopes in which they are mailed. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Sections 705(e) and 705(f) of the Code. 2.13 INSPECTORS OF ELECTION ---------------------- In advance of any meeting of shareholders, the Board of Directors may appoint inspectors of election to act at the meeting and any adjournment thereof. If inspectors of election are not so appointed or designated or if any persons so appointed fail to appear or refuse to act, then the Chairman of the meeting may, and on the request of any shareholder or a shareholder's proxy shall, appoint inspectors of election (or persons to replace those who so fail to appear) at the meeting. The number of inspectors shall be either one (1) or three (3). If appointed at a meeting on the request of one (1) or more shareholders or proxies, the majority of shares represented in person or by proxy shall determine whether one (1) or three (3) inspectors are to be appointed. The inspectors of election shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, and the authenticity, validity, and effect of proxies, receive votes, ballots or consents, hear and determine all challenges and questions in any way arising in connection with the right to vote, count and tabulate all votes or consents, determine when the polls shall close, determine the result and do any other acts that may be proper to conduct the election or vote with fairness to all shareholders. ARTICLE III. DIRECTORS --------- 3.1 POWERS ------ Subject to the provisions of the Code and any limitations in the Articles of Incorporation and these Bylaws relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the Board of Directors. The Board may delegate the management of the day-to-day operation of the business of the corporation to a management company or other person provided that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the Board. 7 3.2 NUMBER OF DIRECTORS ------------------- The following paragraph shall apply until the time of closing of the corporation's initial public offering of its Common Stock, at which time it shall cease to be effective and shall be deleted from these Bylaws without further act or deed: The authorized number of directors of the corporation shall be not less than three (3) nor more than five (5) (which in no case shall be greater than two times the stated minimum minus one), and the exact number of directors shall be three (3) until changed, within the limits specified above, by a resolution amending each exact number, duly adopted by the Board of Directors or by the shareholders. The minimum and maximum number of directors may be changed, or a definite number may be fixed without provision for an indefinite number, by a duly adopted amendment to the Articles of Incorporation or by an amendment to this Bylaw duly adopted by the vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that an amendment reducing the fixed number or minimum number of directors to a number less than five (5) cannot be adopted if the votes cast against its adoption at a meeting, or the shares not consenting in the case of an action by written consent, are equal to more than sixteen and two-thirds percent (16 2/3%) of the outstanding shares entitled to vote thereon. The following paragraph shall become effective without further act or deed upon the closing of the corporation's initial public offering of its Common Stock: The authorized number of directors of the corporation shall be not less than five (5) nor more than nine (9) (which in no case shall be greater than two times the stated minimum minus one), and the exact number of directors shall be seven (7) until changed, within the limits specified above, by a resolution amending each exact number, duly adopted by the Board of Directors or by the shareholders. The minimum and maximum number of directors may be changed, or a definite number may be fixed without provision for an indefinite number, by a duly adopted amendment to the Articles of Incorporation or by an amendment to this Bylaw duly adopted by the vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that an amendment reducing the fixed number or minimum number of directors to a number less than five (5) cannot be adopted if the votes cast against its adoption at a meeting, or the shares not consenting in the case of an action by written consent, are equal to more than sixteen and two-thirds percent (16 2/3%) of the outstanding shares entitled to vote thereon. No reduction of the authorized number of directors shall have the effect of removing any director before that director's term of office expires. 3.3 ELECTION AND TERM OF OFFICE OF DIRECTORS ---------------------------------------- At each annual meeting of shareholders, directors shall be elected to hold office until the next annual meeting. Each director, including a director elected to fill a vacancy, shall hold office until the expiration of the term for which elected and until a successor has been elected and qualified, except in the case of the death, resignation, or removal of such a director. 8 3.4 REMOVAL ------- The entire Board of Directors or any individual director may be removed from office without cause by the affirmative vote of a majority of the outstanding shares entitled to vote on such removal; provided, however, that unless the entire Board is removed, no individual director may be removed when the votes cast against such director's removal, or not consenting in writing to such removal, would be sufficient to elect that director if voted cumulatively at an election at which the same total number of votes cast were cast (or, if such action is taken by written consent, all shares entitled to vote were voted) and the entire number of directors authorized at the time of such director's most recent election were then being elected. 3.5 RESIGNATION AND VACANCIES ------------------------- Any director may resign effective upon giving oral or written notice to the Chairman of the Board, the President, the Secretary or the Board of Directors, unless the notice specifies a later time for the effectiveness of such resignation. If the resignation of a director is effective at a future time, the Board of Directors may elect a successor to take office when the resignation becomes effective. Vacancies on the Board of Directors may be filled by a majority of the remaining directors, or if the number of directors then in office is less than a quorum by (i) unanimous written consent of the directors then in office, (ii) the affirmative vote of a majority of the directors then in office at a meeting held pursuant to notice or waivers of notice, or (iii) a sole remaining director; however, a vacancy created by the removal of a director by the vote or written consent of the shareholders or by court order may be filled only by the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum), or by the unanimous written consent of all shares entitled to vote thereon. Each director so elected shall hold office until the next annual meeting of the shareholders and until a successor has been elected and qualified, or until his or her death, resignation or removal. A vacancy or vacancies in the Board of Directors shall be deemed to exist (i) in the event of the death, resignation or removal of any director, (ii) if the Board of Directors by resolution declares vacant the office of a director who has been declared of unsound mind by an order of court or convicted of a felony, (iii) if the authorized number of directors is increased, or (iv) if the shareholders fail, at any meeting of shareholders at which any director or directors are elected, to elect the full authorized number of directors to be elected at that meeting. The shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors, but any such election by written consent, other than to fill a vacancy created by removal, shall require the consent of the holders of a majority of the outstanding shares entitled to vote thereon. A director may not be elected by written consent to fill a vacancy created by removal except by unanimous consent of all shares entitled to vote for the election of directors. 9 3.6 PLACE OF MEETINGS; MEETINGS BY TELEPHONE, ELECTRONIC VIDEO SCREEN ----------------------------------------------------------------- COMMUNICATION, ETC. ------------------- Regular meetings of the Board of Directors may be held at any place within or outside the State of California that has been designated from time to time by resolution of the Board. In the absence of such a designation, regular meetings shall be held at the principal executive office of the corporation. Special meetings of the Board may be held at any place within or outside the State of California that has been designated in the notice of the meeting or, if not stated in the notice or if there is no notice, at the principal executive office of the corporation. So long as permitted by statute, directors may participate in a meeting through any means of communication, including conference telephone, electronic video screen communications, or other communications equipment. Participating in a meeting pursuant to this section constitutes presence in person at that meeting if each participating director is provided the means to communicate with all of the other directors concurrently and (i) the meeting is held by conference telephone or video conferencing or other communications mode enabling participants to determine, through voice or image recognition, that a participant is or is not a director entitled to participate in the meeting or (ii) another communications device (such as a computer modem) is used in conjunction with another method (determined in the discretion of the chairperson of the meeting) enabling participants to determine that a participant is or is not a director entitled to participate in the meeting. Such verification method may include use of passwords or similar codes for gaining access to the meeting or encryption and authentication technology approved in the discretion of the chairperson. 3.7 REGULAR MEETINGS ---------------- Regular meetings of the Board of Directors may be held without notice if the time and place of such meetings are fixed by the Board of Directors. 3.8 SPECIAL MEETINGS; NOTICE ------------------------ Subject to the provisions of the following paragraph, special meetings of the Board of Directors for any purpose or purposes may be called at any time by the Chairman of the Board, the President, any Vice President, the Secretary or any two (2) directors. Notice of the time and place of special meetings shall be delivered personally or by telephone to each director or sent by first-class mail, telegram, charges prepaid, or by telecopier, addressed to each director at that director's address as it is shown on the records of the corporation. If the notice is mailed, it shall be deposited in the United States mail at least four (4) days before the time of the holding of the meeting. If the notice is delivered personally or by telephone or by telecopier or telegram, it shall be delivered personally or by telephone or by telecopier or to the telegraph company at least forty-eight (48) hours before the time of the holding of the meeting. Any oral notice given personally or by telephone may be communicated either to the director or to a person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. The notice need not specify the purpose of the meeting. 10 3.9 QUORUM ------ A majority of the authorized number of directors shall constitute a quorum for the transaction of business, except to adjourn as provided in Section 3.11 of these Bylaws. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present is the act of the Board of Directors, subject to the provisions of Section 310 of the Code (as to approval of contracts or transactions in which a director has a direct or indirect material financial interest), Section 311 of the Code (as to appointment of committees), Section 317(e) of the Code (as to indemnification of directors), the Articles of Incorporation, and other applicable law. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting. 3.10 WAIVER OF NOTICE ---------------- Notice of a meeting need not be given to any director who signs a waiver of notice or a consent to holding the meeting or an approval of the minutes thereof, whether before or after the meeting, or who attends the meeting without protesting, prior thereto or at its commencement, the lack of notice to such director. All such waivers, consents, and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. A waiver of notice need not specify the purpose of any regular or special meeting of the Board of Directors. 3.11 ADJOURNMENT ----------- A majority of the directors present, whether or not a quorum is present, may adjourn any meeting to another time and place. 3.12 NOTICE OF ADJOURNMENT --------------------- If the meeting is adjourned for more than twenty-four (24) hours, notice of any adjournment to another time and place shall be given prior to the time of the adjourned meeting to the directors who were not present at the time of the adjournment. 3.13 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING ------------------------------------------------- Any action required or permitted to be taken by the Board of Directors may be taken without a meeting, if all members of the Board individually or collectively consent in writing to such action. Such written consent or consents shall be filed with the minutes of the proceedings of the Board. Such action by written consent shall have the same force and effect as a unanimous vote of the Board of Directors. 3.14 FEES AND COMPENSATION OF DIRECTORS ---------------------------------- Directors and members of committees may receive such compensation, if any, for their services and such reimbursement of expenses as may be fixed or determined by resolution of the Board of Directors. This Section 3.14 shall not be construed to preclude any director from 11 serving the corporation in any other capacity as an officer, agent, employee or otherwise and receiving compensation for those services. 3.15 APPROVAL OF LOANS TO OFFICERS ----------------------------- If these Bylaws have been approved by the corporation's shareholders in accordance with the Code, the corporation may, upon the approval of the Board of Directors alone, make loans of money or property to, or guarantee the obligations of, any officer of the corporation or of its parent, if any, whether or not a director, or adopt an employee benefit plan or plans authorizing such loans or guaranties provided that (i) the Board of Directors determines that such a loan or guaranty or plan may reasonably be expected to benefit the corporation, (ii) the corporation has outstanding shares held of record by 100 or more persons (determined as provided in Section 605 of the Code) on the date of approval by the Board of Directors, and (iii) the approval of the Board of Directors is by a vote sufficient without counting the vote of any interested director or directors. Notwithstanding the foregoing, the corporation shall have the power to make loans permitted by the Code. ARTICLE IV. COMMITTEES ---------- 4.1 COMMITTEES OF DIRECTORS ----------------------- The Board of Directors may, by resolution adopted by a majority of the authorized number of directors, designate one or more committees, each consisting of two (2) or more directors, to serve at the pleasure of the Board. The Board may designate one or more directors as alternate members of any committee, who may replace any absent member at any meeting of the committee. The appointment of members or alternate members of a committee requires the vote of a majority of the authorized number of directors. Any such committee shall have authority to act in the manner and to the extent provided in the resolution of the Board and may have all the authority of the Board, except with respect to: (a) The approval of any action which, under the Code, also requires shareholders' approval or approval of the outstanding shares. (b) The filling of vacancies on the Board of Directors or in any committee. (c) The fixing of compensation of the directors for serving on the Board or on any committee. (d) The amendment or repeal of these Bylaws or the adoption of new Bylaws. (e) The amendment or repeal of any resolution of the Board of Directors which by its express terms is not so amendable or repealable. 12 (f) A distribution to the shareholders of the corporation, except at a rate, in a periodic amount or within a price range set forth in the Articles of Incorporation or determined by the Board of Directors. (g) The appointment of any other committees of the Board of Directors or the members thereof. 4.2 MEETINGS AND ACTION OF COMMITTEES --------------------------------- Meetings and actions of committees shall be governed by, and held and taken in accordance with, the provisions of Article III of these Bylaws, Section 3.6 (place of meetings), Section 3.7 (regular meetings), Section 3.8 (special meetings and notice), Section 3.9 (quorum), Section 3.10 (waiver of notice), Section 3.11 (adjournment), Section 3.12 (notice of adjournment), and Section 3.13 (action without meeting), with such changes in the context of those Bylaws as are necessary to substitute the committee and its members for the Board of Directors and its members; provided, however, that the time of regular meetings of committees may be determined either by resolution of the Board of Directors or by resolution of the committee, that special meetings of committees may also be called by resolution of the Board of Directors, and that notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The Board of Directors may adopt rules for the government of any committee not inconsistent with the provisions of these Bylaws. ARTICLE V. OFFICERS -------- 5.1 OFFICERS -------- The officers of the corporation shall be a President, a Secretary, and a Chief Financial Officer. The corporation may also have, at the discretion of the Board of Directors, a Chairman of the Board, one or more Vice Presidents, one or more Assistant Secretaries, one or more Assistant Treasurers, and such other officers as may be appointed in accordance with the provisions of Section 5.3 of these Bylaws. Any number of offices may be held by the same person. 5.2 APPOINTMENT OF OFFICERS ----------------------- The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 5.3 or Section 5.5 of these Bylaws, shall be chosen by the Board and serve at the pleasure of the Board, subject to the rights, if any, of an officer under any contract of employment. 5.3 SUBORDINATE OFFICERS -------------------- The Board of Directors may appoint, or may empower the Chairman of the Board or the President to appoint, such other officers as the business of the corporation may require, each 13 of whom shall hold office for such period, have such authority, and perform such duties as are provided in these Bylaws or as the Board of Directors may from time to time determine. 5.4 REMOVAL AND RESIGNATION OF OFFICERS ----------------------------------- Subject to the rights, if any, of an officer under any contract of employment, all officers serve at the pleasure of the Board of Directors and any officer may be removed, either with or without cause, by the Board of Directors at any regular or special meeting of the Board or, except in case of an officer chosen by the Board of Directors, by any officer upon whom such power of removal may be conferred by the Board of Directors. Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time specified in that notice; and, unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. 5.5 VACANCIES IN OFFICES -------------------- A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in these Bylaws for regular appointments to that office. 5.6 CHAIRMAN OF THE BOARD --------------------- The Chairman of the Board, if such an officer be elected, shall, if present, preside at meetings of the Board of Directors and exercise and perform such other powers and duties as may from time to time be assigned by the Board of Directors or as may be prescribed by these Bylaws. If there is no President, then the Chairman of the Board shall also be the chief executive officer of the corporation and shall have the powers and duties prescribed in Section 5.7 of these Bylaws. 5.7 PRESIDENT --------- Subject to such supervisory powers, if any, as may be given by the Board of Directors to the Chairman of the Board, if there be such an officer, the President shall be the chief executive officer of the corporation and shall, subject to the control of the Board of Directors, have general supervision, direction, and control of the business and the officers of the corporation. The President shall preside at all meetings of the shareholders and, in the absence or nonexistence of a Chairman of the Board, at all meetings of the Board of Directors. The President shall have the general powers and duties of management usually vested in the office of President of a corporation, and shall have such other powers and duties as may be prescribed by the Board of Directors or these Bylaws. 5.8 VICE PRESIDENTS --------------- In the absence or disability of the President, the Vice Presidents, if any, in order of their rank as fixed by the Board of Directors or, if not ranked, a Vice President designated by the 14 Board of Directors, shall perform all the duties of the President and when so acting shall have all the powers of, and be subject to all the restrictions upon, the President. The Vice Presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the Board of Directors, these Bylaws, the President or the Chairman of the Board. 5.9 SECRETARY --------- The Secretary shall keep or cause to be kept, at the principal executive office of the corporation or such other place as the Board of Directors may direct, a book of minutes of all meetings and actions of Directors, committees of directors and shareholders. The minutes shall show the time and place of each meeting, whether regular or special (and, if special, how authorized and the notice given), the names of those present at directors' meetings or committee meetings, the number of shares present or represented at shareholders' meetings, and the proceedings thereof. The Secretary shall keep, or cause to be kept, at the principal executive office of the corporation or at the office of the corporation's transfer agent or registrar, as determined by resolution of the Board of Directors, a share register, or a duplicate share register, showing the names of all shareholders and their addresses, the number and classes of shares held by each, the number and date of certificates evidencing such shares, and the number and date of cancellation of every certificate surrendered for cancellation. The Secretary shall give, or cause to be given, notice of all meetings of the shareholders and of the Board of Directors required to be given by law or by these Bylaws. The Secretary shall keep the seal of the corporation, if one be adopted, in safe custody and shall have such other powers and perform such other duties as may be prescribed by the Board of Directors or by these Bylaws. 5.10 CHIEF FINANCIAL OFFICER ----------------------- The Chief Financial Officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, retained earnings, and shares. The books of account shall at all reasonable times be open to inspection by any director. The Chief Financial Officer shall deposit all money and other valuables in the name and to the credit of the corporation with such depositaries as may be designated by the Board of Directors. The Chief Financial Officer shall disburse the funds of the corporation as may be ordered by the Board of Directors, shall render to the President and directors, whenever they request it, an account of all of his or her transactions as Chief Financial Officer and of the financial condition of the corporation, and shall have such other powers and perform such other duties as may be prescribed by the Board of Directors or these Bylaws. 15 ARTICLE VI. INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES, -------------------------------------------------- AND OTHER AGENTS ---------------- 6.1 INDEMNIFICATION OF DIRECTORS ---------------------------- The corporation shall, to the maximum extent and in the manner permitted by the Code, indemnify each of its directors against expenses (as defined in Section 317(a) of the Code), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was a director of the corporation. For purposes of this Article VI, a "director" of the corporation includes any person (i) who is or was a director of the corporation, (ii) who is or was serving at the request of the corporation as a director of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or (iii) who was a director of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. 6.2 INDEMNIFICATION OF OTHERS ------------------------- The corporation shall have the power, to the extent and in the manner permitted by the Code, to indemnify each of its employees, officers, and agents (other than directors) against expenses (as defined in Section 317(a) of the Code), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was an employee, officer, or agent of the corporation. For purposes of this Article VI, an "employee" or "officer" or "agent" of the corporation (other than a director) includes any person (i) who is or was an employee, officer, or agent of the corporation, (ii) who is or was serving at the request of the corporation as an employee, officer, or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or (iii) who was an employee, officer, or agent of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. 6.3 PAYMENT OF EXPENSES IN ADVANCE ------------------------------ Expenses and attorneys' fees incurred in defending any civil or criminal action or proceeding for which indemnification is required pursuant to Section 6.1, or if otherwise authorized by the Board of Directors, shall be paid by the corporation in advance of the final disposition of such action or proceeding upon receipt of an undertaking by or on behalf of the indemnified party to repay such amount if it shall ultimately be determined that the indemnified party is not entitled to be indemnified as authorized in this Article VI. 6.4 INDEMNITY NOT EXCLUSIVE ----------------------- The indemnification provided by this Article VI shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any Bylaw, agreement, vote of shareholders or directors or otherwise, both as to action in an official capacity and as to 16 action in another capacity while holding such office. The rights to indemnity hereunder shall continue as to a person who has ceased to be a director, officer, employee, or agent and shall inure to the benefit of the heirs, executors, and administrators of the person. 6.5 INSURANCE INDEMNIFICATION ------------------------- The corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation against any liability asserted against or incurred by such person in such capacity or arising out of that person's status as such, whether or not the corporation would have the power to indemnify that person against such liability under the provisions of this Article VI. 6.6 CONFLICTS --------- No indemnification or advance shall be made under this Article VI, except where such indemnification or advance is mandated by law or the order, judgment or decree of any court of competent jurisdiction, in any circumstance where it appears: (1) That it would be inconsistent with a provision of the Articles of Incorporation, these Bylaws, a resolution of the shareholders or an agreement in effect at the time of the accrual of the alleged cause of the action asserted in the proceeding in which the expenses were incurred or other amounts were paid, which prohibits or otherwise limits indemnification; or (2) That it would be inconsistent with any condition expressly imposed by a court in approving a settlement. 6.7 RIGHT TO BRING SUIT ------------------- If a claim under this Article is not paid in full by the corporation within 90 days after a written claim has been received by the corporation (either because the claim is denied or because no determination is made), the claimant may at any time thereafter bring suit against the corporation to recover the unpaid amount of the claim and, if successful in whole or in part, the claimant shall also be entitled to be paid the expenses of prosecuting such claim. The corporation shall be entitled to raise as a defense to any such action that the claimant has not met the standards of conduct that make it permissible under the Code for the corporation to indemnify the claimant for the claim. Neither the failure of the corporation (including its Board of Directors, independent legal counsel, or its shareholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is permissible in the circumstances because he or she has met the applicable standard of conduct, if any, nor an actual determination by the corporation (including its Board of Directors, independent legal counsel, or its shareholders) that the claimant has not met the applicable standard of conduct, shall be a defense to such action or create a presumption for the purposes of such action that the claimant has not met the applicable standard of conduct. 17 6.8 INDEMNITY AGREEMENTS -------------------- The Board of Directors is authorized to enter into a contract with any director, officer, employee or agent of the corporation, or any person who is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, including employee benefit plans, or any person who was a director, officer, employee or agent of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation, providing for indemnification rights equivalent to or, if the Board of Directors so determines and to the extent permitted by applicable law, greater than, those provided for in this Article VI. 6.9 AMENDMENT, REPEAL OR MODIFICATION --------------------------------- Any amendment, repeal or modification of any provision of this Article VI shall not adversely affect any right or protection of a director or agent of the corporation existing at the time of such amendment, repeal or modification. ARTICLE VII. RECORDS AND REPORTS ------------------- 7.1 MAINTENANCE AND INSPECTION OF SHARE REGISTER -------------------------------------------- The corporation shall keep either at its principal executive office or at the office of its transfer agent or registrar (if either be appointed), as determined by resolution of the Board of Directors, a record of its shareholders listing the names and addresses of all shareholders and the number and class of shares held by each shareholder. A shareholder or shareholders of the corporation holding at least five percent (5%) in the aggregate of the outstanding voting shares of the corporation or who hold at least one percent (1%) of such voting shares and have filed a Schedule 14B with the United States Securities and Exchange Commission relating to the election of directors, shall have an absolute right to do either or both of the following (i) inspect and copy the record of shareholders' names, addresses, and shareholdings during usual business hours upon five (5) days' prior written demand upon the corporation, or (ii) obtain from the transfer agent for the corporation, upon written demand and upon the tender of such transfer agent's usual charges for such list (the amount of which charges shall be stated to the shareholder by the transfer agent upon request), a list of the shareholders' names and addresses who are entitled to vote for the election of directors, and their shareholdings, as of the most recent record date for which it has been compiled or as of a date specified by the shareholder subsequent to the date of demand. The list shall be made available on or before the later of five (5) business days after the demand is received or the date specified therein as the date as of which the list is to be compiled. The record of shareholders shall also be open to inspection and copying by any shareholder or holder of a voting trust certificate at any time during usual business hours upon written demand on the corporation, for a purpose reasonably related to the holder's interests as a shareholder or holder of a voting trust certificate. 18 Any inspection and copying under this Section 7.1 may be made in person or by an agent or attorney of the shareholder or holder of a voting trust certificate making the demand. 7.2 MAINTENANCE AND INSPECTION OF BYLAWS ------------------------------------ The corporation shall keep at its principal executive office or, if its principal executive office is not in the State of California, at its principal business office in California, the original or a copy of these Bylaws as amended to date, which shall be open to inspection by the shareholders at all reasonable times during office hours. If the principal executive office of the corporation is outside the State of California and the corporation has no principal business office in such state, then it shall, upon the written request of any shareholder, furnish to such shareholder a copy of these Bylaws as amended to date. 7.3 MAINTENANCE AND INSPECTION OF OTHER CORPORATE RECORDS ----------------------------------------------------- The accounting books and records and the minutes of proceedings of the shareholders and the Board of Directors, and committees of the Board of Directors shall be kept at such place or places as are designated by the Board of Directors or, in absence of such designation, at the principal executive office of the corporation. The minutes shall be kept in written form, and the accounting books and records shall be kept either in written form or in any other form capable of being converted into written form. The minutes and accounting books and records shall be open to inspection upon the written demand on the corporation of any shareholder or holder of a voting trust certificate at any reasonable time during usual business hours, for a purpose reasonably related to such holder's interests as a shareholder or as the holder of a voting trust certificate. Such inspection by a shareholder or holder of a voting trust certificate may be made in person or by an agent or attorney and the right of inspection includes the right to copy and make extracts. Such rights of inspection shall extend to the records of each subsidiary corporation of the corporation. 7.4 INSPECTION BY DIRECTORS ----------------------- Every director shall have the absolute right at any reasonable time to inspect and copy all books, records, and documents of every kind and to inspect the physical properties of the corporation and each of its subsidiary corporations, domestic or foreign. Such inspection by a director may be made in person or by an agent or attorney and the right of inspection includes the right to copy and make extracts. 7.5 ANNUAL REPORT TO SHAREHOLDERS; WAIVER ------------------------------------- The Board of Directors shall cause an annual report to be sent to the shareholders not later than one hundred twenty (120) days after the close of the fiscal year adopted by the corporation. Such report shall be sent to the shareholders at least fifteen (15) (or, if sent by third-class mail, thirty-five (35)) days prior to the annual meeting of shareholders to be held during the next fiscal year and in the manner specified in Section 2.5 of these Bylaws for giving notice to shareholders of the corporation. 19 The annual report shall contain a balance sheet as of the end of the fiscal year and an income statement and statement of changes in financial position for the fiscal year, accompanied by any report thereon of independent accountants or, if there is no such report, the certificate of an authorized officer of the corporation that the statements were prepared without audit from the books and records of the corporation. The foregoing requirement of an annual report shall be waived so long as the shares of the corporation are held by fewer than one hundred (100) holders of record. 7.6 FINANCIAL STATEMENTS -------------------- If no annual report for the fiscal year has been sent to shareholders, then the corporation shall, upon the written request of any shareholder made more than one hundred twenty (120) days after the close of such fiscal year, deliver or mail to the person making the request, within thirty (30) days thereafter, a copy of a balance sheet as of the end of such fiscal year and an income statement and statement of changes in financial position for such fiscal year. A shareholder or shareholders holding at least five percent (5%) of the outstanding shares of any class of the corporation may make a written request to the corporation for an income statement of the corporation for the three-month, six-month or nine-month period of the current fiscal year ended more than thirty (30) days prior to the date of the request and a balance sheet of the corporation as of the end of that period. The statements shall be delivered or mailed to the person making the request within thirty (30) days thereafter. A copy of the statements shall be kept on file in the principal office of the corporation for twelve (12) months and it shall be exhibited at all reasonable times to any shareholder demanding an examination of the statements or a copy shall be mailed to the shareholder. If the corporation has not sent to the shareholders its annual report for the last fiscal year, the statements referred to in the first paragraph of this Section 7.6 shall likewise be delivered or mailed to the shareholder or shareholders within thirty (30) days after the request. The quarterly income statements and balance sheets referred to in this section shall be accompanied by the report thereon, if any, of any independent accountants engaged by the corporation or the certificate of an authorized officer of the corporation that the financial statements were prepared without audit from the books and records of the corporation. 7.7 REPRESENTATION OF SHARES OF OTHER CORPORATIONS ---------------------------------------------- The Chairman of the Board, the President, any Vice President, the Chief Financial Officer, the Secretary or Assistant Secretary of this corporation, or any other person authorized by the Board of Directors or the President or a Vice President, is authorized to vote, represent, and exercise on behalf of this corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority herein granted may be exercised either by such person directly or by any other person authorized to do so by proxy or power of attorney duly executed by such person having the authority. 20 ARTICLE VIII. GENERAL MATTERS --------------- 8.1 RECORD DATE FOR PURPOSES OTHER THAN NOTICE AND VOTING ----------------------------------------------------- For purposes of determining the shareholders entitled to receive payment of any dividend or other distribution or allotment of any rights or entitled to exercise any rights in respect of any other lawful action (other than with respect to notice or voting at a shareholders meeting or action by shareholders by written consent without a meeting), the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) days prior to any such action. Only shareholders of record at the close of business on the record date are entitled to receive the dividend, distribution or allotment of rights, or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date, except as otherwise provided in the Articles of Incorporation or the Code. If the Board of Directors does not so fix a record date, then the record date for determining shareholders for any such purpose shall be at the close of business on the day on which the Board adopts the resolution relating thereto or the sixtieth (60th) day prior to the date of that action, whichever is later. 8.2 CHECKS; DRAFTS; EVIDENCES OF INDEBTEDNESS ----------------------------------------- From time to time, the Board of Directors shall determine by resolution which person or persons may sign or endorse all checks, drafts, other orders for payment of money, notes or other evidences of indebtedness that are issued in the name of or payable to the corporation, and only the persons so authorized shall sign or endorse those instruments. 8.3 CORPORATE CONTRACTS AND INSTRUMENTS: HOW EXECUTED ------------------------------------------------- The Board of Directors, except as otherwise provided in these Bylaws, may authorize any officer or officers, or agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation; such authority may be general or confined to specific instances. Unless so authorized or ratified by the Board of Directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. 8.4 CERTIFICATES FOR SHARES ----------------------- A certificate or certificates for shares of the corporation shall be issued to each shareholder when any of such shares are fully paid. The Board of Directors may authorize the issuance of certificates for shares partly paid provided that these certificates shall state the total amount of the consideration to be paid for them and the amount actually paid. All certificates shall be signed in the name of the corporation by the Chairman of the Board or the Vice Chairman of the Board or the President or a Vice President and by the Chief Financial Officer or an Assistant Treasurer or the Secretary or an Assistant Secretary, certifying the number of shares 21 and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificate may be by facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed on a certificate has ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if that person were an officer, transfer agent or registrar at the date of issue. 8.5 LOST CERTIFICATES ----------------- Except as provided in this Section 8.5, no new certificates for shares shall be issued to replace a previously issued certificate unless the latter is surrendered to the corporation or its transfer agent or registrar and cancelled at the same time. The Board of Directors may, in case any share certificate or certificate for any other security is lost, stolen or destroyed (as evidenced by a written affidavit or affirmation of such fact), authorize the issuance of replacement certificates on such terms and conditions as the Board may require; the Board may require indemnification of the corporation secured by a bond or other adequate security sufficient to protect the corporation against any claim that may be made against it, including any expense or liability, on account of the alleged loss, theft or destruction of the certificate or the issuance of the replacement certificate. 8.6 CONSTRUCTION; DEFINITIONS ------------------------- Unless the context requires otherwise, the general provisions, rules of construction, and definitions in the Code shall govern the construction of these Bylaws. Without limiting the generality of this provision, the singular number includes the plural, the plural number includes the singular, and the term "person" includes both a corporation and a natural person. ARTICLE IX. AMENDMENTS ---------- 9.1 AMENDMENT BY SHAREHOLDERS ------------------------- New Bylaws may be adopted or these Bylaws may be amended or repealed by the vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that if the Articles of Incorporation of the corporation set forth the number of authorized Directors of the corporation, then the authorized number of Directors may be changed only by an amendment of the Articles of Incorporation. 9.2 AMENDMENT BY DIRECTORS ---------------------- Subject to the rights of the shareholders as provided in Section 9.1 of these Bylaws, Bylaws, other than a Bylaw or an amendment of a Bylaw changing the authorized number of directors (except to fix the authorized number of directors pursuant to a Bylaw providing for a variable number of directors), may be adopted, amended or repealed by the Board of Directors. 22 9.3 RECORD OF AMENDMENTS -------------------- Whenever an amendment or new Bylaw is adopted, it shall be copied in the book of minutes with the original Bylaws. If any Bylaw is repealed, the fact of repeal, with the date of the meeting at which the repeal was enacted or written consent was filed, shall be stated in said book. ARTICLE X INTERPRETATION -------------- 10.1 INTERPRETATION -------------- Reference in these Bylaws to any provision of the California Corporations Code shall be deemed to include all amendments thereof. 23 SECRETARY'S CERTIFICATE OF ADOPTION OF BYLAWS OF HEADLANDS MORTGAGE COMPANY I, the undersigned, do hereby certify: 1. That I am the duly elected and acting Secretary of Headlands Mortgage Company, a California corporation. 2. That the foregoing Bylaws constitute the Bylaws of said corporation as adopted by the Directors of said corporation by unanimous written consent on _______________, 1997. IN WITNESS WHEREOF, I have hereunto subscribed my name this _____ day of ____________, 1997. _______________________________________ Gilbert J. MacQuarrie Secretary 24 BYLAWS OF HEADLANDS MORTGAGE CORPORTIATON History of Actions Taken Related to Bylaws Date ----------------- ---- Bylaws Adopted __________________________________ ____________ __________________________________ ____________ __________________________________ ____________ __________________________________ ____________ __________________________________ ____________ __________________________________ ____________ 25 EX-4.1 4 SPECIMEN COMMON STOCK CERTIFICATE EXHIBIT 4.1 - ----------------- ----------- ---------------- Number Shares - ----------------- ---------------- HEADLANDS(R) MORTGAGE COMPANY INCORPORATED UNDER THE LAWS OF THE STATE OF CALIFORNIA COMMON STOCK COMMON STOCK CUSIP [___________] THIS CERTIFIES THAT IS THE OWNER OF FULLY PAID AND NON ASSESSABLE SHARES OF THE COMMON STOCK, WITHOUT PAR VALUE, OF HEADLANDS(R) MORTGAGE COMPANY transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney upon surrender of this Certificate properly endorsed. This Certificate is not valid until countersigned and registered by the Transfer Agent and Registrar. This Certificate and the shares represented are issued and shall be held subject to all the provisions of the Articles of Incorporation and the Bylaws of the Corporation and any amendments thereto, to all of which the holder of this Certificate, by acceptance hereof, assents. See reverse hereof for a statement regarding the rights, preferences, privileges and restrictions granted to or imposed upon the respective classes or series of shares of stock of the Corporation WITNESS the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers. Dated: PRESIDENT COUNTERSIGNED AND REGISTERED: THE BANK OF NEW YORK SECRETARY TRANSFER AGENT AND REGISTRAR BY AUTHORIZED SIGNATURE A statement of the rights, preferences, privileges and restrictions granted to or imposed upon the respective classes or series of shares of stock of the Corporation, and upon the holders thereof as established by the Articles of Incorporation or by any certificate of determination of preferences, and the number of shares constituting each series or class and the designations thereof, may be obtained by any shareholder of the Corporation upon request and without charge from the Secretary of the Corporation at the principal office of the Corporation. The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM - as tenants in common TEN ENT - as tenants by the entireties JT TEN - as joint tenants with right of survivorship and not as tenants in common UNIF GIFT MIN ACT - ________________ Custodian ________________ (Cust) (Minor) Under Uniform Gifts to Minors Act__________________________ (State) UNIF TRF MIN ACT - _________________ Custodian (until age ____) (Cust) _______________ under Uniform Transfers to Minors Act ___________ (Minor) (State) Additional abbreviations may also be used though not in the above list. FOR VALUE RECEIVED, ___________ hereby sell, assign and transfer unto ________________________________________________________________________________ (PLEASE PRINT OR TYPEWRITE, NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE) ________________________________________________________________________________ ________________________________________________________________________________ __________________________________________________________________________Shares of the common stock represented by the within Certificate, and do hereby irrevocably constitute and appoint ________________________________________________________________________Attorney to transfer the said stock on the books of the within-named Corporation with full power of substitution in the premises. Date_____________________ ________________________________________ ________________________________________ NOTICE THE SIGNATURE(S) TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER. Signature(s) Guaranteed: _____________________________________ The signature should be guaranteed by a brokerage firm or a financial institution that is a member of a securities approved Medallion program, such as Securities Transfer Agents Medallion Program (STAMP), Stock Exchanges Medallion Program (SEMP) or New York Stock Exchange, Inc. Medallion Signature Program (MSP). EX-9.1 5 VOTING TRUST AGREEMENT EXHIBIT 9.1 VOTING TRUST AGREEMENT FOR THE STOCK OF HEADLANDS MORTGAGE COMPANY, MARIN CONVEYANCING CORPORATION, HEADLANDS INSURANCE AGENCY, INC. THIS VOTING TRUST AGREEMENT (the "Trust Agreement") is made and entered into as of the 15th day of September, 1997, between and among HEADLANDS MORTGAGE COMPANY, a California corporation ("HMC"), MARIN CONVEYANCING CORPORATION, a California corporation ("Marin") and HEADLANDS INSURANCE AGENCY, INC., a California corporation ("HIA") (collectively, the "Companies"), each shareholder of the Companies who has executed this Trust Agreement (the "Beneficiary" or "Beneficiaries"), and PETER T. PAUL (the "Voting Trustee"), who is also a Beneficiary and is the Chief Executive Officer and a director of each of the Companies. RECITALS -------- A. Each Beneficiary owns shares of the common stock of HMC, Marin and HIA (collectively, the "Shares"). During the term of this Trust Agreement, the term "Shares" shall be deemed to include: (i) any shares of common stock of HMC, Marin and HIA hereafter acquired by any Beneficiary directly from HMC, Marin or HIA or acquired from another Beneficiary in any non-public transaction at any time; (ii) any securities distributed or issued with respect to the Shares, and (iii) any securities into which Shares may be converted at any time. B. The Beneficiaries have divergent goals in their investment in the Shares and their investment in the Companies. The Jessica M. Paul Irrevocable Trust ("Jessica Irrevocable Trust"), the Peter T. Paul Living Trust ("Peter Living Trust") and Jessica M. Paul Grantor Trust ("Jessica Grantor Trust") wish to hold their Shares for the long term but the Peter Living Trust and the Jessica Grantor Trust wish to be repaid both an unsecured subordinated note dated July 26, 1996, with a face amount of nine million six hundred seventy thousand dollar ($9,670,000) and an unsecured promissory note dated May 21, 1997, with a face amount of seven hundred sixty-eight thousand five hundred ten dollars and sixty- one cents ($768,510.61) owed to them by HMC (collectively the "Subordinated Debt"). The "Hart Family Beneficiaries" consist of Dennis M. Hart, Katherine E. Hart, D. Michael Hart Jr., Elizabeth A. Hart and Christopher K. Hart. The Hart Family Beneficiaries wish to sell some or all of their Shares, depending on the type of transaction. C. If HMC, Marin, HIA or all of them engage in an initial public offering, the Hart Family Beneficiaries wish to authorize the Voting Trustee to obtain piggy-back registration rights for future public offerings and to sell at least the following minimum number of Shares of HMC, Marin, HIA or all of them but no more than the following maximum number of Shares, at the best price the underwriter, selected by the Voting Trustee, can achieve:
Minimum No. of Maximum No. of Shares Shares to be Sold to be Sold -------------- -------------- Katherine E. Hart 25 62.25 D. Michael Hart, Jr. 25 62.25 Elizabeth A. Hart 25 62.25 Christopher K. Hart 25 62.25 --- ------ Total 100 250.00
D. If HMC, Marin, HIA or all of them engage in a merger and receive publicly traded stock, the Hart Family Beneficiaries are willing to authorize the Voting Trustee to receive, in exchange for all of the Hart Family Beneficiaries' Shares, an amount equal to the best price the investment banker selected by the Voting Trustee can achieve, payable at least twenty percent (20%) in cash or publicly traded stock or securities, subject to the usual securities restrictions and/or restrictions necessary to accomplish a pooling of interests, and the balance in debt instruments, securities, or contractual rights, payable over six (6) years at an interest rate at least equal to floating one year LIBOR plus one percent (1%). E. In the event of a sale of at least eighty percent (80%) of the Shares of HMC, Marin, HIA or all of them to a buyer, the Hart Family Beneficiaries are willing to authorize the Voting Trustee to receive, in exchange for all of the Hart Family Beneficiaries' Shares, an amount equal to the best price the investment banker selected by the Voting Trustee can achieve, payable at least twenty percent (20%) in cash or publicly traded stock or securities, subject to the usual securities restrictions and/or restrictions necessary to accomplish a pooling of interests, and the balance in debt instruments, securities, or contractual rights payable over six (6) years at an interest rate at least equal to floating one year LIBOR plus one percent (1%). F. In the event of a sale of substantially all of the assets of HMC, Marin, HIA or all of them, the Hart Family Beneficiaries are willing to authorize the Voting Trustee to receive, in exchange for all of the Hart Family Beneficiaries' Shares, an amount equal to the best price the investment banker selected by the Voting Trustee can achieve, payable at least twenty percent (20%) in cash or publicly traded stock or securities, subject to the usual securities restrictions and/or restrictions necessary to accomplish a pooling of interests and the balance in debt instruments, securities, or contractual rights payable over six (6) years at an interest rate at least equal to floating one year LIBOR plus one percent (1%). G. Due to the interest rate payable on the Subordinated Debt, all of the Beneficiaries wish that the Subordinated Debt be paid immediately in each of the above scenarios. H. The Beneficiaries believe they can collectively achieve their divergent goals by appointing Peter T. Paul as Voting Trustee to act on their behalf to pursue a public offering, 2 merger or sale that would allow the Beneficiaries to sell their Shares and to allow the repayment to the Peter Living Trust and the Jessica Grantor Trust of the Subordinated Debt as discussed above. The Beneficiaries deem it to be in their best interests to confer upon the Voting Trustee the power to vote the Shares as a group on the terms and subject to the conditions set forth in this Trust Agreement. AGREEMENT --------- NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and the mutual provisions contained in this Trust Agreement, the parties agree as follows: 1. APPOINTMENT OF VOTING TRUSTEE. In consideration of the mutual covenants and agreements contained in this Trust Agreement, the Beneficiaries hereby create a trust, and each Beneficiary appoints Peter T. Paul as Voting Trustee of such trust and hereby sets aside, transfers, and delivers to the Voting Trustee the Shares. The Voting Trustee shall hold the Shares in trust for the term set forth in Paragraph 9.1 (Term Of The Trust) and for the benefit of the Beneficiaries, and the heirs, executors, administrators, successors and assigns of the Beneficiaries. Peter T. Paul agrees to serve as the Voting Trustee of the Trust and accepts title to the Shares which are conveyed or transferred to the Voting Trustee under this Trust Agreement, without liability or responsibility for the condition or validity of that title. Such Shares are subject to those proxies previously granted by the owners of such Shares pursuant to the First Amendment to the Headlands Shareholders Settlement and Mutual Release Agreement dated July 26, 1996 (the "Proxies"), and subject to the agreement titled "Agreement Between Stockholders and Operating Philosophy and Principles of a New Corporation dated April 30, 1986" (the "Shareholder Agreement"). Each Beneficiary agrees that the transfer to the Voting Trustee is not a sale or other transfer under the Shareholder Agreement. The Shares have been or will be conveyed or transferred to the Voting Trustee, in trust, with power of sale, only for the uses and purposes and upon the terms set forth in this Trust Agreement. The Voting Trustee agrees to perform the duties of the Voting Trustee and to hold the trust estate, the proceeds thereof, and any other property which may be later added to the trust estate according to the terms of this Trust Agreement. Any shares of stock of one or more of the Companies which may be issued to subscribers other than the Beneficiaries may be similarly subject to all of the terms and conditions of this Trust Agreement upon the following: (i) the Voting Trustee consents to the receipt of the subscribers' stock in one or more of the Companies; (ii) such subscriber endorses and delivers to the Voting Trustee the stock certificates of one or more of the Companies; and (iii) such subscriber signs this Trust Agreement. The trust created by this Trust Agreement is not intended to be, shall not be deemed to be, and shall not be treated as, a general partnership, limited partnership, joint venture, corporation or joint stock company or association. The relationship of Beneficiaries to the Voting Trustee shall be solely that of beneficiaries of the trust created by this Trust Agreement, and the rights of the Beneficiaries shall be limited to those conferred upon the Beneficiaries by this Trust Agreement. 3 2. TRANSFER OF SHARES IN EXCHANGE FOR VOTING TRUST CERTIFICATES. 2.1 Transfer By Beneficiaries To Voting Trustee. Upon the signing of ------------------------------------------- this Trust Agreement, each of the Beneficiaries will duly endorse or cause to be endorsed in blank the certificate or certificates representing all of said shares of stock of all of the Companies now owned by such Beneficiary, and will then deliver such stock certificates to the Voting Trustee. Any and all certificates for additional Shares of one or more of the Companies which shall hereafter be acquired by or issued or transferred to any of the Beneficiaries during the term of this Trust Agreement shall likewise be endorsed and delivered to the Voting Trustee to be held by the Voting Trustee under the terms of this Trust Agreement. Upon termination of this Trust Agreement, the Voting Trustee will immediately take all actions necessary to transfer any and all of the stock certificates of the Companies to the then Beneficiaries. 2.2 Issuance By The Companies Of Stock Certificates To Voting Trustee. ----------------------------------------------------------------- Upon surrender to HMC, Marin and HIA by the Voting Trustee of such endorsed stock certificates transferred by any Beneficiary to this trust, HMC, Marin and HIA shall issue to the Voting Trustee a stock certificate or certificates representing the Shares deposited in trust under this Trust Agreement and registered as follows: "Peter T. Paul as Voting Trustee under a Voting Trust Agreement dated September 15, 1997," and, if required, shall qualify such issuance with the California Commissioner of Corporations. 2.3 Issuance Of Voting Trust Certificates To Beneficiaries. In exchange ------------------------------------------------------ for the voting stock of HMC, Marin and HIA delivered by each Beneficiary and by each person who becomes a signatory to this Trust Agreement, the Voting Trustee shall issue and deliver to such Beneficiary or signatory, voting trust certificates ("Voting Trust Certificates") representing the Shares deposited by such Beneficiary or signatory in substantially the form of Exhibit A (Voting --------- Trust Certificate) to this Trust Agreement. 3. POWERS AND DUTIES OF VOTING TRUSTEE. 3.1 Voting Of Shares. The Voting Trustee shall possess and be entitled ---------------- to exercise all the voting rights and powers of an owner of all Shares deposited under this Trust Agreement to: (i) approve and sign on behalf of any holder of any Shares deposited under this Trust Agreement an Underwriting Agreement, Registration Statement, Market Stand-off or Lock-Up Agreements, Registration Rights Agreement, Co-Sale Agreement or any other agreement, which will permit HMC, Marin, HIA, or any combination thereof to issue shares or securities in a public offering and will permit the shares to be traded on a national securities exchange or in the NASDAQ National Market, provided that such offering provides that the Hart Family Beneficiaries receive the consideration set forth in the Recitals and the Subordinated Debt is repaid in full upon completion of the offering; (ii) approve the sale of the Shares to a buyer, provided that such sale provides that the Hart Family Beneficiaries receive the consideration set forth in the Recitals and that the Subordinated Debt is repaid in full at the time of sale; (iii) approve an agreement for merger of HMC, Marin, HIA or any combination thereof with, or sale of HMC, Marin, HIA or any combination thereof to, an acquiring 4 company, provided that such merger or sale provides that the Hart Family Beneficiaries receive the consideration set forth in the Recitals and that the Subordinated Debt is repaid in full at the time of sale or merger; (iv) approve the merger or combination of one or all of HMC, Marin, HIA or the establishment of Marin or HIA as one or more subsidiaries of HMC to achieve any of the transactions listed in (i) through (iii) above; or (v) convert one or all of HMC, Marin or HIA into a real estate investment trust to achieve one or all of the transactions listed in (i) through (iii) above; (vi) approve the issuance of stock options of up to fifteen percent (15%) of the outstanding shares of HMC or to provide similar bonus compensation to the officers of HMC as recommended by the compensation committee of HMC; or (vii) vote or give written consent at, and take part in, all regular or special meetings of shareholders in HMC, Marin and HIA as to those matters pertaining to Paragraph 3.1. 3.2 Voting Restrictions. Notwithstanding Paragraph 3.1 (Voting Of ------------------- Shares), the Voting Trustee may not vote the Shares of stock subject to this Trust Agreement to dilute the voting or economic rights of the Shares without first obtaining the consent of the Beneficiaries pursuant to Paragraph 3.10 (Polling Of Beneficiaries); provided, however, that the issuance by HMC, Marin, or HIA of shares or securities pursuant to a public offering or the grant of stock options to employees as set forth above is a permissible dilution of the voting or economic rights of the Shares by the Voting Trustee. 3.3 No Sale Of Shares. Except as provided in Paragraph 3.1 (Voting Of ------------------ Shares) and Paragraph 3.7 (Security Interest For Repayment), the Voting Trustee shall have no authority to sell, pledge, hypothecate, encumber or otherwise dispose of any Shares transferred to the Voting Trustee in accordance with this Trust Agreement; provided, however, that if the Voting Trustee receives, as part of a stock split, stock dividend or otherwise, an interest in HMC, Marin or HIA representing fractional Shares, the Voting Trustee shall have the authority to sell or otherwise dispose of such fractional interests. 3.4 Company Notices And Financial Information. The Voting Trustee shall ----------------------------------------- forward to Dennis M. Hart for the Hart Family Beneficiaries and to each of the remaining Beneficiaries, within five (5) calendar days of receipt by the Voting Trustee, copies of all notices of meetings of shareholders, and all of the material sent by HMC, Marin or HIA to the shareholders of HMC, Marin or HIA, which are received by the Voting Trustee as a record shareholder of HMC, Marin or HIA and a copy of the monthly internal financial statement package. 3.5 Other Activities Of Voting Trustee. The Voting Trustee may be a ---------------------------------- Beneficiary entitled to the same rights and benefits as other Beneficiaries, may act as a director, officer, employee or creditor of HMC, Marin, HIA or any combination thereof or any affiliate of HMC, Marin, HIA or any combination thereof and in such capacity may receive compensation, interest or principal payments from HMC, Marin, HIA or any combination thereof and the affiliates of HMC, Marin, HIA or any combination thereof, may purchase, sell, own, hold or deal in Voting Trust Certificates, may contract with HMC, Marin, HIA or any combination thereof or any other party and may be pecuniarily interested in any transaction to which HMC, Marin, HIA or any combination thereof may be a party, or in which HMC, 5 Marin, HIA or any combination thereof may in any way be interested, as fully as though the Voting Trustee were not the Voting Trustee. 3.6 Reimbursement Of Expenses. The Voting Trustee is expressly ------------------------- authorized to incur and pay such reasonable expenses and charges and to employ and pay such agents, attorneys, and counsel as the Voting Trustee may deem necessary and proper for administering this Trust Agreement. Each Voting Trust Certificate holder severally agrees to reimburse the Voting Trustee for any such expenses and charges in proportion to the beneficial interest of such holder in the trust created by this Trust Agreement. 3.7 Security Interest For Repayment. The Voting Trustee is hereby ------------------------------- granted a security interest in the Shares and in any proceeds from the Shares and, if the Beneficiaries do not pay the Voting Trustee the expense reimbursement set forth in Paragraph 3.6 (Reimbursement Of Expenses), the Voting Trustee is authorized to foreclose on such Shares and the proceeds on such Shares, including the right of the Voting Trustee to deduct from the dividends or other property received by the Voting Trustee on the Shares amounts equivalent to the un-reimbursed expenses and the right to sell some or all of the Shares to pay such expenses. 3.8 Discretion Of Trustee. Except as provided in Paragraph 3.2 (Voting --------------------- Restrictions) and Paragraph 3.3 (No Sale Of Shares), the Voting Trustee shall be entitled to exercise the absolute discretion and judgment of the Voting Trustee in voting the Shares or otherwise acting under this Trust Agreement, provided that the Voting Trustee shall not act in a manner inconsistent with the purposes of this Trust Agreement as set forth in the Recitals. 3.9 Polling Of Beneficiaries. Should any question arise upon which the ------------------------ Voting Trustee shall desire the opinion of the Beneficiaries or for which the Voting Trustee may not vote pursuant to Paragraph 3.2 (Voting Restrictions), a meeting for such purpose shall be called by said Voting Trustee. Written notice of each such meeting shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each Beneficiary entitled to vote at such meeting. Such notice shall state the place, date and hour of the meeting and the general nature of the business to be transacted, and no other business may be transacted. Notice of such meetings shall be given in accordance with Section 11 (Notices) addressed to the address of such Beneficiary appearing on the records of the Voting Trustee or given by the Beneficiary to the Voting Trustee for the purpose of notice, or, if no such address appears or is given, at the place where the principal executive office of HMC is located or by the publication at least once in a newspaper of general circulation in the county in which the principal executive office of HMC is located. At such meeting the owners of a majority or more in interest of such Voting Trust Certificates may determine the manner in which they desire said Voting Trustee to act and in all events the Voting Trustee shall not be called upon or required to take any action as a result of such a meeting unless and until the Voting Trustee has been fully and satisfactorily indemnified against all loss, damage, claim or injury to which the Voting Trustee might be subjected, either by reason of the action of the Voting Trustee or by reason of the position of the Voting Trustee as Voting Trustee under this Trust Agreement. 6 The transactions at any meeting of Beneficiaries, however called and noticed, and wherever held, are as valid as though had at a meeting duly held after regular call and notice, if a quorum is present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by proxy, signs a written waiver of notice, or a consent to the holding of the meeting or an approval of the minutes thereof. Any action of the Beneficiaries may be taken without a meeting and without prior notice if a consent in writing, setting forth the actions so taken, shall be signed by the holders of outstanding Voting Trust Certificates having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all Beneficiaries entitled to vote thereon were present and voted. 4. OWNERSHIP AND TRANSFER OF VOTING TRUST CERTIFICATES. 4.1 Certificate Book. The Voting Trustee shall keep at the offices of ---------------- HMC correct books of account of all the business and transactions of the Voting Trustee showing all money received by the Voting Trustee, all distributions made by the Voting Trustee, and all unpaid obligations. The Voting Trustee shall also keep at the offices of HMC a book, to be known as the Certificate Book, containing the names of all persons who are Beneficiaries, the addresses to which notice to the Beneficiaries should be sent, the number of Shares represented by the Trust Certificates held by the Beneficiaries at the time when the Beneficiaries became the owners thereof. This Trust Agreement, the books of account of the trust, and the Certificate Book, shall be open for inspection by any Beneficiary, any shareholder of HMC, Marin or HIA who is not a Beneficiary, or the agent of a Beneficiary or a shareholder of HMC, Marin or HIA, upon the same terms as the record of shareholders of HMC, Marin or HIA is open to inspection to such persons. 4.2 Shareholder Agreement And Proxies. During the term of this Trust --------------------------------- Agreement and upon the termination of this Trust Agreement, the Shares and Trust Certificates shall be subject to the Shareholder Agreement and Proxies and shall be subject to the transfer restrictions in the Shareholder Agreement. 4.3 Transfer of Trust Certificates. Trust Certificates shall be ------------------------------ transferable (provided such transfer does not violate the restrictions on transfer contained in this Trust Agreement, the Shareholder Agreement and the Proxies as set forth on the Trust Certificate or imposed by law) upon: (i) the surrender of such Trust Certificates (duly endorsed in blank, duly endorsed to the transferee, or accompanied by a proper instrument of assignment which is either duly endorsed in blank or endorsed to the transferee); (ii) the attachment to the Trust Certificate of all requisite tax stamps; (iii) the delivery to the Voting trustee of an amount sufficient to pay all federal, state and local taxes or other governmental charges, if any, then payable in connection with such transfer and to reimburse the Voting Trustee for any reasonable and necessary costs, taxes and expenses associated with the transfer; and (iv) recording the transfer in the Certificate Book. Upon the surrender of any Trust Certificate for transfer, the Voting Trustee shall cancel such Trust Certificate and issue to the transferee one (1) or more new Trust Certificates in the same form and representing the same number of Shares of common stock in the aggregate as the Trust Certificate presented for cancellation. 7 4.4 Registered Owner. The Voting Trustee may treat the registered holder ---------------- of each Trust Certificate as the absolute owner thereof for all purposes whatsoever, and, accordingly, shall not be required to recognize any legal, equitable or other claim or interest in such Trust Certificate on the part of any other person, whether or not such person or the Voting Trustee shall have express or other notice thereof. 4.5 Lost Trust Certificates. If a Trust Certificate is lost, stolen, ----------------------- mutilated or destroyed, the Voting Trustee, in the discretion of the Voting Trustee, may issue a duplicate of such Trust Certificate upon the receipt by the Voting Trustee of the following: (i) reasonable evidence of such fact to the Voting Trustee; (ii) a bond, undertaking or indemnity satisfactory to the Voting Trustee; (ii) the existing Trust Certificate, if mutilated; and (iv) sufficient fees and expenses to reimburse the Voting Trustee for the reasonable costs, taxes and expenses associated with the transfer. 4.6 Securities Laws Restrictions. The Trust Certificates may not be ---------------------------- offered, sold, transferred or hypothecated in the absence of registration or the availability of an exemption from registration under the Securities Act of 1933, as amended, and without compliance with any applicable state law regulating securities. Each Beneficiary agrees not to sell, transfer, pledge or hypothecate the Trust Certificates unless the Voting Trustee is reasonably satisfied that the Trust Certificates may be so transferred or disposed of without such registration under the Act or qualification under applicable state laws, and unless such transfer does not violate any applicable provisions of the Shareholder Agreement. Each Beneficiary agrees that the Voting Trustee may refuse to transfer any Trust Certificate except as aforesaid. 5. DISTRIBUTIONS. 5.1 Cash Dividends On The Shares. Until the termination of this Trust ---------------------------- Agreement as hereinafter provided, and except as provided by Paragraph 3.8 (Security Interest For Repayment) and Paragraph 9.4 (Withholding On Distributions), each Beneficiary shall be entitled to receive cash dividends directly from HMC, Marin and HIA. 5.2 Stock And Property Distributions On the Shares. The Voting Trustee ---------------------------------------------- shall receive and hold, subject to the terms of this Trust Agreement, any voting securities of HMC, Marin or HIA issued with respect to the Shares by reason of any capital reorganization, stock split, combination or the like, and shall issue and deliver Trust Certificates therefor to the holders of the Trust Certificates in proportion to the respective interests of such holders as shown on the books of the Voting Trustee. If at any time during the term of this Trust Agreement the Voting Trustee shall receive or collect any monies through a distribution by HMC, Marin or HIA to the Beneficiaries of HMC, Marin or HIA, other than in payment of cash dividends, or shall receive any property (other than shares of stock of HMC, Marin or HIA) through a distribution by HMC, Marin or HIA to the Beneficiaries of HMC, Marin or HIA, the Voting Trustee shall distribute the same to the Beneficiaries registered as such at the close of business on the record date. 8 5.3 Dissolution Distributions From The Shares. In the event of ----------------------------------------- dissolution or total or partial liquidation of HMC, Marin or HIA, whether voluntary or involuntary, the Voting Trustee shall distribute to each Beneficiary, in proportion to the respective interest of each Beneficiary, any monies, securities, rights, or property received by the Voting Trustee with respect to the Shares. 5.4 Subscription Rights From The Shares. If any securities of HMC, Marin ----------------------------------- or HIA are offered for subscription by the holders of common stock of HMC, Marin or HIA, the Voting Trustee shall, promptly upon receipt of notice of such offer, mail a copy of such notice to the Beneficiaries. If a Beneficiary requests that the Voting Trustee subscribe to such offering on behalf of such Beneficiary and the Beneficiary delivers this request and the sum of money required to pay for such subscription at least five (5) days prior to the last day fixed by HMC, Marin or HIA for the subscription and payment for such securities, the Voting Trustee shall make such subscription and payment, and upon receiving from HMC, Marin or HIA the certificates for securities so purchased, shall issue to such Beneficiary a Voting Trust Certificate in respect of such securities. If any subscription rights are not exercised by any of the Beneficiaries entitled thereto, the Voting Trustee may subscribe and pay for the new securities on behalf of any other Beneficiary or Beneficiaries desiring the same who shall comply with the provisions of this Paragraph 5.4 or may, in the discretion of the Voting Trustee, sell such rights and distribute the proceeds of such sale to the Beneficiary entitled thereto. 6. RECORD DATE FOR DETERMINATION OF BENEFICIARIES. The Voting Trustee may fix, in advance, a record date for the determination of the Beneficiaries entitled to notice of any meeting of Beneficiaries, or to vote, or entitled to receive payment of any dividend or other distribution, or any allotment of rights, or to exercise rights in respect of any other lawful action. The record date so fixed shall be not more than sixty (60) nor less than ten (10) days prior to the date of the meeting nor more than sixty (60) days prior to any other action. If the purpose of the record date is a distribution pursuant to Section 5 (Distributions From The Trust), such record date shall be fixed so that each Beneficiary shall receive all amounts to which such Beneficiary is entitled under such Section 5 (Distributions From The Trust). When a record date is fixed, only the Beneficiaries of record on that date are entitled to notice of, and to vote at, the meeting, or to receive the dividend, distribution or allotment of rights, or to exercise of the rights, as the case may be, notwithstanding any transfer of Voting Trust Certificates after the record date. A determination of Beneficiaries of record entitled to notice of or to vote at a meeting of shareholders of HMC, Marin or HIA shall apply to any adjournment of the meeting unless a new record date for the adjourned meeting is fixed by the Voting Trustee. The Voting Trustee shall fix a new record date if the meeting is adjourned for more than forty-five (45) days. If no record date is fixed by the Voting Trustee, the record date for determining Beneficiaries entitled to notice of, or to vote at, a meeting of shareholders of HMC, Marin or HIA shall be at the close of business on the business day immediately before the day on which notice is given or, if notice is waived, at the close of business on the business day immediately before the day on which the meeting is held. The record date for determining Beneficiaries for any purpose other than as set forth in this Section 6 shall be at 9 the close of business on the day on which the Voting Trustee adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such other action, whichever is later. 7. INTERPRETATION OF THE TRUST. The Voting Trustee is authorized and empowered to construe this Trust Agreement and the reasonable construction by the Voting Trustee made in good faith shall be conclusive and binding upon the Beneficiaries and upon all parties to this Trust Agreement. The Voting Trustee may consult with legal counsel, which may be counsel to HMC, Marin or HIA, and any action under this Trust Agreement taken or suffered in good faith by the Voting Trustee in accordance with the opinion of such counsel shall be conclusive upon the parties hereto and the Voting Trustee shall be fully protected and be subject to no liability in respect thereof. 8. LIABILITY AND INDEMNIFICATION OF VOTING TRUSTEE. The Voting Trustee shall have no responsibility: (i) for any action taken by the Voting Trustee, as Voting Trustee; (ii) for acts or omissions of any employee or agent of the Voting Trustee; or (iii) by reason of any error of law, except for the gross negligence or willful breach or misconduct of the Voting Trustee. HMC, Marin or HIA and the Beneficiaries jointly and severally agree to indemnify, defend and hold the Voting Trustee harmless from and against any and all liability arising out of the holding by the Voting Trustee of any stock under this Trust Agreement or any action taken by the Voting Trustee under this Trust Agreement, except for the gross negligence or willful breach or misconduct of the Voting Trustee. The Voting Trustee shall not be required to give any bond or other security for the discharge of the duties of the Voting Trustee. 9. TERMINATION OF THE INTEREST OF A BENEFICIARY OR THE TRUST. 9.1 Term Of The Trust. Each Beneficiary agrees that the trust created by ----------------- the Trust Agreement shall be irrevocable for the term set forth in this Paragraph 9.1. A Beneficiary may not withdraw the Shares of such Beneficiary at any time before the termination of this Trust Agreement. This Trust Agreement shall continue in effect until, and shall terminate upon, the earliest to occur of any of the following events (a "Terminating Event"): (i) September 30, 2000; (ii) the date on which one of the transactions set forth in Paragraph 3.1 (Voting Of Shares) occurs; or (iii) the failure to elect a successor Voting Trustee pursuant to Section 10 (Resignation And Replacement of Voting Trustee). The termination of the Trust shall not terminate: (A) the security interest of the Voting Trustee granted pursuant to Paragraph 3.7 (Security Interest For Repayment); and (B) the exculpation of liability and indemnity provided to the Voting Trustee pursuant to Section 8 (Liability And Indemnification Of Voting Trustee). 9.2 Exchange Of Shares For Voting Trust Certificates Upon Expiration Of ------------------------------------------------------------------- Trust. As soon as practicable after the expiration of the term of this Trust - ----- Agreement as set forth in Paragraph 9.1 (Term Of The Trust), but no longer than ten (10) days after such expiration, the holder of a Voting Trust Certificate may present such Trust Certificate to the Voting Trustee and, upon such presentation, the Voting Trustee shall deliver to such holder a voting stock certificate or certificates of HMC, Marin and HIA, as the case may be, which certificate shall 10 be fully paid and nonassessable; provided, however, that each Beneficiary agrees that such Shares shall be subject to any agreements entered into by the Voting Trustee for such Shares, including Registration Rights Agreements, Piggy-Back Registration Rights, Market Stand-off or Lock-Up Agreements, Underwriting Agreements and Co-Sale Agreements. As a condition to exchanging the Trust Certificates for Shares, the Voting Trustee may require any Beneficiary to execute any agreements confirming that the Shares are subject to the agreements entered into by the Voting Trustee. If any Beneficiary cannot be located or fails or refuses to surrender Voting Trust Certificates in exchange for Shares or other securities, the Voting Trustee may, in the sole discretion of the Voting Trustee, deliver the Shares or other securities to HMC, Marin and HIA, or to any bank or trust company in California, for the benefit of the person or persons entitled thereto. Upon such delivery, the Voting Trustee shall be fully acquitted and discharged with respect to the Shares or other securities. 9.3 Surrender Of Shares For Cancellation Of Interest Of Beneficiary. The --------------------------------------------------------------- Voting Trustee may at any time in the discretion of the Voting Trustee, and to such extent as the Voting Trustee may deem advisable, deliver in exchange for Voting Trust Certificates, certificates for Shares of common stock or other securities of HMC, Marin or HIA in an amount equal to the Shares represented by such Voting Trust Certificates in order to enable the surrender to HMC, Marin or HIA for cancellation of the Shares so delivered, or otherwise as the Voting Trustee may, in the absolute discretion of the Voting Trustee, deem advisable. The delivery of any such Shares to any one (1) or more holders of Voting Trust Certificates shall not entitle such holder or holders or any other holder or holders of Voting Trust Certificates to demand delivery of all or any part of the Shares of HMC, Marin or HIA remaining deposited under this Trust Agreement. 9.4 Withholding On Distributions. The Voting Trustee may withhold and ---------------------------- deduct from every distribution of every kind under this Trust Agreement, including the distributions provided in Section 5 (Distributions From the Trust) and distributions on the termination of a Beneficiary or the trust, the following amounts to the extent that such compensation, expenses and amounts remain unpaid or un-reimbursed: (i) any taxes, assessments, and/or other amounts that may be required by any present or future law or laws to be deducted or withheld; and (ii) expenses and charges incurred pursuant to Paragraph 3.6 (Reimbursement Of Expenses). 9.5 Final Accounting. Within ninety (90) days after the termination of ---------------- this Trust Agreement, the then Voting Trustee will render a final accounting to the Beneficiaries and to HMC, Marin and HIA. 9.6 Replacement Of Voting Trustee And Distribution Of Shares. On January -------------------------------------------------------- 15, 1999, the Voting Trustee shall distribute to all of the Beneficiaries the Shares held in Trust except for eighty (80) Shares held by the Peter Living Trust, ten (10) Shares held by the Jessica Grantor Trust, and ten (10) Shares held by the Jessica Irrevocable Trust, and, after such distribution, Peter T. Paul shall resign as Voting Trustee and Dennis M. Hart shall thereafter be Voting Trustee. 11 10. RESIGNATION AND REPLACEMENT OF VOTING TRUSTEE. The Voting Trustee may at any time resign by delivering to HMC, Marin or HIA and the Beneficiaries in writing the resignation of the Voting Trustee to take effect thirty (30) days thereafter. In the event of the resignation, death, or permanent disability of the Voting Trustee, the Beneficiaries holding fifty-one percent (51%) of the Voting Trust Certificates shall, at their discretion, elect a new Voting Trustee. If the Beneficiaries do not elect a new Voting Trustee within sixty (60) days following such resignation, death or determination of disability, then the trust created by this Trust Agreement shall terminate. A duly elected successor Voting Trustee shall have all the rights, powers and duties of a Voting Trustee under this Trust Agreement in the same manner as if originally named as a Voting Trustee in this Trust Agreement. 11. NOTICES. All notices, requests and other communications provided for in this Trust Agreement shall be in writing, unless otherwise specified in this Trust Agreement, and shall be delivered by hand, by air courier, by facsimile (with receipt confirmed) or by first-class mail, postage prepaid, to the Hart Family Beneficiaries as set forth below and as for the other Beneficiaries to the address for each Beneficiary set forth on the Voting Trust Certificate of such Beneficiary or such different address as may be delivered by such Beneficiary to the Voting Trustee. Any notice to the Voting Trustee shall be sufficiently given by mailing such notice to the Voting Trustee at the following address: Peter T. Paul as Voting Trustee Headlands Mortgage Company 700 Larkspur Landing Circle, Suite 250 Larkspur, CA 94939 Any notice to the Hart Family Beneficiaries shall be sufficiently given by mailing such notice to: Hart Family Beneficiaries c/o J. Michael Shepherd Brobeck, Phleger & Harrison LLP Spear Street Tower One Market Street San Francisco, CA 94105 All notices shall be conclusively deemed to have been received on the earlier of: (i) actual receipt by the addressee; (ii) confirmation of receipt by facsimile; or (iii) three (3) business days after deposit in the United States mail or with a courier. 12. TITLES AND CAPTIONS. The parties agree that this Trust Agreement contains Section, Paragraph or subparagraph titles or captions only as a matter of convenience to facilitate references in this Trust Agreement, and that the use of these titles or captions shall in no way limit, explain, define, amend, supplement or extend the text and the provisions of any Section, Paragraph or subparagraph of this Trust Agreement. 12 13. GOVERNING LAW. The parties have entered into this Trust Agreement in the State of California and agree that the laws of the State of California govern this Trust Agreement and all questions with respect to the Trust Agreement, the interpretation of the Trust Agreement and the rights and liabilities of the parties. The parties agree that the proper venue for disputes between the parties shall be San Francisco, California and the parties irrevocably submit to the exclusive jurisdiction of and service of process through the appropriate state or federal court located in San Francisco, California, subject to the provisions of Section 14 (Resolution Of Disputes). 14. RESOLUTION OF DISPUTES. 14.1 Mediation. If a dispute, controversy or claim: (i) occurs, in law --------- or in equity; (ii) involves the Voting Trustee, the Beneficiaries, HMC, Marin or HIA; and (iii) arises under, out of, in connection with, or in relation to this Trust Agreement and any amendments to this Trust Agreement or a breach of this Trust Agreement, the parties agree first to try in good faith to settle the dispute by mediation under the Commercial Mediation Rules of the American Arbitration Association before resorting to alternative dispute resolution as set forth below. 14.2 Alternative Dispute Resolution. If the mediation provided by ------------------------------ Paragraph 14.1 (Mediation) does not resolve the dispute within thirty (30) calendar days from the date the dispute, controversy or claim is submitted to mediation by any person (the "Mediation Period"), the parties agree that neutral binding alternative dispute resolution shall decide and settle such dispute (the "ADR Process"). Within ten (10) calendar days following the expiration of the Mediation Period, the parties agree to deliver a notice of submission of dispute ("Notice Of Submission") to the office of Judicial Arbitration and Mediation Services ("JAMS") in San Francisco, California, and to hold any hearing for binding resolution pursuant to the ADR Process in San Francisco, California, as follows: 14.2.1 Selection Of Hearing Officer. JAMS shall promptly select a ---------------------------- single retired California Superior Court Judge to be the hearing officer ("Hearing Officer"). The Hearing Officer shall not have any actual or perceived conflict of interest with: (i) any party; (ii) any affiliate of a party; or (iii) the respective counsel of any party or the affiliate of any party. The Hearing Officer shall have extensive and recent civil trial experience and shall not have been primarily a judge serving in the criminal courts. The first hearing day shall be scheduled not later than thirty (30) calendar days following the appointment of the Hearing Officer and the hearing process shall be concluded within thirty (30) calendar days from commencement. 14.2.2 Hearing. The Hearing Officer shall preside over the ADR ------- Process and shall take relevant evidence and testimony at an oral hearing as if such Hearing Officer were sitting as a California Superior Court Judge. At the conclusion of the oral hearing, the Hearing Officer shall orally announce a tentative decision on the facts and issues which form the basis of the dispute. 13 14.2.3 Decision Of Hearing Officer. Within ten (10) calendar days --------------------------- following conclusion of the oral hearing, the Hearing Officer shall prepare and deliver to each of the parties a written decision, accompanied by a statement of facts, law, underlying reasons and conclusions necessary to fully explain the decision of the Hearing Officer ("Final Decision"). In announcing the tentative decision and in rendering the Final Decision, the Hearing Officer shall be required to follow California law in the interpretation of any document or agreement, including this Trust Agreement, in admitting evidence and in fashioning a remedy. The Hearing Officer shall not have the power or authority to award any amount in the nature or character of punitive or exemplary damages, but shall have the power to issue an award for compensatory damages, and shall have the power and authority to issue an injunction or make any award in the nature or character of equitable relief. If the Final Decision requires payment by any one (1) party of any amount of money to the other party, the Hearing Officer shall require that payment be made within thirty (30) calendar days following issuance of the Final Decision, and, if payment is not timely made, the Final Decision shall provide the party to whom payment is due with the right but not the obligation to seek immediate enforcement of the Final Decision by a court of competent jurisdiction. 14.2.4 Costs. The Hearing Officer shall divide the parties in the ----- dispute into groups of similar interests, and the fees and costs for JAMS and the Hearing Officer shall be pro-rated between these groups and be payable by these groups. Each party shall pay the attorneys' fees and costs of such party. If advance payment or deposit is required prior to commencement of the ADR Process, each party to the dispute hereby represents and warrants that such party shall timely pay and deposit said amount. If any party fails to timely pay any amount required by the Hearing Officer or JAMS, the non-defaulting party shall have the right but not the obligation to make said payment or apply to the Hearing Officer for a noticed hearing on the issue of payment of fees and seek entry of a default award against the defaulting party. 14.2.5 Remedies To Enforce Final Decision And Mediation. The ------------------------------------------------ parties acknowledge that it would be impossible to fix money damages for violations of this Trust Agreement and that such violations would cause irreparable injuries for which active remedy at law is not available, and, therefore, this Trust Agreement may be enforced by specific performance or injunctive relief. Notwithstanding the foregoing, nothing in this Trust Agreement shall be interpreted to bar any party hereto from seeking injunctive relief with respect to any controversy or claim arising out of or relating to this Trust Agreement. The filing of a judicial action to enable the recording of a notice of pending action for order of attachment, receivership, injunction, or other provisional remedies, shall not constitute a waiver of the right to the ADR Process under this provision. In no event shall a party have the right to demand the ADR Process after the date when institution of legal or equitable proceedings based on such claim, dispute or any other matter in question would be barred by the applicable statute of limitations. This agreement to engage in the ADR Process shall be specifically enforceable under prevailing law. 14.2.6 Notice. BY INITIALING IN THE SPACE BELOW YOU ARE AGREEING ------ TO HAVE ANY DISPUTE ARISING OUT OF THE MATTERS INCLUDED 14 IN THE "ALTERNATIVE DISPUTE RESOLUTION" PROVISION OF THIS TRUST AGREEMENT DECIDED BY NEUTRAL ARBITRATION AS PROVIDED BY CALIFORNIA LAW AND YOU ARE GIVING UP ANY RIGHTS YOU MIGHT POSSESS TO HAVE THE DISPUTE LITIGATED IN A COURT OR JURY TRIAL. BY INITIALING IN THE SPACE BELOW YOU ARE GIVING UP YOUR JUDICIAL RIGHTS TO DISCOVERY AND APPEAL, UNLESS THOSE RIGHTS ARE SPECIFICALLY INCLUDED IN THE ----- "ALTERNATIVE DISPUTE RESOLUTION" PROVISION OF THIS TRUST AGREEMENT. IF YOU REFUSE TO SUBMIT TO THE ADR PROCESS AFTER AGREEING TO THIS PROVISION, YOU MAY BE COMPELLED TO SUBMIT TO THE ADR PROCESS UNDER THE AUTHORITY OF THE CALIFORNIA CODE OF CIVIL PROCEDURE. YOUR AGREEMENT TO THIS ADR PROVISION IS VOLUNTARY. WE HAVE READ AND UNDERSTAND THE FOREGOING AND AGREE TO SUBMIT DISPUTES ARISING OUT OF THE MATTERS INCLUDED IN THE "ALTERNATIVE DISPUTE RESOLUTION" PROVISION OF THIS TRUST AGREEMENT TO NEUTRAL ALTERNATIVE DISPUTE RESOLUTION. VOTING TRUSTEE'S INITIALS _____ COMPANY'S INITIALS _____ TRUSTEE OF PETER T. PAUL LIVING TRUSTEE OF JESSICA M. PAUL INITIALS _____ GRANTOR TRUST TRUST INITIALS _____ TRUSTEE OF JESSICA M. PAUL IRREVOCABLE TRUST INITIALS _____ DENNIS M. HART'S INITIALS _____ KATHERINE E. HART'S INITIALS _____ D. MICHAEL HART, JR.'S INITIALS _____ ELIZABETH A. HART'S INITIALS _____ CHRISTOPHER K. HART'S INITIALS _____ 15. SUCCESSORS AND ASSIGNS. Except as expressly set forth to the contrary, this Trust Agreement shall be binding upon and inure to the benefit of the successors, assigns, heirs, administrators, executors and legal representatives of the parties hereto. 16. COUNTERPARTS. The parties may execute this Trust Agreement in any number of counterparts and, as so executed, the counterparts shall constitute one and the same agreement. The parties agree that each such counterpart is an original and shall be binding upon all of the parties, even though all of the parties are not signatories to the same counterpart. One of such counterparts shall be kept with the records of the Voting Trustee by the Voting Trustee at the principal business office of HMC, Marin and HIA. HMC, Marin and HIA and each Beneficiary shall be furnished with a conformed copy of this Trust Agreement. 15 IN WITNESS WHEREOF, the parties have executed this Trust Agreement as of the day and year first above written. "COMPANIES" "HMC" HEADLANDS MORTGAGE COMPANY, a California corporation By:________________________________ PETER T. PAUL, Chief Executive Officer "MARIN" MARIN CONVEYANCING CORPORATION, a California corporation By:________________________________ PETER T. PAUL, Chief Executive Officer "HIA" HEADLANDS INSURANCE AGENCY, INC., a California corporation By:________________________________ PETER T. PAUL, Chief Executive Officer "VOTING TRUSTEE" ___________________________________ PETER T. PAUL, as Voting Trustee of the Voting Trust for the Stock of Headlands Mortgage Company, a California corporation. [SIGNATURES CONTINUED ON FOLLOWING PAGE] 16 "BENEFICIARIES" THE JESSICA M. PAUL IRREVOCABLE TRUST __________________________________ DANIEL W. PAUL, as Trustee of the Jessica M. Paul Irrevocable Trust dated May 21, 1997. No. of Shares: 60 THE JESSICA M. PAUL GRANTOR TRUST __________________________________ GILBERT J. MACQUARRIE, as Trustee of the Jessica M. Paul Grantor Trust dated May 21, 1997 No. of Shares: 60 PETER T. PAUL LIVING TRUST __________________________________ PETER T. PAUL, as Trustee of the Peter T. Paul Living Trust dated May 21, 1997 No. of Shares: 480 _________________________________ DENNIS M. HART No. of Shares: 100 _________________________________ KATHERINE E. HART No. of Shares: 100 _________________________________ D. MICHAEL HART, JR. No. of Shares: 66_ _________________________________ ELIZABETH A. HART No. of Shares: 66_ _________________________________ CHRISTOPHER K. HART No. of Shares: 66_ 17 EXHIBIT A TO THE VOTING TRUST AGREEMENT FOR THE SHARES OF HEADLANDS MORTGAGE COMPANY, MARIN CONVEYANCING CORPORATION, HEADLANDS INSURANCE AGENCY, INC. VOTING TRUST CERTIFICATE No. __________ __________________________________ (_______) Voting Common Shares of Headlands Mortgage Company __________________________________ (_______) Voting Common Shares of Marin Conveyancing Corporation __________________________________ (_______) Voting Common Shares of Headlands Insurance Agency, Inc. Issued to the following Beneficiary: Name: _____________________________ Address: _____________________________ _____________________________ THIS IS TO CERTIFY THAT: 1. This Voting Trust Certificate is issued in the name of the Beneficiary set forth above evidencing the ownership of the number of voting common stock set forth above of the capital stock of Headlands Mortgage Company, Marin Conveyancing Corporation and Headlands Insurance Agency, Inc. (collectively, the "Companies"). This Voting Trust Certificate is issued pursuant to, and the rights of the holder hereof are subject to, the terms and conditions of a Voting Trust Agreement (the "Trust Agreement") dated September __, 1997, by and among the Companies, the Beneficiaries and Peter T. Paul (the "Voting Trustee"). Executed copies of the Voting Trust Agreement are kept on file by the Voting Trustee and the Secretaries of the Companies at the principal offices of the Companies at 700 Larkspur Landing Circle, Suite 250, Larkspur, California 94939. The Trust Agreement as filed is open to inspection in accordance with the requirements of law. A conformed copy of the Voting Trust Agreement has been delivered to the holder hereof. 2. By acceptance of this Voting Trust Certificate, the holder hereof agrees to be bound by the terms of this Voting Trust Certificate and of the Voting Trust Agreement. 3. Upon the expiration of the term of the trust as set forth in Paragraph 9.1 (Term Of The Trust) of the Trust Agreement, the above named holder of this Voting Trust Certificate shall be entitled to receive a certificate or certificates, for an aggregate of ________________________ (______) shares of voting common stock of Headlands Mortgage Company, ________________________ (______) shares of voting common stock of Marin Conveyancing Corporation, and ________________________ (______) shares of voting common stock of Headlands Insurance Agency, Inc., or any securities and/or cash received by the Voting Trustee in exchange thereof and, in the meantime and from time to time, to receive payments of cash dividends, if any, on a like number of shares standing in the name of such holder; provided, however, that the Voting Trustee is permitted to withhold upon any distributions of dividends or upon termination of the Trust Agreement if any expenses of administration are not paid by the Beneficiary and the Voting Trustee is granted a security interest in the Shares and the proceeds from such Shares to secure the repayment of these expenses. If the Voting Trustee shall receive any certificates for shares of common stock of HMC, Marin or HIA or other voting securities issued by way of dividend on or in exchange for the stock certificates for shares represented by this Voting Trust Certificate, the Voting Trustee shall hold such stock certificates in accordance with the terms of the Voting Trust Agreement and shall issue Voting Trust Certificates therefor. 4. Until the retransfer to the holder hereof of certificates for the shares of common stock represented by this Voting Trust Certificate, the Voting Trustee shall possess and be entitled, in the discretion of the Voting Trustee, to exercise all rights and powers to vote such shares as provided in the Voting Trust Agreement, and to give consents with respect to any lawful corporate action, and no holder of this Voting Trust Certificate shall in such capacity have any rights or powers to vote such shares or to give consents with respect to or otherwise take part in any corporate action. 5. This Voting Trust Certificate is transferable only in accordance with the terms of the Voting Trust Agreement and only upon: (i) the surrender of such Voting Trust Certificate (duly endorsed in blank, duly endorsed to the transferee, or accompanied by a proper instrument of assignment which is either duly endorsed in blank or duly endorsed to the transferee); (ii) the attachment to this Voting Trust Certificate of all requisite tax stamps; (iii) the delivery to the Voting Trustee of an amount sufficient to pay all federal, state and local taxes or other governmental charges, if any, then payable in connection with such transfer and to reimburse the Voting Trustee for the costs, taxes and expenses associated with the transfer, including reasonable attorneys' fees and costs; and (iv) upon recording the transfer in the Certificate Book. Until this Voting Trust Certificate is transferred as above, the Voting Trustee may treat the registered holder hereof as the absolute owner hereof for all purposes whatsoever. 3 IN WITNESS WHEREOF, the undersigned Voting Trustee has caused this Voting Trust Certificate to be signed this _____ day of _______________, 1997. "VOTING TRUSTEE" ___________________________________ PETER T. PAUL, as Voting Trustee of the Voting Trust for the Stock of Headlands Mortgage Company, a California corporation. 4 VOTING TRUST AGREEMENT FOR THE STOCK OF HEADLANDS MORTGAGE COMPANY, MARIN CONVEYANCING CORPORATION HEADLANDS INSURANCE AGENCY, INC. TABLE OF CONTENTS FOR VOTING TRUST AGREEMENT FOR THE STOCK OF HEADLANDS MORTGAGE COMPANY, MARIN CONVEYANCING CORPORATION, HEADLANDS INSURANCE AGENCY, INC.
Page ---- 1. APPOINTMENT OF VOTING TRUSTEE..........................................................................3 2. TRANSFER OF SHARES IN EXCHANGE FOR VOTING TRUST CERTIFICATES...........................................4 2.1 Transfer By Beneficiaries To Voting Trustee.......................................................4 2.2 Issuance By The Companies Of Stock Certificates To Voting Trustee.................................4 2.3 Issuance Of Voting Trust Certificates To Beneficiaries............................................4 3. POWERS AND DUTIES OF VOTING TRUSTEE....................................................................4 3.1 Voting Of Shares..................................................................................4 3.2 Voting Restrictions...............................................................................5 3.3 No Sale Of Shares.................................................................................5 3.4 Company Notices And Financial Information.........................................................5 3.5 Other Activities Of Voting Trustee................................................................5 3.6 Reimbursement Of Expenses.........................................................................6 3.7 Security Interest For Repayment...................................................................6 3.8 Discretion Of Trustee.............................................................................6 3.9 Polling Of Beneficiaries..........................................................................6 4. OWNERSHIP AND TRANSFER OF VOTING TRUST CERTIFICATES....................................................7 4.1 Certificate Book..................................................................................7 4.2 Shareholder Agreement And Proxies.................................................................7 4.3 Transfer of Trust Certificates....................................................................7 4.4 Registered Owner..................................................................................8 4.5 Lost Trust Certificates...........................................................................8 4.6 Securities Laws Restrictions......................................................................8 5. DISTRIBUTIONS..........................................................................................8 5.1 Cash Dividends On The Shares......................................................................8 5.2 Stock And Property Distributions On the Shares....................................................8 5.3 Dissolution Distributions From The Shares.........................................................9 5.4 Subscription Rights From The Shares...............................................................9 6. RECORD DATE FOR DETERMINATION OF BENEFICIARIES.........................................................9
-1- 7. INTERPRETATION OF THE TRUST...............................................................................10 8. LIABILITY AND INDEMNIFICATION OF VOTING TRUSTEE...........................................................10 9. TERMINATION OF THE INTEREST OF A BENEFICIARY OR THE TRUST.................................................10 9.1 Term Of The Trust.................................................................................10 9.2 Exchange Of Shares For Voting Trust Certificates Upon Expiration Of Trust.........................10 9.3 Surrender Of Shares For Cancellation Of Interest Of Beneficiary...................................11 9.4 Withholding On Distributions......................................................................11 9.5 Final Accounting..................................................................................11 10. RESIGNATION AND REPLACEMENT OF VOTING TRUSTEE.............................................................12 11. NOTICES...................................................................................................12 12. TITLES AND CAPTIONS.......................................................................................12 13. GOVERNING LAW.............................................................................................13 14. RESOLUTION OF DISPUTES....................................................................................13 14.1 Mediation.........................................................................................13 14.2 Alternative Dispute Resolution....................................................................13 14.2.1 Selection Of Hearing Officer......................................................................13 14.2.2 Hearing...........................................................................................13 14.2.3 Decision Of Hearing Officer.......................................................................14 14.2.4 Costs.............................................................................................14 14.2.5 Remedies To Enforce Final Decision And Mediation..................................................14 14.2.6 Notice............................................................................................14 15. SUCCESSORS AND ASSIGNS....................................................................................15 16. COUNTERPARTS..............................................................................................15
-2- FIRST AMENDMENT TO THE VOTING TRUST AGREEMENT FOR THE STOCK OF HEADLANDS MORTGAGE COMPANY, MARIN CONVEYANCING CORPORATION AND HEADLANDS INSURANCE AGENCY, INC. THIS FIRST AMENDMENT TO THE VOTING TRUST AGREEMENT (the "Amendment") is made and entered into as of the 17th day of October, 1997, between and among HEADLANDS MORTGAGE COMPANY, a California corporation ("HMC"), MARIN CONVEYANCING CORPORATION, a California corporation ("Marin") and HEADLANDS INSURANCE AGENCY, INC., a California corporation ("HIA") (collectively, the "Companies"), each shareholder of the Companies who has executed this Amendment (the "Beneficiary" or "Beneficiaries"), and PETER T. PAUL (the "Voting Trustee"), who is also a Beneficiary and is the Chief Executive Officer and a director of each of the Companies. RECITALS -------- A. The parties hereto executed a Voting Trust Agreement effective September 15, 1997 (the "Trust Agreement"). The terms defined in the Trust Agreement have the same definitions in this Amendment. The parties to the Trust Agreement provided in Recital C that, in the event of an initial public offering, certain shares of each of the Hart Family Beneficiaries would be sold other than shares held by Dennis M. Hart. The parties wish to revise the Recital C to change the order of the sale of the shares in the event of an initial public offering to provide first for the sale of a minimum number of 100 shares representing the holding by each of D. Michael Hart Jr., Elizabeth A. Hart, and Christopher K. Hart of thirty-three and one-third (33 _) Shares, then, if additional shares can be sold, the balance of the shares held by D. Michael Hart Jr., Elizabeth A. Hart and Christopher K. Hart, pro-rata among them, and then, if additional shares can be sold, up to fifty (50) shares held by Katherine E. Hart. In addition, as of the date of this Amendment, Dennis M. Hart has been unable to deliver the physical stock certificate representing the 100 shares of HMC held of record in his name and Katherine E. Hart has been unable to deliver the physical stock certificate representing 50 shares of HMC held of record in her name since a lender holds these shares as a security interest for loans which are currently in default. Dennis M. Hart and Katherine E. Hart are willing to authorize the Voting Trustee to contact the lender to obtain delivery to the Voting Trust of the share certificates currently held by the lender and, if 250 shares of HMC are being sold in an initial public offering, to arrange for the fifty (50) shares held by such lender attributable to Katherine Hart to be sold in any initial public offering. B. To streamline the management of HMC, Marin and HIA, the Beneficiaries also are willing to authorize the Voting Trustee to sign on their behalf the agreements attached hereto as Exhibit A and Exhibit B, granting HMC the option to purchase the shares of Marin and/or HIA at the book value of these companies of $170,000 for Marin and $60,000 for HIA; provided however that the option payments of $3,285 for Marin and $1,715 for HIA and all the additional payments for the stock of Marin and HIA are made directly to the Beneficiaries. C. To attract quality directors to the Board of Directors of the Company, the Beneficiaries are also willing to amend Section 3.2(vi) to permit the stock options authorized by that section to be offered to both directors who are not employees of the Company and officers. AGREEMENT --------- NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and the mutual provisions contained in this Amendment, the parties agree as follows: 1. AMENDMENT OF THE RECITALS. The parties agree that Recital C in the Trust Agreement is deleted in its entirety and the following is inserted in its place: C. If HMC, Marin, HIA or all of them engage in an initial public offering, the Hart Family Beneficiaries wish to authorize the Voting Trustee to obtain piggy-back registration rights for future public offerings of unsold shares of HMC, Marin and HIA and to sell at least the following minimum number of Shares of HMC, Marin, HIA or all of them but no more than the following maximum number of Shares, at the best price the underwriter, selected by the Voting Trustee, can achieve. The minimum number of shares to be sold are 100 shares representing the holding by each of D. Michael Hart Jr., Elizabeth A. Hart, and Christopher K. Hart of thirty-three and one-third (33 _) Shares, then, if additional shares can be sold, the balance of the shares held by D. Michael Hart Jr., Elizabeth A. Hart, and Christopher K. Hart, pro-rata among them, and then, if additional shares can be sold, up to fifty (50) shares held by Katherine E. Hart for a total maximum number of Shares of two hundred and fifty (250). 2. AUTHORIZATION OF VOTING TRUSTEE TO OBTAIN TRANSFER OF CERTIFICATES. The following is appended to follow after the last sentence of Paragraph 2.1 (Transfer By Beneficiaries To Voting Trustee): Dennis M. Hart and Katherine E. Hart authorize the Voting Trustee to contact and negotiate directly with any lender who has physical possession of any stock certificates of any of the Companies to obtain the release of such shares to the Voting Trustee without obtaining any further consent from Dennis M. Hart or Katherine E. Hart for such release. Dennis M. Hart and Katherine E. Hart are hereby authorizing the Voting Trustee: (i) to arrange for such lender to accept the Voting Trust Certificates as substitute collateral for the security interest of such lender; (ii) to arrange for the sale of Katherine E Hart's shares held by such lender in any initial public offering, provided such sale is consistent with the ordering provided by Recital C; (iii) to transfer the tradeable Shares received in any initial public offering and/or funds obtained in the sale of any Share in an initial public offering into an escrow or interpleader for the benefit of such lender, and/or (iii) to rely on a written statement from such lender stating the amount of the debt secured by such certificates and, notwithstanding Paragraph 5.1 (Cash Dividends On The Shares) and Paragraph 5.2 (Stock And Property Distributions On The Shares), to permit any distributions on such certificates held by such lender or the sales proceeds from the sale of such shares in any public offering to repay to such lender the amount set forth on such written statement. Dennis M. Hart and Katherine E. Hart hereby release the Voting Trustee from any liability the Voting Trustee may have to Dennis M. Hart and Katherine E. Hart as a result of the negotiations by the Voting Trustee with a lender to obtain the release of the stock certificates of any of the Companies and the repayment of any of the amounts due to any lenders holding the stock certificates of the Companies as security. 3. OPTION GRANTED TO HMC FOR SHARES IN MARIN AND HIC. The following is appended to follow after the last sentence of Paragraph 3.3 (No Sale Of Shares): Notwithstanding the provisions above of this Paragraph 3.3, the Beneficiaries authorize the Voting Trustee to enter into the Option Agreements attached hereto as Exhibit A and Exhibit B on behalf of each of the Beneficiaries to grant to --------- --------- HMC an option to purchase all of the Marin and HIC shares owned by the Beneficiaries; provided however that HMC shall make all option payments and purchase price payments directly to the Beneficiaries. Notwithstanding Paragraph 9.1 (Term Of Trust), the Voting Trust shall not terminate as to the Marin and HMC shares, while either option remains unexercised by HMC. If the Option is exercised, each Beneficiary shall submit their Voting Trust certificates to the Voting Trustee and the Voting Trustee shall issue new Voting Trust Certificates which evidence the withdrawal of such shares from the Voting Trust. If the Option is not exercised and the Voting Trustee must distribute share certificates of Marin and HMC to any Beneficiary, the Voting Trustee shall place a legend on the shares to evidence the granting of the option to HMC on such shares. 4. GRANT OF STOCK OPTIONS IN HMC TO NON-EMPLOYEE DIRECTORS. 4.1 Subsection (vi) of Paragraph 3.1 (Voting of Shares) of the Trust Agreement is deleted in its entirety and the following is inserted in its place: (vi) approve the issuance of stock options of up to fifteen percent (15%) of the outstanding shares of HMC or to provide similar bonus compensation to the officers of HMC and those directors who are not employees of HMC, as recommended by the compensation committee of HMC 4.2 Paragraph 3.2 (Voting Restrictions) is deleted in its entirety and the following is inserted in its place: 3.2 Voting Restrictions. Notwithstanding Paragraph 3.1 (Voting Of ------------------- Shares), the Voting Trustee may not vote the Shares of stock subject to this Trust Agreement to dilute the 3 voting or economic rights of the Shares without first obtaining the consent of the Beneficiaries pursuant to Paragraph 3.10 (Polling Of Beneficiaries); provided, however, that the issuance by HMC, Marin, or HIA of shares or securities pursuant to a public offering or the grant of stock options to non- employee directors, to officers or employees as set forth above is a permissible dilution of the voting or economic rights of the Shares by the Voting Trustee. 5. CONTINUATION OF VOTING TRUST AFTER AN INITIAL PUBLIC OFFERING. The following new paragraph 9.7 is adopted as part of the Voting Trust Agreement: 9.7 Continuation After An Initial Public Offering. Notwithstanding --------------------------------------------- Paragraph 9.1 (Term Of The Trust), each Beneficiary and the Voting Trustee agree that if HMC engages in a public offering such that the shares of HMC becoming publicly traded on an exchange, then: (i) the trust created by the Trust Agreement shall continue until the earliest of (A) September 30, 2000; or (B) the failure to elect a successor Voting Trustee pursuant to Section 10 (Resignation And Replacement Of Voting Trustee); (ii) Paragraph 9.6 (Resignation Of Voting Trustee And Distribution Of Shares) shall not apply and shall not have any force and effect after such public offering; (iii) each Beneficiary may request that the Voting Trustee sell on the public market all or part of the shares of HMC attributable to such Beneficiary at the best execution price reasonably attainable by such Voting Trustee, subject to any lock-up provisions restricting the sale of such shares and federal or state securities restrictions in making such sales; and the Voting Trustee shall distribute the net proceeds from such sales to such Beneficiaries within a reasonable time after the receipt of the proceeds from such sale; (v) notwithstanding Section 3.2 (Voting Restrictions), the Voting Trustee has the authority to vote to amend the articles of HMC to permit the elimination of cumulative voting upon a public offering by HMC; and (vi) the provision of the last phrase of Paragraph 3.4 (Company Notices And Financial Information) requiring the Voting Trustee to forward a copy of the monthly internal financial statement package shall not apply and shall have no force an effect. 6. SUCCESSORS AND ASSIGNS. Except as expressly set forth to the contrary, this Amendment shall be binding upon and inure to the benefit of the successors, assigns, heirs, administrators, executors and legal representatives of the parties hereto. 7. COUNTERPARTS. The parties may execute this Amendment in any number of counterparts and, as so executed, the counterparts shall constitute one and the same agreement. The parties agree that each such counterpart is an original and shall be binding upon all of the parties, even though all of the parties are not signatories to the same counterpart. One of such counterparts shall be kept with the records of the Voting Trustee by the Voting Trustee at the 4 principal business office of HMC, Marin and HIA. HMC, Marin and HIA and each Beneficiary shall be furnished with a conformed copy of this Amendment. IN WITNESS WHEREOF, the parties have executed this Amendment as of the day and year first above written. "COMPANIES" "HMC" HEADLANDS MORTGAGE COMPANY, a California corporation By:________________________________ PETER T. PAUL, Chief Executive Officer "MARIN" MARIN CONVEYANCING CORPORATION, a California corporation By:________________________________ PETER T. PAUL, Chief Executive Officer "HIA" HEADLANDS INSURANCE AGENCY, INC., a California corporation By:________________________________ PETER T. PAUL, Chief Executive Officer "VOTING TRUSTEE" ___________________________________ PETER T. PAUL, as Voting Trustee of the Voting Trust for the Stock of Headlands Mortgage Company, Marin Conveyancing Corporation and Headlands Insurance Agency, Inc. [Signatures Continued on Page 6] 5 [Signatures Continued from Page 5] "BENEFICIARIES" THE JESSICA M. PAUL IRREVOCABLE TRUST __________________________________ DANIEL W. PAUL, as Trustee of the Jessica M. Paul Irrevocable Trust dated May 21, 1997. No. of Shares: 60 THE JESSICA M. PAUL GRANTOR TRUST __________________________________ GILBERT J. MACQUARRIE, as Trustee of the Jessica M. Paul Grantor Trust dated May 21, 1997 No. of Shares: 60 PETER T. PAUL LIVING TRUST __________________________________ PETER T. PAUL, as Trustee of the Peter T. Paul Living Trust dated May 21, 1997 No. of Shares: 480 _________________________________ DENNIS M. HART No. of Shares: 100 _________________________________ KATHERINE E. HART No. of Shares: 100 _________________________________ D. MICHAEL HART, JR. No. of Shares: 66_ [Signatures Continued on Page 7] 6 [Signatures Continued from Page 6] _________________________________ ELIZABETH A. HART No. of Shares: 66_ _________________________________ CHRISTOPHER K. HART No. of Shares: 66_ 7 EX-10.1.1 6 EMPLOYMENT AGREEMENT - PETER T. PAUL EXHIBIT 10.1.1 ------------- EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT ("Agreement"), effective as of the ____ day of _______________, 1997, is entered into by and between Peter T. Paul ("Executive") and Headlands Mortgage Company, a California corporation ("Company"), and is effective as of and conditioned upon the completion of the Company's sale of ____________________________ (____________) shares of Common Stock in an initial public offering. The Company desires to establish its right to the continued services of the Executive, in the capacity described below, on the terms and conditions and subject to the rights of termination hereinafter set forth, and the Executive is willing to accept such employment on such terms and conditions. In consideration of the mutual agreements hereinafter set forth, the Executive and the Company have agreed and do hereby agree as follows: 1. EMPLOYMENT BY THE COMPANY. The Company does hereby employ, engage and ------------------------- hire the Executive as Chairman of the Board, President and Chief Executive Officer of the Company, and the Executive does hereby accept and agree to such hiring, engagement and employment. The Executive's duties shall be such executive and managerial duties as the Board of Directors of the Company or its subsidiaries shall from time to time prescribe and as provided in the bylaws of the Company. The terms of this Agreement shall be subject to the personnel policies of the Company as determined by the Board of Directors from time to time, except to the extent that any such policy would have a material adverse effect on the rights of the Executive under the terms of this Agreement. The Executive shall devote such time, energy and skill to the performance of his duties for the Company and for the benefit of the Company as may be necessary or required for the effective conduct and operation of the Company's business. Furthermore, the Executive shall exercise due diligence and care in the performance of his duties to the Company under this Agreement. 2. TERM OF AGREEMENT. The term ("Term") of this Agreement shall commence ----------------- on the date of the closing of the initial public offering referred to above (the "Effective Date") and shall continue through December 31, 1999; provided, however, that on each December 31 commencing December 31, 1998 the Term of the Agreement shall automatically be extended for one additional year unless, not later than three months prior to any such December 31, either party shall have given written notice to the other that it does not wish to extend the Term of the Agreement. 3. COMPENSATION. (a) BASE SALARY. The Company shall pay the Executive, and the ----------- Executive agrees to accept from the Company, in payment for his services to the Company beginning on the Effective Date, a base salary at the rate to be determined by the Compensation Committee of the Board of Directors and provided to the Executive in writing ("Base Salary"), which is subject to change upon thirty (30) days' notice and shall initially be set at Ninety Thousand Dollars ($90,000.00). Base Salary is payable in equal semimonthly installments or at such other time or times as the Executive and Company agree. (b) PERFORMANCE BONUS - BOARD OF DIRECTORS DISCRETION. The Executive ------------------------------------------------- shall be eligible to receive an incentive performance bonus in accordance with the Bonus Incentive Compensation Plan established by the Company. Except as provided in Section 7, any such bonus awarded to the Executive shall be payable in the amount, in the manner and at the time determined by the Compensation Committee of the Company's Board of Directors in its sole and absolute discretion. (c) ANNUAL REVIEW. The Compensation Committee of the Company's Board ------------- of Directors shall, at least annually, review the Executive's entire compensation package to determine whether it continues to meet the Company's compensation objectives. Such annual review will include a determination of (i) whether to increase the Base Salary set forth in Section 3(a) and (ii) the incentive performance bonus to be awarded in accordance with Section 3(b). 4. FRINGE BENEFITS. The Executive shall be entitled to participate in --------------- any benefit programs adopted from time to time by the Company for the benefit of its executive employees at an appropriate level for the duties of the officer, and the Executive shall be entitled to receive such other fringe benefits as may be granted from time to time by the Company's Board of Directors or its Compensation Committee. (a) BENEFIT PLANS. The Executive shall be entitled to participate in ------------- any benefit plans relating to stock options, stock purchases, pension, thrift, profit sharing, life insurance, medical coverage, education or other retirement or employee benefits available to other executive employees of the Company at an appropriate level for the duties of the office, subject to any restrictions (including waiting periods) specified in such plans. The Company shall make commercially reasonable efforts to obtain medical and disability insurance, and such other forms of insurance as the Board of Directors shall determine, for its employees. (b) VACATION. The Executive shall be entitled to the number of weeks -------- of paid vacation per calendar year as specified in the Company's employee manual based on the time served as an employee of the Company, with such vacation to be scheduled and taken in accordance with the Company's standard vacation policies. 5. BUSINESS EXPENSES. The Company shall reimburse the Executive for any ----------------- and all necessary, customary and usual expenses, properly receipted in accordance with Company policies, incurred by the Executive on behalf of the Company. 6. TERMINATION OF EXECUTIVE'S EMPLOYMENT. (a) DEATH. If the Executive dies while employed by the Company, his ----- employment shall immediately terminate. The Company's obligation to pay the Executive's Base Salary shall cease as of the date of Executive's death. Thereafter, Executive's beneficiaries or his 2 estate shall receive benefits in accordance with the Company's retirement, insurance and other applicable programs and plans then in effect. (b) DISABILITY. ---------- (i) If, as a result of the Executive's incapacity due to physical or mental illness ("Disability"), Executive shall have been absent from the full-time performance of his duties with the Company for six (6) consecutive months, and, within thirty (30) days after written notice is provided to him by the Company, he shall not have returned to the full-time performance of his duties, the Executive's employment under this Agreement may be terminated by the Company for Disability. During any period prior to such termination during which the Executive is absent from the full-time performance of his duties with the Company due to Disability, the Company shall continue to pay the Executive his Base Salary at the rate in effect at the commencement of such period of Disability. Subsequent to such termination, the Executive's benefits shall be determined under the Company's retirement, insurance and other compensation programs then in effect in accordance with the terms of such programs. (ii) If, however, as a result of the Executive's partial incapacity due to physical or mental illness in which Executive shall not have been absent from his duties for six consecutive months and shall have returned to work on a full-time basis but is not able to perform at the same level as when hired and/or is not able to perform the same functions for which originally hired ("Partial Disability"), the Company shall make reasonable efforts to accommodate the Executive's Partial Disability by modifying his job description appropriately, together with a commensurate adjustment in compensation; provided, however, the Company shall be required to so continue the employment of the Executive in the event of a Partial Disability of the Executive only if the Company determines, in its sole discretion, that it can create a position for which the Executive would be suited and that would be economically advantageous to the Company. (c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate ------------------------------------ the Executive's employment under this Agreement for "Cause," at any time prior to expiration of the Term of the Agreement, only in the event of (i) acts or omissions constituting gross negligence, recklessness or willful misconduct on the part of the Executive in respect of his fiduciary obligations or otherwise relating to the business of the Company, (ii) the Executive's material breach of this Agreement, or (iii) the Executive's conviction or entry of a plea of nolo contendre for fraud, misappropriation or embezzlement. In such a case, the Executive's employment under this Agreement may be terminated immediately without any advance written notice, and the Company's obligation to pay the Executive's Base Salary, any bonus and fringe benefits will cease as of the termination date. (d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive shall -------------------------------------------- have the right to terminate this Agreement for Good Reason. For purposes of this Agreement, "Good Reason" shall mean the occurrence, without the Executive's express written consent, of any one or more of the following events: 3 (i) A reduction in title and/or compensation of the Executive or the assignment of duties to the Executive not consistent with those of a senior executive of the Company, except in connection with the Company's termination of the Executive's employment for Cause pursuant to Section 6(c) or as otherwise expressly contemplated herein; (ii) The Company's material breach of any of the provisions of this Agreement, including, but not limited to, a reduction by the Company in the Executive's Base Salary in effect as of the Effective Date; or a change in the conditions of the Executive's employment (e.g., including, without limitation, a ---- failure by the Company to provide the Executive with incentive compensation and benefits plans that provide benefits and the opportunity to obtain incentive compensation, in each case comparable to those available under benefits programs in effect as of the Effective Date and at an appropriate level for the duties of the officer, etc.); (iii) The relocation of the Company's principal executive offices to a location more than twenty-five (25) miles from its location as of the Effective Date or the Company's requiring the Executive to be based anywhere other than the Company's principal executive offices, except for requiring travel on the Company's business to an extent substantially consistent with the Executive's duties hereunder; or (iv) A change in control as defined in Section 8 below. The Executive agrees to provide the Company with thirty (30) days' prior written notice of any termination for Good Reason. (e) TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON. The Executive ------------------------------------------------ may at any time during the Term of this Agreement terminate his employment hereunder for any reason or no reason by giving the Company notice in writing not less than one hundred twenty (120) days in advance of such termination. Except as may be provided in Section 9, the Executive shall have no further obligations to the Company after the effective date of termination, as set forth in the notice. Notwithstanding the foregoing, in the event any "person" (as defined in Section 8 below) begins a tender or exchange offer, circulates a proxy to shareholders or takes other steps to effect a Change of Control, the Executive agrees that he will not voluntarily leave the employ of the Company, and will render services to the Company commensurate with his position, until such "person" has abandoned or terminated efforts to effect a Change of Control or until a Change of Control has occurred. In the event of a termination by the Executive under this paragraph, the Company will pay only the portion of Base Salary or previously awarded bonus unpaid as of the termination date. Fringe benefits which have accrued and/or vested on the termination date will continue in effect according to their terms, but no additional accrual or vesting will take place. 7. COMPENSATION UPON TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, OR --------------------------------------------------------------------- BY THE EXECUTIVE FOR GOOD REASON. If the Executive's employment shall be - -------------------------------- terminated (i) by the Company other than for Cause, or (ii) by the Executive for Good Reason, the Executive shall be entitled to the following benefits: 4 (a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay ----------------------------- the Executive any portion of the Executive's Base Salary or previously awarded Bonus not paid prior to the termination date. (b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount ----------------- (the "Severance Amount") equal to two times the Executive's combined Base Salary and bonus compensation for the preceding fiscal year. The Severance Amount shall be payable fifty percent (50%) within five (5) days after the termination date and the remaining fifty percent (50%) shall be payable in twelve (12) equal consecutive monthly installments beginning on the first day of the month following the termination date. (c) IMMEDIATE VESTING OF STOCK OPTIONS. The Company shall take all ---------------------------------- appropriate action to ensure that all stock options on the Company's stock owned by the Executive as of the Effective Date and which have not been exercised prior to the termination date become immediately exercisable by the Executive, whether or not the right to exercise such stock options would otherwise then be vested in the Executive. The provisions of this Section 7(c) shall constitute an amendment to any existing stock option agreements of the Company as of the Effective Date. All other stock options owned by the Executive as of the termination date shall be exercisable in accordance with the Company's stock option plan and the applicable stock option agreements. (d) CONTINUATION OF FRINGE BENEFITS. From and after termination of ------------------------------- the Executive's employment, the Company shall continue to provide the Executive with all life insurance and medical coverage fringe benefits set forth in Section 4 as if the Executive's employment under the Agreement had not been terminated until the earlier to occur of (i) such time as the Executive finds full-time employment or (ii) the expiration of twelve (12) months. Notwithstanding the immediately preceding sentence, if, as the result of termination of the Executive's employment, the Executive and/or his otherwise eligible dependents or beneficiaries shall become ineligible for benefits under any one of the Company's benefit plans or the cost of providing such benefits exceeds two hundred percent (200%) of the cost of providing such benefits to other members of senior management, the Company, at the Company's option, shall (i) continue to provide the Executive and his eligible dependents or beneficiaries with benefits at a level at least equivalent to the level of benefits for which the Executive and his dependents and beneficiaries were eligible under such plans immediately prior to the termination date or (ii) for any fringe benefit not so provided, the Company shall pay the Executive 200% of the cost of providing such fringe benefit to other members of senior management. (e) EXCISE TAX GROSS-UP. In the event that the Executive becomes ------------------- entitled to the benefit payments provided under subparagraphs (a)-(d) of this Section 7.A ("Benefit Payments"), and if any of the Benefit Payments will be subject to any excise tax ("Excise Tax") imposed under section 4999 of the Internal Revenue Code of 1986, as amended from time to time, or successor sections thereto, the Company shall pay to the Executive an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Benefit Payments and any federal, state and local income tax and Excise Tax upon the Gross-Up Payment, shall be equal to the amount of the Benefit Payments. Upon the Executive's termination date, the Company shall estimate and pay 5 to the Executive the Gross-Up Payment. In the event that the Excise Tax is subsequently determined to be less than the amount estimated at the termination date, the Executive shall repay to the Company, at the time that the amount of such reduction in Excise Tax is finally determined, the difference plus interest on the amount of such repayment at 10% per annum. In the event that the Excise Tax is determined to exceed the amount estimated at the termination date, the Company shall make an additional Gross-Up Payment in respect of such excess at the time that the amount of such excess is finally determined, plus interest at 10% per annum. The Executive and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Benefit Payments. (f) NO MITIGATION REQUIRED; NO OTHER ENTITLEMENT TO BENEFITS UNDER -------------------------------------------------------------- AGREEMENT. The Executive shall not be required in any way to mitigate the - --------- amount of any payment provided for in this Section 7, including, but not limited to, by seeking other employment, nor shall the amount of any payment provided for in this Section 7 be reduced by any compensation earned by the Executive as a result of employment with another employer after the termination date of employment, or otherwise. Except as set forth in this Section 7, following a termination governed by this Section 7, the Executive shall not be entitled to any other compensation or benefits set forth in this Agreement, except as may be separately negotiated by the parties and approved by the Board of Directors of the Company in writing in conjunction with the termination of Executive's employment under this Section 7. 8. CHANGE IN CONTROL. A "Change in Control" shall be deemed to have ----------------- occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied. (a) Any "person," as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934 (the "Exchange Act") (other than the Company; any trustee or other fiduciary holding securities under an Executive benefit plan of the Company; or any company owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of the stock of the Company), is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of the securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or from a transferor in a transaction expressly approved or consented to by the Board of Directors) representing more than 25% of the combined voting power of the Company's then outstanding securities; or (b) During any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board of Directors and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clause (a), (c) or (d) of this section), (i) whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two- thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved or (ii) whose election is to replace 6 a person who ceases to be a director due to death, disability or age, cease for any reason to constitute a majority thereof; or (c) The shareholders of the Company approve a merger or consolidation of the Company with other corporation, other than (i) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an Executive benefit plan of the Company, at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or (d) The shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. 9. DISPUTE RELATING TO EXECUTIVE'S TERMINATION OF EMPLOYMENT FOR GOOD ------------------------------------------------------------------ REASON. If the Executive resigns his employment with the Company alleging in - ------ good faith as the basis for such resignation any of the "Good Reasons" specified in Section 6(d), and if the Company then disputes the Executive's right to the payment of benefits under Section 7, the Company shall continue to pay the Executive the full compensation (including, but not limited to, his Base Salary) in effect at the date the Executive provided notice of such resignation, and the Company shall continue the Executive as a participant in al compensation, benefit and insurance plans in which the Executive was then a participant, until the earlier of the expiration of the Term of the Agreement or the date the dispute is finally resolved, either by jurisdiction which is not appealable or with respect to which the time for appeal has expired and no appeal has been perfected. For the purposes of this Section, the Company shall bear the burden of proving that the grounds for the Executive's resignation do not fall within the scope of Section 6(d), and there shall be a rebuttable presumption that the Executive alleged such grounds in good faith. 10. NONCOMPETITION PROVISIONS. ------------------------- (a) NONCOMPETITION. The Executive agrees that during the Term of this -------------- Agreement prior to any termination of his employment hereunder and for a period of twelve (12) months following the occurrence of any event entitling the Executive to Benefit Payments according to the provisions of Section 7 and in consideration therefor, provided the Company makes all such payments when due, he will not directly or indirectly, without the prior written consent of the Company, manage, operate, join, control, participate in, or be connected as a stockholder (other than as a holder of shares publicly traded on a stock exchange or the Nasdaq National Market), partner, or other equity holder with, or as an officer, director or employee of, any other real estate lender whose business strategy is competitive with that of the Company, as determined by a majority of the Company's independent directors ("Competing Business"). It is further expressly agreed that the Company will or would suffer irreparable injury if the Executive were to compete with the Company or any subsidiary or affiliate of the Company in violation of 7 this Agreement and that the Company would by reason of such competition be entitled to injunctive relief in a court of appropriate jurisdiction, and the Executive further consents and stipulates to the entry of such injunctive relief in such a court prohibiting the Executive from competing with the Company or any subsidiary or affiliate of the Company, in the areas of business set forth above, in violation of this Agreement. (b) RIGHT TO COMPANY MATERIALS. The Executive agrees that all styles, -------------------------- designs, lists, materials, books, files, reports, correspondence, records and other documents ("Company Materials") used, prepared or made available to the Executive, shall be and shall remain the property of the Company. Upon the termination of employment or the expiration of this Agreement, all Company Materials shall be returned immediately to the Company, and the Executive shall not make or retain any copies thereof. (c) SOLICITING EXECUTIVES. The Executive promises and agrees that --------------------- during the noncompetition period defined in paragraph (a) he will not directly or indirectly solicit any of the Company executives or employees to work for any Competing Business. 11. NOTICES. All notices and other communications under this Agreement ------- shall be in writing and shall be given by fax or first class mail, certified or registered with return receipt requested, and shall be deemed to have been duly given three (3) days after mailing or twenty-four (24) hours after transmission of a fax to the respective persons named below: If to Company: Headlands Mortgage Company Attn: Board of Directors 1100 Larkspur Landing Circle Suite 101 Larkspur, CA 94939 Phone: (415) 461-6790 Fax: (415) 461-2128 If to Executive: Peter T. Paul 550 Riviera Circle Larkspur, CA 94939 Phone: (415) 924-7066 Either party may change such party's address for notices by notice duly given pursuant hereto. 12. ATTORNEYS' FEES. In the event judicial determination is necessary of --------------- any dispute arising as to the parties' rights and obligations hereunder, each party shall have the right, in addition to any other relief granted by the court, to attorneys' fees based on a determination by the court of the extent to which each party has prevailed as to the material issues raised in determination of the dispute. 8 13. TERMINATION OF PRIOR AGREEMENTS. This Agreement terminates and ------------------------------- supersedes any and all prior agreements and understandings between the parties with respect to employment or with respect to the compensation of the Executive by the Company. 14. ASSIGNMENT; SUCCESSORS. This Agreement is personal in its nature and ---------------------- neither of the parties hereto shall, without the consent of the other, assign or transfer this Agreement or any rights or obligations hereunder; provided that, in the event of the merger, consolidation, transfer, or sale of all or substantially all of the assets of the Company with or to any other individual or entity, this Agreement shall, subject to the provisions hereof, be binding upon and inure to the benefit of such successor and such successor shall discharge and perform all the promises, covenants, duties, and obligations of the Company hereunder. 15. GOVERNING LAW. This Agreement and the legal relations thus created ------------- between the parties hereto shall be governed by and construed under and in accordance with the laws of the State of California. 16. ENTIRE AGREEMENT; HEADINGS. This Agreement embodies the entire -------------------------- agreement of the parties respecting the matters within its scope and may be modified only in writing. Section headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. 17. WAIVER; MODIFICATION. Failure to insist upon strict compliance with -------------------- any of the terms, covenants or conditions hereof shall not be deemed a waiver of such term, covenant or condition, nor shall any waiver or relinquishment of, or failure to insist upon strict compliance with, any right or power hereunder at any one or more times be deemed a waiver or relinquishment of such right or power at any other time or times. This Agreement shall not be modified in any respect except by a writing executed by each party hereto. 18. SEVERABILITY. In the event that a court of competent jurisdiction ------------ determines that any portion of this Agreement is in violation of any statute or public policy, only the portions of this Agreement that violate such statute or public policy shall be stricken. All portions of this Agreement that do not violate any statute or public policy shall continue in full force and effect. Further, any court order striking any portion of this Agreement shall modify the stricken terms as narrowly as possible to give as much effect as possible to the intentions of the parties under this Agreement. 19. INDEMNIFICATION. The Company shall indemnify and hold Executive --------------- harmless to the maximum extent permitted by California Law and the Bylaws of the Company. 20. COUNTERPARTS. This Agreement may be executed in counterparts. ------------ 9 IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer, and the Executive has hereunto signed this Agreement, as of the date first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By____________________________________ _______________________________________ PETER T. PAUL 10 EX-10.1.2 7 EMPLOYMENT AGREEMENT - BECKY S. POISSON EXHIBIT 10.1.2 ------------- EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT ("Agreement"), effective as of the ____ day of _______________, 1997, is entered into by and between Becky S. Poisson ("Executive") and Headlands Mortgage Company, a California corporation ("Company"), and is effective as of and conditioned upon the completion of the Company's sale of ___________________________ (___________) shares of Common Stock in an initial public offering. The Company desires to establish its right to the continued services of the Executive, in the capacity described below, on the terms and conditions and subject to the rights of termination hereinafter set forth, and the Executive is willing to accept such employment on such terms and conditions. In consideration of the mutual agreements hereinafter set forth, the Executive and the Company have agreed and do hereby agree as follows: 1. EMPLOYMENT BY THE COMPANY. The Company does hereby employ, engage and ------------------------- hire the Executive as Executive Vice President, Operations, and the Executive does hereby accept and agree to such hiring, engagement and employment. The Executive's duties shall be such executive and managerial duties as the Board of Directors of the Company or its subsidiaries shall from time to time prescribe and as provided in the bylaws of the Company. The terms of this Agreement shall be subject to the personnel policies of the Company as determined by the Board of Directors from time to time, except to the extent that any such policy would have a material adverse effect on the rights of the Executive under the terms of this Agreement. The Executive shall devote such time, energy and skill to the performance of her duties for the Company and for the benefit of the Company as may be necessary or required for the effective conduct and operation of the Company's business. Furthermore, the Executive shall exercise due diligence and care in the performance of her duties to the Company under this Agreement. 2. TERM OF AGREEMENT. The term ("Term") of this Agreement shall commence ----------------- on the date of the closing of the initial public offering referred to above (the "Effective Date") and shall continue through December 31, 1999; provided, however, that on each December 31 commencing December 31, 1998 the Term of the Agreement shall automatically be extended for one additional year unless, not later than three months prior to any such December 31, either party shall have given written notice to the other that it does not wish to extend the Term of the Agreement. 3. COMPENSATION. (a) BASE SALARY. The Company shall pay the Executive, and the ----------- Executive agrees to accept from the Company, in payment for her services to the Company beginning on the Effective Date, a base salary at the rate to be determined by the Compensation Committee of the Board of Directors and provided to the Executive in writing ("Base Salary"), 1 which is subject to change upon thirty (30) days' notice and shall initially be set at Ninety-Four Thousand Dollars ($94,000.00). Base Salary is payable in equal semimonthly installments or at such other time or times as the Executive and Company agree. (b) PERFORMANCE BONUS - BOARD OF DIRECTORS DISCRETION. The Executive ------------------------------------------------- shall be eligible to receive an incentive performance bonus in accordance with the Bonus Incentive Compensation Plan established by the Company. Except as provided in Section 7, any such bonus awarded to the Executive shall be payable in the amount, in the manner and at the time determined by the Compensation Committee of the Company's Board of Directors in its sole and absolute discretion. (c) ANNUAL REVIEW. The Compensation Committee of the Company's Board ------------- of Directors shall, at least annually, review the Executive's entire compensation package to determine whether it continues to meet the Company's compensation objectives. Such annual review will include a determination of (i) whether to increase the Base Salary set forth in Section 3(a) and (ii) the incentive performance bonus to be awarded in accordance with Section 3(b). 4. FRINGE BENEFITS. The Executive shall be entitled to participate in --------------- any benefit programs adopted from time to time by the Company for the benefit of its executive employees at an appropriate level for the duties of the officer, and the Executive shall be entitled to receive such other fringe benefits as may be granted from time to time by the Company's Board of Directors or its Compensation Committee. (a) BENEFIT PLANS. The Executive shall be entitled to participate in ------------- any benefit plans relating to stock options, stock purchases, pension, thrift, profit sharing, life insurance, medical coverage, education or other retirement or employee benefits available to other executive employees of the Company at an appropriate level for the duties of the office, subject to any restrictions (including waiting periods) specified in such plans. The Company shall make commercially reasonable efforts to obtain medical and disability insurance, and such other forms of insurance as the Board of Directors shall determine, for its employees. (b) VACATION. The Executive shall be entitled to the number of weeks -------- of paid vacation per calendar year as specified in the Company's employee manual based on the time served as an employee of the Company, with such vacation to be scheduled and taken in accordance with the Company's standard vacation policies. 5. BUSINESS EXPENSES. The Company shall reimburse the Executive for any ----------------- and all necessary, customary and usual expenses, properly receipted in accordance with Company policies, incurred by the Executive on behalf of the Company. 6. TERMINATION OF EXECUTIVE'S EMPLOYMENT. (a) DEATH. If the Executive dies while employed by the Company, her ----- employment shall immediately terminate. The Company's obligation to pay the Executive's Base Salary shall cease as of the date of Executive's death. Thereafter, Executive's beneficiaries or 2 her estate shall receive benefits in accordance with the Company's retirement, insurance and other applicable programs and plans then in effect. (b) DISABILITY. ---------- (i) If, as a result of the Executive's incapacity due to physical or mental illness ("Disability"), Executive shall have been absent from the full-time performance of her duties with the Company for six (6) consecutive months, and, within thirty (30) days after written notice is provided to her by the Company, she shall not have returned to the full-time performance of her duties, the Executive's employment under this Agreement may be terminated by the Company for Disability. During any period prior to such termination during which the Executive is absent from the full-time performance of her duties with the Company due to Disability, the Company shall continue to pay the Executive her Base Salary at the rate in effect at the commencement of such period of Disability. Subsequent to such termination, the Executive's benefits shall be determined under the Company's retirement, insurance and other compensation programs then in effect in accordance with the terms of such programs. (ii) If, however, as a result of the Executive's partial incapacity due to physical or mental illness in which Executive shall not have been absent from her duties for six consecutive months and shall have returned to work on a full-time basis but is not able to perform at the same level as when hired and/or is not able to perform the same functions for which originally hired ("Partial Disability"), the Company shall make reasonable efforts to accommodate the Executive's Partial Disability by modifying her job description appropriately, together with a commensurate adjustment in compensation; provided, however, the Company shall be required to so continue the employment of the Executive in the event of a Partial Disability of the Executive only if the Company determines, in its sole discretion, that it can create a position for which the Executive would be suited and that would be economically advantageous to the Company. (c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate ------------------------------------ the Executive's employment under this Agreement for "Cause," at any time prior to expiration of the Term of the Agreement, only in the event of (i) acts or omissions constituting gross negligence, recklessness or willful misconduct on the part of the Executive in respect of her fiduciary obligations or otherwise relating to the business of the Company, (ii) the Executive's material breach of this Agreement, or (iii) the Executive's conviction or entry of a plea of nolo contendre for fraud, misappropriation or embezzlement. In such a case, the Executive's employment under this Agreement may be terminated immediately without any advance written notice, and the Company's obligation to pay the Executive's Base Salary, any bonus and fringe benefits will cease as of the termination date. (d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive shall -------------------------------------------- have the right to terminate this Agreement for Good Reason. For purposes of this Agreement, "Good Reason" shall mean the occurrence, without the Executive's express written consent, of any one or more of the following events: 3 (i) A reduction in title and/or compensation of the Executive or the assignment of duties to the Executive not consistent with those of a senior executive of the Company, except in connection with the Company's termination of the Executive's employment for Cause pursuant to Section 6(c) or as otherwise expressly contemplated herein; (ii) The Company's material breach of any of the provisions of this Agreement, including, but not limited to, a reduction by the Company in the Executive's Base Salary in effect as of the Effective Date; or a change in the conditions of the Executive's employment (e.g., including, without limitation, a ---- failure by the Company to provide the Executive with incentive compensation and benefits plans that provide benefits and the opportunity to obtain incentive compensation, in each case comparable to those available under benefits programs in effect as of the Effective Date and at an appropriate level for the duties of the officer, etc.); (iii) The relocation of the Company's principal executive offices to a location more than twenty-five (25) miles from its location as of the Effective Date or the Company's requiring the Executive to be based anywhere other than the Company's principal executive offices, except for requiring travel on the Company's business to an extent substantially consistent with the Executive's duties hereunder; or (iv) A change in control as defined in Section 8 below. The Executive agrees to provide the Company with thirty (30) days' prior written notice of any termination for Good Reason. (e) TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON. The Executive ------------------------------------------------ may at any time during the Term of this Agreement terminate her employment hereunder for any reason or no reason by giving the Company notice in writing not less than one hundred twenty (120) days in advance of such termination. Except as may be provided in Section 9, the Executive shall have no further obligations to the Company after the effective date of termination, as set forth in the notice. Notwithstanding the foregoing, in the event any "person" (as defined in Section 8 below) begins a tender or exchange offer, circulates a proxy to shareholders or takes other steps to effect a Change of Control, the Executive agrees that she will not voluntarily leave the employ of the Company, and will render services to the Company commensurate with her position, until such "person" has abandoned or terminated efforts to effect a Change of Control or until a Change of Control has occurred. In the event of a termination by the Executive under this paragraph, the Company will pay only the portion of Base Salary or previously awarded bonus unpaid as of the termination date. Fringe benefits which have accrued and/or vested on the termination date will continue in effect according to their terms, but no additional accrual or vesting will take place. 7. COMPENSATION UPON TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, OR --------------------------------------------------------------------- BY THE EXECUTIVE FOR GOOD REASON. If the Executive's employment shall be - -------------------------------- terminated (i) by the Company other than for Cause, or (ii) by the Executive for Good Reason, the Executive shall be entitled to the following benefits: 4 (a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay ----------------------------- the Executive any portion of the Executive's Base Salary or previously awarded Bonus not paid prior to the termination date. (b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount ----------------- (the "Severance Amount") equal to two times the Executive's combined Base Salary and bonus compensation for the preceding fiscal year. The Severance Amount shall be payable fifty percent (50%) within five (5) days after the termination date and the remaining fifty percent (50%) shall be payable in twelve (12) equal consecutive monthly installments beginning on the first day of the month following the termination date. (c) IMMEDIATE VESTING OF STOCK OPTIONS. The Company shall take all ---------------------------------- appropriate action to ensure that all stock options on the Company's stock owned by the Executive as of the Effective Date and which have not been exercised prior to the termination date become immediately exercisable by the Executive, whether or not the right to exercise such stock options would otherwise then be vested in the Executive. The provisions of this Section 7(c) shall constitute an amendment to any existing stock option agreements of the Company as of the Effective Date. All other stock options owned by the Executive as of the termination date shall be exercisable in accordance with the Company's stock option plan and the applicable stock option agreements. (d) CONTINUATION OF FRINGE BENEFITS. From and after termination of ------------------------------- the Executive's employment, the Company shall continue to provide the Executive with all life insurance and medical coverage fringe benefits set forth in Section 4 as if the Executive's employment under the Agreement had not been terminated until the earlier to occur of (i) such time as the Executive finds full-time employment or (ii) the expiration of twelve (12) months. Notwithstanding the immediately preceding sentence, if, as the result of termination of the Executive's employment, the Executive and/or her otherwise eligible dependents or beneficiaries shall become ineligible for benefits under any one of the Company's benefit plans or the cost of providing such benefits exceeds two hundred percent (200%) of the cost of providing such benefits to other members of senior management, the Company, at the Company's option, shall (i) continue to provide the Executive and her eligible dependents or beneficiaries with benefits at a level at least equivalent to the level of benefits for which the Executive and her dependents and beneficiaries were eligible under such plans immediately prior to the termination date or (ii) for any fringe benefit not so provided, the Company shall pay the Executive 200% of the cost of providing such fringe benefit to other members of senior management. (e) EXCISE TAX GROSS-UP. In the event that the Executive becomes ------------------- entitled to the benefit payments provided under subparagraphs (a)-(d) of this Section 7.A ("Benefit Payments"), and if any of the Benefit Payments will be subject to any excise tax ("Excise Tax") imposed under section 4999 of the Internal Revenue Code of 1986, as amended from time to time, or successor sections thereto, the Company shall pay to the Executive an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Benefit Payments and any federal, state and local income tax and Excise Tax upon the Gross-Up Payment, shall be equal to the amount of the Benefit Payments. Upon the Executive's termination date, the Company shall estimate and pay 5 to the Executive the Gross-Up Payment. In the event that the Excise Tax is subsequently determined to be less than the amount estimated at the termination date, the Executive shall repay to the Company, at the time that the amount of such reduction in Excise Tax is finally determined, the difference plus interest on the amount of such repayment at 10% per annum. In the event that the Excise Tax is determined to exceed the amount estimated at the termination date, the Company shall make an additional Gross-Up Payment in respect of such excess at the time that the amount of such excess is finally determined, plus interest at 10% per annum. The Executive and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Benefit Payments. (f) NO MITIGATION REQUIRED; NO OTHER ENTITLEMENT TO BENEFITS UNDER -------------------------------------------------------------- AGREEMENT. The Executive shall not be required in any way to mitigate the - --------- amount of any payment provided for in this Section 7, including, but not limited to, by seeking other employment, nor shall the amount of any payment provided for in this Section 7 be reduced by any compensation earned by the Executive as a result of employment with another employer after the termination date of employment, or otherwise. Except as set forth in this Section 7, following a termination governed by this Section 7, the Executive shall not be entitled to any other compensation or benefits set forth in this Agreement, except as may be separately negotiated by the parties and approved by the Board of Directors of the Company in writing in conjunction with the termination of Executive's employment under this Section 7. 8. CHANGE IN CONTROL. A "Change in Control" shall be deemed to have ----------------- occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied. (a) Any "person," as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934 (the "Exchange Act") (other than the Company; any trustee or other fiduciary holding securities under an Executive benefit plan of the Company; or any company owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of the stock of the Company), is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of the securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or from a transferor in a transaction expressly approved or consented to by the Board of Directors) representing more than 25% of the combined voting power of the Company's then outstanding securities; or (b) During any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board of Directors and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clause (a), (c) or (d) of this section), (i) whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two- thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved or (ii) whose election is to replace 6 a person who ceases to be a director due to death, disability or age, cease for any reason to constitute a majority thereof; or (c) The shareholders of the Company approve a merger or consolidation of the Company with other corporation, other than (i) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an Executive benefit plan of the Company, at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or (d) The shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. 9. DISPUTE RELATING TO EXECUTIVE'S TERMINATION OF EMPLOYMENT FOR GOOD ------------------------------------------------------------------ REASON. If the Executive resigns her employment with the Company alleging in - ------ good faith as the basis for such resignation any of the "Good Reasons" specified in Section 6(d), and if the Company then disputes the Executive's right to the payment of benefits under Section 7, the Company shall continue to pay the Executive the full compensation (including, but not limited to, her Base Salary) in effect at the date the Executive provided notice of such resignation, and the Company shall continue the Executive as a participant in al compensation, benefit and insurance plans in which the Executive was then a participant, until the earlier of the expiration of the Term of the Agreement or the date the dispute is finally resolved, either by jurisdiction which is not appealable or with respect to which the time for appeal has expired and no appeal has been perfected. For the purposes of this Section, the Company shall bear the burden of proving that the grounds for the Executive's resignation do not fall within the scope of Section 6(d), and there shall be a rebuttable presumption that the Executive alleged such grounds in good faith. 10. NONCOMPETITION PROVISIONS. ------------------------- (a) NONCOMPETITION. The Executive agrees that during the Term of this -------------- Agreement prior to any termination of her employment hereunder and for a period of twelve (12) months following the occurrence of any event entitling the Executive to Benefit Payments according to the provisions of Section 7 and in consideration therefor, provided the Company makes all such payments when due, she will not directly or indirectly, without the prior written consent of the Company, manage, operate, join, control, participate in, or be connected as a stockholder (other than as a holder of shares publicly traded on a stock exchange or the Nasdaq National Market), partner, or other equity holder with, or as an officer, director or employee of, any other real estate lender whose business strategy is competitive with that of the Company, as determined by a majority of the Company's independent directors ("Competing Business"). It is further expressly agreed that the Company will or would suffer irreparable injury if the Executive were to compete with the Company or any subsidiary or affiliate of the Company in violation of 7 this Agreement and that the Company would by reason of such competition be entitled to injunctive relief in a court of appropriate jurisdiction, and the Executive further consents and stipulates to the entry of such injunctive relief in such a court prohibiting the Executive from competing with the Company or any subsidiary or affiliate of the Company, in the areas of business set forth above, in violation of this Agreement. (b) RIGHT TO COMPANY MATERIALS. The Executive agrees that all styles, -------------------------- designs, lists, materials, books, files, reports, correspondence, records and other documents ("Company Materials") used, prepared or made available to the Executive, shall be and shall remain the property of the Company. Upon the termination of employment or the expiration of this Agreement, all Company Materials shall be returned immediately to the Company, and the Executive shall not make or retain any copies thereof. (c) SOLICITING EXECUTIVES. The Executive promises and agrees that --------------------- during the noncompetition period defined in paragraph (a) she will not directly or indirectly solicit any of the Company executives or employees to work for any Competing Business. 11. NOTICES. All notices and other communications under this Agreement ------- shall be in writing and shall be given by fax or first class mail, certified or registered with return receipt requested, and shall be deemed to have been duly given three (3) days after mailing or twenty-four (24) hours after transmission of a fax to the respective persons named below: If to Company: Headlands Mortgage Company Attn: Board of Directors 1100 Larkspur Landing Circle Suite 101 Larkspur, CA 94939 Phone: (415) 461-6790 Fax: (415) 461-2128 If to Executive: Becky S. Poisson 785 Creek Drive Boulder Creek, CA 95006 Phone: (415) 338-2376 Either party may change such party's address for notices by notice duly given pursuant hereto. 12. ATTORNEYS' FEES. In the event judicial determination is necessary of --------------- any dispute arising as to the parties' rights and obligations hereunder, each party shall have the right, in addition to any other relief granted by the court, to attorneys' fees based on a determination by the court of the extent to which each party has prevailed as to the material issues raised in determination of the dispute. 8 13. TERMINATION OF PRIOR AGREEMENTS. This Agreement terminates and ------------------------------- supersedes any and all prior agreements and understandings between the parties with respect to employment or with respect to the compensation of the Executive by the Company. 14. ASSIGNMENT; SUCCESSORS. This Agreement is personal in its nature and ---------------------- neither of the parties hereto shall, without the consent of the other, assign or transfer this Agreement or any rights or obligations hereunder; provided that, in the event of the merger, consolidation, transfer, or sale of all or substantially all of the assets of the Company with or to any other individual or entity, this Agreement shall, subject to the provisions hereof, be binding upon and inure to the benefit of such successor and such successor shall discharge and perform all the promises, covenants, duties, and obligations of the Company hereunder. 15. GOVERNING LAW. This Agreement and the legal relations thus created ------------- between the parties hereto shall be governed by and construed under and in accordance with the laws of the State of California. 16. ENTIRE AGREEMENT; HEADINGS. This Agreement embodies the entire -------------------------- agreement of the parties respecting the matters within its scope and may be modified only in writing. Section headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. 17. WAIVER; MODIFICATION. Failure to insist upon strict compliance with -------------------- any of the terms, covenants or conditions hereof shall not be deemed a waiver of such term, covenant or condition, nor shall any waiver or relinquishment of, or failure to insist upon strict compliance with, any right or power hereunder at any one or more times be deemed a waiver or relinquishment of such right or power at any other time or times. This Agreement shall not be modified in any respect except by a writing executed by each party hereto. 18. SEVERABILITY. In the event that a court of competent jurisdiction ------------ determines that any portion of this Agreement is in violation of any statute or public policy, only the portions of this Agreement that violate such statute or public policy shall be stricken. All portions of this Agreement that do not violate any statute or public policy shall continue in full force and effect. Further, any court order striking any portion of this Agreement shall modify the stricken terms as narrowly as possible to give as much effect as possible to the intentions of the parties under this Agreement. 19. INDEMNIFICATION. The Company shall indemnify and hold Executive --------------- harmless to the maximum extent permitted by California Law and the Bylaws of the Company. 20. COUNTERPARTS. This Agreement may be executed in counterparts. ------------ 9 IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer, and the Executive has hereunto signed this Agreement, as of the date first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By_____________________________________ _______________________________________ BECKY S. POISSON 10 EX-10.1.3 8 EMPLOYMENT AGREEMENT - GILBERT J. MACQUARRIE EXHIBIT 10.1.3 ------------- EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT ("Agreement"), effective as of the ____ day of _______________, 1997, is entered into by and between Gilbert J. MacQuarrie ("Executive") and Headlands Mortgage Company, a California corporation ("Company"), and is effective as of and conditioned upon the completion of the Company's sale of __________________________ (___________) shares of Common Stock in an initial public offering. The Company desires to establish its right to the continued services of the Executive, in the capacity described below, on the terms and conditions and subject to the rights of termination hereinafter set forth, and the Executive is willing to accept such employment on such terms and conditions. In consideration of the mutual agreements hereinafter set forth, the Executive and the Company have agreed and do hereby agree as follows: 1. EMPLOYMENT BY THE COMPANY. The Company does hereby employ, engage and ------------------------- hire the Executive as Executive Vice President, Chief Financial Officer and Secretary of the Company, and the Executive does hereby accept and agree to such hiring, engagement and employment. The Executive's duties shall be such executive and managerial duties as the Board of Directors of the Company or its subsidiaries shall from time to time prescribe and as provided in the bylaws of the Company. The terms of this Agreement shall be subject to the personnel policies of the Company as determined by the Board of Directors from time to time, except to the extent that any such policy would have a material adverse effect on the rights of the Executive under the terms of this Agreement. The Executive shall devote such time, energy and skill to the performance of his duties for the Company and for the benefit of the Company as may be necessary or required for the effective conduct and operation of the Company's business. Furthermore, the Executive shall exercise due diligence and care in the performance of his duties to the Company under this Agreement. 2. TERM OF AGREEMENT. The term ("Term") of this Agreement shall commence ----------------- on the date of the closing of the initial public offering referred to above (the "Effective Date") and shall continue through December 31, 1999; provided, however, that on each December 31 commencing December 31, 1998 the Term of the Agreement shall automatically be extended for one additional year unless, not later than three months prior to any such December 31, either party shall have given written notice to the other that it does not wish to extend the Term of the Agreement. 3. COMPENSATION. (a) BASE SALARY. The Company shall pay the Executive, and the ----------- Executive agrees to accept from the Company, in payment for his services to the Company beginning on the Effective Date, a base salary at the rate to be determined by the Compensation Committee of the Board of Directors and provided to the Executive in writing ("Base Salary"), 1 which is subject to change upon thirty (30) days' notice and shall initially be set at Ninety-Four Thousand Dollars ($94,000.00). Base Salary is payable in equal semimonthly installments or at such other time or times as the Executive and Company agree. (b) PERFORMANCE BONUS - BOARD OF DIRECTORS DISCRETION. The Executive ------------------------------------------------- shall be eligible to receive an incentive performance bonus in accordance with the Bonus Incentive Compensation Plan established by the Company. Except as provided in Section 7, any such bonus awarded to the Executive shall be payable in the amount, in the manner and at the time determined by the Compensation Committee of the Company's Board of Directors in its sole and absolute discretion. (c) ANNUAL REVIEW. The Compensation Committee of the Company's Board ------------- of Directors shall, at least annually, review the Executive's entire compensation package to determine whether it continues to meet the Company's compensation objectives. Such annual review will include a determination of (i) whether to increase the Base Salary set forth in Section 3(a) and (ii) the incentive performance bonus to be awarded in accordance with Section 3(b). 4. FRINGE BENEFITS. The Executive shall be entitled to participate in --------------- any benefit programs adopted from time to time by the Company for the benefit of its executive employees at an appropriate level for the duties of the officer, and the Executive shall be entitled to receive such other fringe benefits as may be granted from time to time by the Company's Board of Directors or its Compensation Committee. (a) BENEFIT PLANS. The Executive shall be entitled to participate in ------------- any benefit plans relating to stock options, stock purchases, pension, thrift, profit sharing, life insurance, medical coverage, education or other retirement or employee benefits available to other executive employees of the Company at an appropriate level for the duties of the office, subject to any restrictions (including waiting periods) specified in such plans. The Company shall make commercially reasonable efforts to obtain medical and disability insurance, and such other forms of insurance as the Board of Directors shall determine, for its employees. (b) VACATION. The Executive shall be entitled to the number of weeks -------- of paid vacation per calendar year as specified in the Company's employee manual based on the time served as an employee of the Company, with such vacation to be scheduled and taken in accordance with the Company's standard vacation policies. 5. BUSINESS EXPENSES. The Company shall reimburse the Executive for any ----------------- and all necessary, customary and usual expenses, properly receipted in accordance with Company policies, incurred by the Executive on behalf of the Company. 6. TERMINATION OF EXECUTIVE'S EMPLOYMENT. (a) DEATH. If the Executive dies while employed by the Company, his ----- employment shall immediately terminate. The Company's obligation to pay the Executive's Base Salary shall cease as of the date of Executive's death. Thereafter, Executive's beneficiaries or his 2 estate shall receive benefits in accordance with the Company's retirement, insurance and other applicable programs and plans then in effect. (b) DISABILITY. ---------- (i) If, as a result of the Executive's incapacity due to physical or mental illness ("Disability"), Executive shall have been absent from the full-time performance of his duties with the Company for six (6) consecutive months, and, within thirty (30) days after written notice is provided to him by the Company, he shall not have returned to the full-time performance of his duties, the Executive's employment under this Agreement may be terminated by the Company for Disability. During any period prior to such termination during which the Executive is absent from the full-time performance of his duties with the Company due to Disability, the Company shall continue to pay the Executive his Base Salary at the rate in effect at the commencement of such period of Disability. Subsequent to such termination, the Executive's benefits shall be determined under the Company's retirement, insurance and other compensation programs then in effect in accordance with the terms of such programs. (ii) If, however, as a result of the Executive's partial incapacity due to physical or mental illness in which Executive shall not have been absent from his duties for six consecutive months and shall have returned to work on a full-time basis but is not able to perform at the same level as when hired and/or is not able to perform the same functions for which originally hired ("Partial Disability"), the Company shall make reasonable efforts to accommodate the Executive's Partial Disability by modifying his job description appropriately, together with a commensurate adjustment in compensation; provided, however, the Company shall be required to so continue the employment of the Executive in the event of a Partial Disability of the Executive only if the Company determines, in its sole discretion, that it can create a position for which the Executive would be suited and that would be economically advantageous to the Company. (c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate ------------------------------------ the Executive's employment under this Agreement for "Cause," at any time prior to expiration of the Term of the Agreement, only in the event of (i) acts or omissions constituting gross negligence, recklessness or willful misconduct on the part of the Executive in respect of his fiduciary obligations or otherwise relating to the business of the Company, (ii) the Executive's material breach of this Agreement, or (iii) the Executive's conviction or entry of a plea of nolo contendre for fraud, misappropriation or embezzlement. In such a case, the Executive's employment under this Agreement may be terminated immediately without any advance written notice, and the Company's obligation to pay the Executive's Base Salary, any bonus and fringe benefits will cease as of the termination date. (d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive shall -------------------------------------------- have the right to terminate this Agreement for Good Reason. For purposes of this Agreement, "Good Reason" shall mean the occurrence, without the Executive's express written consent, of any one or more of the following events: 3 (i) A reduction in title and/or compensation of the Executive or the assignment of duties to the Executive not consistent with those of a senior executive of the Company, except in connection with the Company's termination of the Executive's employment for Cause pursuant to Section 6(c) or as otherwise expressly contemplated herein; (ii) The Company's material breach of any of the provisions of this Agreement, including, but not limited to, a reduction by the Company in the Executive's Base Salary in effect as of the Effective Date; or a change in the conditions of the Executive's employment (e.g., including, without limitation, a ---- failure by the Company to provide the Executive with incentive compensation and benefits plans that provide benefits and the opportunity to obtain incentive compensation, in each case comparable to those available under benefits programs in effect as of the Effective Date and at an appropriate level for the duties of the officer, etc.); (iii) The relocation of the Company's principal executive offices to a location more than twenty-five (25) miles from its location as of the Effective Date or the Company's requiring the Executive to be based anywhere other than the Company's principal executive offices, except for requiring travel on the Company's business to an extent substantially consistent with the Executive's duties hereunder; or (iv) A change in control as defined in Section 8 below. The Executive agrees to provide the Company with thirty (30) days' prior written notice of any termination for Good Reason. (e) TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON. The Executive ------------------------------------------------ may at any time during the Term of this Agreement terminate his employment hereunder for any reason or no reason by giving the Company notice in writing not less than one hundred twenty (120) days in advance of such termination. Except as may be provided in Section 9, the Executive shall have no further obligations to the Company after the effective date of termination, as set forth in the notice. Notwithstanding the foregoing, in the event any "person" (as defined in Section 8 below) begins a tender or exchange offer, circulates a proxy to shareholders or takes other steps to effect a Change of Control, the Executive agrees that he will not voluntarily leave the employ of the Company, and will render services to the Company commensurate with his position, until such "person" has abandoned or terminated efforts to effect a Change of Control or until a Change of Control has occurred. In the event of a termination by the Executive under this paragraph, the Company will pay only the portion of Base Salary or previously awarded bonus unpaid as of the termination date. Fringe benefits which have accrued and/or vested on the termination date will continue in effect according to their terms, but no additional accrual or vesting will take place. 7. COMPENSATION UPON TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, OR --------------------------------------------------------------------- BY THE EXECUTIVE FOR GOOD REASON. If the Executive's employment shall be - -------------------------------- terminated (i) by the Company other than for Cause, or (ii) by the Executive for Good Reason, the Executive shall be entitled to the following benefits: 4 (a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay ----------------------------- the Executive any portion of the Executive's Base Salary or previously awarded Bonus not paid prior to the termination date. (b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount ----------------- (the "Severance Amount") equal to two times the Executive's combined Base Salary and bonus compensation for the preceding fiscal year. The Severance Amount shall be payable fifty percent (50%) within five (5) days after the termination date and the remaining fifty percent (50%) shall be payable in twelve (12) equal consecutive monthly installments beginning on the first day of the month following the termination date. (c) IMMEDIATE VESTING OF STOCK OPTIONS. The Company shall take all ---------------------------------- appropriate action to ensure that all stock options on the Company's stock owned by the Executive as of the Effective Date and which have not been exercised prior to the termination date become immediately exercisable by the Executive, whether or not the right to exercise such stock options would otherwise then be vested in the Executive. The provisions of this Section 7(c) shall constitute an amendment to any existing stock option agreements of the Company as of the Effective Date. All other stock options owned by the Executive as of the termination date shall be exercisable in accordance with the Company's stock option plan and the applicable stock option agreements. (d) CONTINUATION OF FRINGE BENEFITS. From and after termination of ------------------------------- the Executive's employment, the Company shall continue to provide the Executive with all life insurance and medical coverage fringe benefits set forth in Section 4 as if the Executive's employment under the Agreement had not been terminated until the earlier to occur of (i) such time as the Executive finds full-time employment or (ii) the expiration of twelve (12) months. Notwithstanding the immediately preceding sentence, if, as the result of termination of the Executive's employment, the Executive and/or his otherwise eligible dependents or beneficiaries shall become ineligible for benefits under any one of the Company's benefit plans or the cost of providing such benefits exceeds two hundred percent (200%) of the cost of providing such benefits to other members of senior management, the Company, at the Company's option, shall (i) continue to provide the Executive and his eligible dependents or beneficiaries with benefits at a level at least equivalent to the level of benefits for which the Executive and his dependents and beneficiaries were eligible under such plans immediately prior to the termination date or (ii) for any fringe benefit not so provided, the Company shall pay the Executive 200% of the cost of providing such fringe benefit to other members of senior management. (e) EXCISE TAX GROSS-UP. In the event that the Executive becomes ------------------- entitled to the benefit payments provided under subparagraphs (a)-(d) of this Section 7.A ("Benefit Payments"), and if any of the Benefit Payments will be subject to any excise tax ("Excise Tax") imposed under section 4999 of the Internal Revenue Code of 1986, as amended from time to time, or successor sections thereto, the Company shall pay to the Executive an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Benefit Payments and any federal, state and local income tax and Excise Tax upon the Gross-Up Payment, shall be equal to the amount of the Benefit Payments. Upon the Executive's termination date, the Company shall estimate and pay 5 to the Executive the Gross-Up Payment. In the event that the Excise Tax is subsequently determined to be less than the amount estimated at the termination date, the Executive shall repay to the Company, at the time that the amount of such reduction in Excise Tax is finally determined, the difference plus interest on the amount of such repayment at 10% per annum. In the event that the Excise Tax is determined to exceed the amount estimated at the termination date, the Company shall make an additional Gross-Up Payment in respect of such excess at the time that the amount of such excess is finally determined, plus interest at 10% per annum. The Executive and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Benefit Payments. (f) NO MITIGATION REQUIRED; NO OTHER ENTITLEMENT TO BENEFITS UNDER -------------------------------------------------------------- AGREEMENT. The Executive shall not be required in any way to mitigate the - --------- amount of any payment provided for in this Section 7, including, but not limited to, by seeking other employment, nor shall the amount of any payment provided for in this Section 7 be reduced by any compensation earned by the Executive as a result of employment with another employer after the termination date of employment, or otherwise. Except as set forth in this Section 7, following a termination governed by this Section 7, the Executive shall not be entitled to any other compensation or benefits set forth in this Agreement, except as may be separately negotiated by the parties and approved by the Board of Directors of the Company in writing in conjunction with the termination of Executive's employment under this Section 7. 8. CHANGE IN CONTROL. A "Change in Control" shall be deemed to have ----------------- occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied. (a) Any "person," as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934 (the "Exchange Act") (other than the Company; any trustee or other fiduciary holding securities under an Executive benefit plan of the Company; or any company owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of the stock of the Company), is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of the securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or from a transferor in a transaction expressly approved or consented to by the Board of Directors) representing more than 25% of the combined voting power of the Company's then outstanding securities; or (b) During any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board of Directors and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clause (a), (c) or (d) of this section), (i) whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two- thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved or (ii) whose election is to replace 6 a person who ceases to be a director due to death, disability or age, cease for any reason to constitute a majority thereof; or (c) The shareholders of the Company approve a merger or consolidation of the Company with other corporation, other than (i) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an Executive benefit plan of the Company, at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or (d) The shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. 9. DISPUTE RELATING TO EXECUTIVE'S TERMINATION OF EMPLOYMENT FOR GOOD ------------------------------------------------------------------ REASON. If the Executive resigns his employment with the Company alleging in - ------ good faith as the basis for such resignation any of the "Good Reasons" specified in Section 6(d), and if the Company then disputes the Executive's right to the payment of benefits under Section 7, the Company shall continue to pay the Executive the full compensation (including, but not limited to, his Base Salary) in effect at the date the Executive provided notice of such resignation, and the Company shall continue the Executive as a participant in al compensation, benefit and insurance plans in which the Executive was then a participant, until the earlier of the expiration of the Term of the Agreement or the date the dispute is finally resolved, either by jurisdiction which is not appealable or with respect to which the time for appeal has expired and no appeal has been perfected. For the purposes of this Section, the Company shall bear the burden of proving that the grounds for the Executive's resignation do not fall within the scope of Section 6(d), and there shall be a rebuttable presumption that the Executive alleged such grounds in good faith. 10. NONCOMPETITION PROVISIONS. ------------------------- (a) NONCOMPETITION. The Executive agrees that during the Term of this -------------- Agreement prior to any termination of his employment hereunder and for a period of twelve (12) months following the occurrence of any event entitling the Executive to Benefit Payments according to the provisions of Section 7 and in consideration therefor, provided the Company makes all such payments when due, he will not directly or indirectly, without the prior written consent of the Company, manage, operate, join, control, participate in, or be connected as a stockholder (other than as a holder of shares publicly traded on a stock exchange or the Nasdaq National Market), partner, or other equity holder with, or as an officer, director or employee of, any other real estate lender whose business strategy is competitive with that of the Company, as determined by a majority of the Company's independent directors ("Competing Business"). It is further expressly agreed that the Company will or would suffer irreparable injury if the Executive were to compete with the Company or any subsidiary or affiliate of the Company in violation of 7 this Agreement and that the Company would by reason of such competition be entitled to injunctive relief in a court of appropriate jurisdiction, and the Executive further consents and stipulates to the entry of such injunctive relief in such a court prohibiting the Executive from competing with the Company or any subsidiary or affiliate of the Company, in the areas of business set forth above, in violation of this Agreement. (b) RIGHT TO COMPANY MATERIALS. The Executive agrees that all styles, -------------------------- designs, lists, materials, books, files, reports, correspondence, records and other documents ("Company Materials") used, prepared or made available to the Executive, shall be and shall remain the property of the Company. Upon the termination of employment or the expiration of this Agreement, all Company Materials shall be returned immediately to the Company, and the Executive shall not make or retain any copies thereof. (c) SOLICITING EXECUTIVES. The Executive promises and agrees that --------------------- during the noncompetition period defined in paragraph (a) he will not directly or indirectly solicit any of the Company executives or employees to work for any Competing Business. 11. NOTICES. All notices and other communications under this Agreement ------- shall be in writing and shall be given by fax or first class mail, certified or registered with return receipt requested, and shall be deemed to have been duly given three (3) days after mailing or twenty-four (24) hours after transmission of a fax to the respective persons named below: If to Company: Headlands Mortgage Company Attn: Board of Directors 1100 Larkspur Landing Circle Suite 101 Larkspur, CA 94939 Phone: (415) 461-6790 Fax: (415) 461-2128 If to Executive: Gilbert J. MacQuarrie 32 Andreas Circle Novato, CA 94945 Phone: (415) 997-6328 Either party may change such party's address for notices by notice duly given pursuant hereto. 12. ATTORNEYS' FEES. In the event judicial determination is necessary of --------------- any dispute arising as to the parties' rights and obligations hereunder, each party shall have the right, in addition to any other relief granted by the court, to attorneys' fees based on a determination by the court of the extent to which each party has prevailed as to the material issues raised in determination of the dispute. 8 13. TERMINATION OF PRIOR AGREEMENTS. This Agreement terminates and ------------------------------- supersedes any and all prior agreements and understandings between the parties with respect to employment or with respect to the compensation of the Executive by the Company. 14. ASSIGNMENT; SUCCESSORS. This Agreement is personal in its nature and ---------------------- neither of the parties hereto shall, without the consent of the other, assign or transfer this Agreement or any rights or obligations hereunder; provided that, in the event of the merger, consolidation, transfer, or sale of all or substantially all of the assets of the Company with or to any other individual or entity, this Agreement shall, subject to the provisions hereof, be binding upon and inure to the benefit of such successor and such successor shall discharge and perform all the promises, covenants, duties, and obligations of the Company hereunder. 15. GOVERNING LAW. This Agreement and the legal relations thus created ------------- between the parties hereto shall be governed by and construed under and in accordance with the laws of the State of California. 16. ENTIRE AGREEMENT; HEADINGS. This Agreement embodies the entire -------------------------- agreement of the parties respecting the matters within its scope and may be modified only in writing. Section headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. 17. WAIVER; MODIFICATION. Failure to insist upon strict compliance with -------------------- any of the terms, covenants or conditions hereof shall not be deemed a waiver of such term, covenant or condition, nor shall any waiver or relinquishment of, or failure to insist upon strict compliance with, any right or power hereunder at any one or more times be deemed a waiver or relinquishment of such right or power at any other time or times. This Agreement shall not be modified in any respect except by a writing executed by each party hereto. 18. SEVERABILITY. In the event that a court of competent jurisdiction ------------ determines that any portion of this Agreement is in violation of any statute or public policy, only the portions of this Agreement that violate such statute or public policy shall be stricken. All portions of this Agreement that do not violate any statute or public policy shall continue in full force and effect. Further, any court order striking any portion of this Agreement shall modify the stricken terms as narrowly as possible to give as much effect as possible to the intentions of the parties under this Agreement. 19. INDEMNIFICATION. The Company shall indemnify and hold Executive --------------- harmless to the maximum extent permitted by California Law and the Bylaws of the Company. 20. COUNTERPARTS. This Agreement may be executed in counterparts. ------------ 9 IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer, and the Executive has hereunto signed this Agreement, as of the date first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By____________________________________ ______________________________________ GILBERT J. MacQUARRIE 10 EX-10.1.4 9 EMPLOYMENT AGREEMENT - STEVEN M. ABREU EXHIBIT 10.1.4 ------------- EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT ("Agreement"), effective as of the ____ day of _______________, 1997, is entered into by and between Steven M. Abreu ("Executive") and Headlands Mortgage Company, a California corporation ("Company"), and is effective as of and conditioned upon the completion of the Company's sale of ____________________________ (__________) shares of Common Stock in an initial public offering. The Company desires to establish its right to the continued services of the Executive, in the capacity described below, on the terms and conditions and subject to the rights of termination hereinafter set forth, and the Executive is willing to accept such employment on such terms and conditions. In consideration of the mutual agreements hereinafter set forth, the Executive and the Company have agreed and do hereby agree as follows: 1. EMPLOYMENT BY THE COMPANY. The Company does hereby employ, engage and ------------------------- hire the Executive as Executive Vice President, Production and Secondary Marketing of the Company, and the Executive does hereby accept and agree to such hiring, engagement and employment. The Executive's duties shall be such executive and managerial duties as the Board of Directors of the Company or its subsidiaries shall from time to time prescribe and as provided in the bylaws of the Company. The terms of this Agreement shall be subject to the personnel policies of the Company as determined by the Board of Directors from time to time, except to the extent that any such policy would have a material adverse effect on the rights of the Executive under the terms of this Agreement. The Executive shall devote such time, energy and skill to the performance of his duties for the Company and for the benefit of the Company as may be necessary or required for the effective conduct and operation of the Company's business. Furthermore, the Executive shall exercise due diligence and care in the performance of his duties to the Company under this Agreement. 2. TERM OF AGREEMENT. The term ("Term") of this Agreement shall commence ----------------- on the date of the closing of the initial public offering referred to above (the "Effective Date") and shall continue through December 31, 1999; provided, however, that on each December 31 commencing December 31, 1998 the Term of the Agreement shall automatically be extended for one additional year unless, not later than three months prior to any such December 31, either party shall have given written notice to the other that it does not wish to extend the Term of the Agreement. 3. COMPENSATION. (a) BASE SALARY. The Company shall pay the Executive, and the ----------- Executive agrees to accept from the Company, in payment for his services to the Company beginning on the Effective Date, a base salary at the rate to be determined by the Compensation Committee of the Board of Directors and provided to the Executive in writing ("Base Salary"), 1 which is subject to change upon thirty (30) days' notice and shall initially be set at One Hundred Thousand Eight Hundred Dollars ($108,000.00). Base Salary is payable in equal semimonthly installments or at such other time or times as the Executive and Company agree. (b) PERFORMANCE BONUS - BOARD OF DIRECTORS DISCRETION. The Executive ------------------------------------------------- shall be eligible to receive an incentive performance bonus in accordance with the Bonus Incentive Compensation Plan established by the Company. Except as provided in Section 7, any such bonus awarded to the Executive shall be payable in the amount, in the manner and at the time determined by the Compensation Committee of the Company's Board of Directors in its sole and absolute discretion. (c) ANNUAL REVIEW. The Compensation Committee of the Company's Board ------------- of Directors shall, at least annually, review the Executive's entire compensation package to determine whether it continues to meet the Company's compensation objectives. Such annual review will include a determination of (i) whether to increase the Base Salary set forth in Section 3(a) and (ii) the incentive performance bonus to be awarded in accordance with Section 3(b). 4. FRINGE BENEFITS. The Executive shall be entitled to participate in --------------- any benefit programs adopted from time to time by the Company for the benefit of its executive employees at an appropriate level for the duties of the officer, and the Executive shall be entitled to receive such other fringe benefits as may be granted from time to time by the Company's Board of Directors or its Compensation Committee. (a) BENEFIT PLANS. The Executive shall be entitled to participate in ------------- any benefit plans relating to stock options, stock purchases, pension, thrift, profit sharing, life insurance, medical coverage, education or other retirement or employee benefits available to other executive employees of the Company at an appropriate level for the duties of the office, subject to any restrictions (including waiting periods) specified in such plans. The Company shall make commercially reasonable efforts to obtain medical and disability insurance, and such other forms of insurance as the Board of Directors shall determine, for its employees. (b) VACATION. The Executive shall be entitled to the number of weeks -------- of paid vacation per calendar year as specified in the Company's employee manual based on the time served as an employee of the Company, with such vacation to be scheduled and taken in accordance with the Company's standard vacation policies. 5. BUSINESS EXPENSES. The Company shall reimburse the Executive for any ----------------- and all necessary, customary and usual expenses, properly receipted in accordance with Company policies, incurred by the Executive on behalf of the Company. 6. TERMINATION OF EXECUTIVE'S EMPLOYMENT. (a) DEATH. If the Executive dies while employed by the Company, his ----- employment shall immediately terminate. The Company's obligation to pay the Executive's Base Salary shall cease as of the date of Executive's death. Thereafter, Executive's beneficiaries or his 2 estate shall receive benefits in accordance with the Company's retirement, insurance and other applicable programs and plans then in effect. (b) DISABILITY. ---------- (i) If, as a result of the Executive's incapacity due to physical or mental illness ("Disability"), Executive shall have been absent from the full-time performance of his duties with the Company for six (6) consecutive months, and, within thirty (30) days after written notice is provided to him by the Company, he shall not have returned to the full-time performance of his duties, the Executive's employment under this Agreement may be terminated by the Company for Disability. During any period prior to such termination during which the Executive is absent from the full-time performance of his duties with the Company due to Disability, the Company shall continue to pay the Executive his Base Salary at the rate in effect at the commencement of such period of Disability. Subsequent to such termination, the Executive's benefits shall be determined under the Company's retirement, insurance and other compensation programs then in effect in accordance with the terms of such programs. (ii) If, however, as a result of the Executive's partial incapacity due to physical or mental illness in which Executive shall not have been absent from his duties for six consecutive months and shall have returned to work on a full-time basis but is not able to perform at the same level as when hired and/or is not able to perform the same functions for which originally hired ("Partial Disability"), the Company shall make reasonable efforts to accommodate the Executive's Partial Disability by modifying his job description appropriately, together with a commensurate adjustment in compensation; provided, however, the Company shall be required to so continue the employment of the Executive in the event of a Partial Disability of the Executive only if the Company determines, in its sole discretion, that it can create a position for which the Executive would be suited and that would be economically advantageous to the Company. (c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate ------------------------------------ the Executive's employment under this Agreement for "Cause," at any time prior to expiration of the Term of the Agreement, only in the event of (i) acts or omissions constituting gross negligence, recklessness or willful misconduct on the part of the Executive in respect of his fiduciary obligations or otherwise relating to the business of the Company, (ii) the Executive's material breach of this Agreement, or (iii) the Executive's conviction or entry of a plea of nolo contendre for fraud, misappropriation or embezzlement. In such a case, the Executive's employment under this Agreement may be terminated immediately without any advance written notice, and the Company's obligation to pay the Executive's Base Salary, any bonus and fringe benefits will cease as of the termination date. (d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive -------------------------------------------- shall have the right to terminate this Agreement for Good Reason. For purposes of this Agreement, "Good Reason" shall mean the occurrence, without the Executive's express written consent, of any one or more of the following events: 3 (i) A reduction in title and/or compensation of the Executive or the assignment of duties to the Executive not consistent with those of a senior executive of the Company, except in connection with the Company's termination of the Executive's employment for Cause pursuant to Section 6(c) or as otherwise expressly contemplated herein; (ii) The Company's material breach of any of the provisions of this Agreement, including, but not limited to, a reduction by the Company in the Executive's Base Salary in effect as of the Effective Date; or a change in the conditions of the Executive's employment (e.g., including, without limitation, a ---- failure by the Company to provide the Executive with incentive compensation and benefits plans that provide benefits and the opportunity to obtain incentive compensation, in each case comparable to those available under benefits programs in effect as of the Effective Date and at an appropriate level for the duties of the officer, etc.); (iii) The relocation of the Company's principal executive offices to a location more than twenty-five (25) miles from its location as of the Effective Date or the Company's requiring the Executive to be based anywhere other than the Company's principal executive offices, except for requiring travel on the Company's business to an extent substantially consistent with the Executive's duties hereunder; or (iv) A change in control as defined in Section 8 below. The Executive agrees to provide the Company with thirty (30) days' prior written notice of any termination for Good Reason. (e) TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON. The Executive ------------------------------------------------ may at any time during the Term of this Agreement terminate his employment hereunder for any reason or no reason by giving the Company notice in writing not less than one hundred twenty (120) days in advance of such termination. Except as may be provided in Section 9, the Executive shall have no further obligations to the Company after the effective date of termination, as set forth in the notice. Notwithstanding the foregoing, in the event any "person" (as defined in Section 8 below) begins a tender or exchange offer, circulates a proxy to shareholders or takes other steps to effect a Change of Control, the Executive agrees that he will not voluntarily leave the employ of the Company, and will render services to the Company commensurate with his position, until such "person" has abandoned or terminated efforts to effect a Change of Control or until a Change of Control has occurred. In the event of a termination by the Executive under this paragraph, the Company will pay only the portion of Base Salary or previously awarded bonus unpaid as of the termination date. Fringe benefits which have accrued and/or vested on the termination date will continue in effect according to their terms, but no additional accrual or vesting will take place. 7. COMPENSATION UPON TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, OR --------------------------------------------------------------------- BY THE EXECUTIVE FOR GOOD REASON. If the Executive's employment shall be - -------------------------------- terminated (i) by the Company other than for Cause, or (ii) by the Executive for Good Reason, the Executive shall be entitled to the following benefits: 4 (a) PAYMENT OF UNPAID BASE SALARY. The Company shall immediately pay ----------------------------- the Executive any portion of the Executive's Base Salary or previously awarded Bonus not paid prior to the termination date. (b) SEVERANCE PAYMENT. The Company shall pay the Executive an amount ----------------- (the "Severance Amount") equal to two times the Executive's combined Base Salary and bonus compensation for the preceding fiscal year. The Severance Amount shall be payable fifty percent (50%) within five (5) days after the termination date and the remaining fifty percent (50%) shall be payable in twelve (12) equal consecutive monthly installments beginning on the first day of the month following the termination date. (c) IMMEDIATE VESTING OF STOCK OPTIONS. The Company shall take all ---------------------------------- appropriate action to ensure that all stock options on the Company's stock owned by the Executive as of the Effective Date and which have not been exercised prior to the termination date become immediately exercisable by the Executive, whether or not the right to exercise such stock options would otherwise then be vested in the Executive. The provisions of this Section 7(c) shall constitute an amendment to any existing stock option agreements of the Company as of the Effective Date. All other stock options owned by the Executive as of the termination date shall be exercisable in accordance with the Company's stock option plan and the applicable stock option agreements. (d) CONTINUATION OF FRINGE BENEFITS. From and after termination of ------------------------------- the Executive's employment, the Company shall continue to provide the Executive with all life insurance and medical coverage fringe benefits set forth in Section 4 as if the Executive's employment under the Agreement had not been terminated until the earlier to occur of (i) such time as the Executive finds full-time employment or (ii) the expiration of twelve (12) months. Notwithstanding the immediately preceding sentence, if, as the result of termination of the Executive's employment, the Executive and/or his otherwise eligible dependents or beneficiaries shall become ineligible for benefits under any one of the Company's benefit plans or the cost of providing such benefits exceeds two hundred percent (200%) of the cost of providing such benefits to other members of senior management, the Company, at the Company's option, shall (i) continue to provide the Executive and his eligible dependents or beneficiaries with benefits at a level at least equivalent to the level of benefits for which the Executive and his dependents and beneficiaries were eligible under such plans immediately prior to the termination date or (ii) for any fringe benefit not so provided, the Company shall pay the Executive 200% of the cost of providing such fringe benefit to other members of senior management. (e) EXCISE TAX GROSS-UP. In the event that the Executive becomes ------------------- entitled to the benefit payments provided under subparagraphs (a)-(d) of this Section 7.A ("Benefit Payments"), and if any of the Benefit Payments will be subject to any excise tax ("Excise Tax") imposed under section 4999 of the Internal Revenue Code of 1986, as amended from time to time, or successor sections thereto, the Company shall pay to the Executive an additional amount (the "Gross-Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Benefit Payments and any federal, state and local income tax and Excise Tax upon the Gross-Up Payment, shall be equal to the amount of the Benefit Payments. Upon the Executive's termination date, the Company shall estimate and pay 5 to the Executive the Gross-Up Payment. In the event that the Excise Tax is subsequently determined to be less than the amount estimated at the termination date, the Executive shall repay to the Company, at the time that the amount of such reduction in Excise Tax is finally determined, the difference plus interest on the amount of such repayment at 10% per annum. In the event that the Excise Tax is determined to exceed the amount estimated at the termination date, the Company shall make an additional Gross-Up Payment in respect of such excess at the time that the amount of such excess is finally determined, plus interest at 10% per annum. The Executive and the Company shall each reasonably cooperate with the other in connection with any administrative or judicial proceedings concerning the existence or amount of liability for Excise Tax with respect to the Benefit Payments. (f) NO MITIGATION REQUIRED; NO OTHER ENTITLEMENT TO BENEFITS UNDER -------------------------------------------------------------- AGREEMENT. The Executive shall not be required in any way to mitigate the - --------- amount of any payment provided for in this Section 7, including, but not limited to, by seeking other employment, nor shall the amount of any payment provided for in this Section 7 be reduced by any compensation earned by the Executive as a result of employment with another employer after the termination date of employment, or otherwise. Except as set forth in this Section 7, following a termination governed by this Section 7, the Executive shall not be entitled to any other compensation or benefits set forth in this Agreement, except as may be separately negotiated by the parties and approved by the Board of Directors of the Company in writing in conjunction with the termination of Executive's employment under this Section 7. 8. CHANGE IN CONTROL. A "Change in Control" shall be deemed to have ----------------- occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied. (a) Any "person," as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934 (the "Exchange Act") (other than the Company; any trustee or other fiduciary holding securities under an Executive benefit plan of the Company; or any company owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of the stock of the Company), is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of the securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or from a transferor in a transaction expressly approved or consented to by the Board of Directors) representing more than 25% of the combined voting power of the Company's then outstanding securities; or (b) During any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board of Directors and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clause (a), (c) or (d) of this section), (i) whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two- thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved or (ii) whose election is to replace 6 a person who ceases to be a director due to death, disability or age, cease for any reason to constitute a majority thereof; or (c) The shareholders of the Company approve a merger or consolidation of the Company with other corporation, other than (i) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an Executive benefit plan of the Company, at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or (d) The shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. 9. DISPUTE RELATING TO EXECUTIVE'S TERMINATION OF EMPLOYMENT FOR GOOD ------------------------------------------------------------------ REASON. If the Executive resigns his employment with the Company alleging in - ------ good faith as the basis for such resignation any of the "Good Reasons" specified in Section 6(d), and if the Company then disputes the Executive's right to the payment of benefits under Section 7, the Company shall continue to pay the Executive the full compensation (including, but not limited to, his Base Salary) in effect at the date the Executive provided notice of such resignation, and the Company shall continue the Executive as a participant in al compensation, benefit and insurance plans in which the Executive was then a participant, until the earlier of the expiration of the Term of the Agreement or the date the dispute is finally resolved, either by jurisdiction which is not appealable or with respect to which the time for appeal has expired and no appeal has been perfected. For the purposes of this Section, the Company shall bear the burden of proving that the grounds for the Executive's resignation do not fall within the scope of Section 6(d), and there shall be a rebuttable presumption that the Executive alleged such grounds in good faith. 10. NONCOMPETITION PROVISIONS. ------------------------- (a) NONCOMPETITION. The Executive agrees that during the Term of this -------------- Agreement prior to any termination of his employment hereunder and for a period of twelve (12) months following the occurrence of any event entitling the Executive to Benefit Payments according to the provisions of Section 7 and in consideration therefor, provided the Company makes all such payments when due, he will not directly or indirectly, without the prior written consent of the Company, manage, operate, join, control, participate in, or be connected as a stockholder (other than as a holder of shares publicly traded on a stock exchange or the Nasdaq National Market), partner, or other equity holder with, or as an officer, director or employee of, any other real estate lender whose business strategy is competitive with that of the Company, as determined by a majority of the Company's independent directors ("Competing Business"). It is further expressly agreed that the Company will or would suffer irreparable injury if the Executive were to compete with the Company or any subsidiary or affiliate of the Company in violation of 7 this Agreement and that the Company would by reason of such competition be entitled to injunctive relief in a court of appropriate jurisdiction, and the Executive further consents and stipulates to the entry of such injunctive relief in such a court prohibiting the Executive from competing with the Company or any subsidiary or affiliate of the Company, in the areas of business set forth above, in violation of this Agreement. (b) RIGHT TO COMPANY MATERIALS. The Executive agrees that all styles, -------------------------- designs, lists, materials, books, files, reports, correspondence, records and other documents ("Company Materials") used, prepared or made available to the Executive, shall be and shall remain the property of the Company. Upon the termination of employment or the expiration of this Agreement, all Company Materials shall be returned immediately to the Company, and the Executive shall not make or retain any copies thereof. (c) SOLICITING EXECUTIVES. The Executive promises and agrees that --------------------- during the noncompetition period defined in paragraph (a) he will not directly or indirectly solicit any of the Company executives or employees to work for any Competing Business. 11. NOTICES. All notices and other communications under this Agreement ------- shall be in writing and shall be given by fax or first class mail, certified or registered with return receipt requested, and shall be deemed to have been duly given three (3) days after mailing or twenty-four (24) hours after transmission of a fax to the respective persons named below: If to Company: Headlands Mortgage Company Attn: Board of Directors 1100 Larkspur Landing Circle Suite 101 Larkspur, CA 94939 Phone: (415) 461-6790 Fax: (415) 461-2128 If to Executive: Steven M. Abreu 18 Windward Hill Road Oakland, CA 94618 Phone: (510) 540-7339 Either party may change such party's address for notices by notice duly given pursuant hereto. 12. ATTORNEYS' FEES. In the event judicial determination is necessary of --------------- any dispute arising as to the parties' rights and obligations hereunder, each party shall have the right, in addition to any other relief granted by the court, to attorneys' fees based on a determination by the court of the extent to which each party has prevailed as to the material issues raised in determination of the dispute. 8 13. TERMINATION OF PRIOR AGREEMENTS. This Agreement terminates and ------------------------------- supersedes any and all prior agreements and understandings between the parties with respect to employment or with respect to the compensation of the Executive by the Company. 14. ASSIGNMENT; SUCCESSORS. This Agreement is personal in its nature and ---------------------- neither of the parties hereto shall, without the consent of the other, assign or transfer this Agreement or any rights or obligations hereunder; provided that, in the event of the merger, consolidation, transfer, or sale of all or substantially all of the assets of the Company with or to any other individual or entity, this Agreement shall, subject to the provisions hereof, be binding upon and inure to the benefit of such successor and such successor shall discharge and perform all the promises, covenants, duties, and obligations of the Company hereunder. 15. GOVERNING LAW. This Agreement and the legal relations thus created ------------- between the parties hereto shall be governed by and construed under and in accordance with the laws of the State of California. 16. ENTIRE AGREEMENT; HEADINGS. This Agreement embodies the entire -------------------------- agreement of the parties respecting the matters within its scope and may be modified only in writing. Section headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. 17. WAIVER; MODIFICATION. Failure to insist upon strict compliance with -------------------- any of the terms, covenants or conditions hereof shall not be deemed a waiver of such term, covenant or condition, nor shall any waiver or relinquishment of, or failure to insist upon strict compliance with, any right or power hereunder at any one or more times be deemed a waiver or relinquishment of such right or power at any other time or times. This Agreement shall not be modified in any respect except by a writing executed by each party hereto. 18. SEVERABILITY. In the event that a court of competent jurisdiction ------------ determines that any portion of this Agreement is in violation of any statute or public policy, only the portions of this Agreement that violate such statute or public policy shall be stricken. All portions of this Agreement that do not violate any statute or public policy shall continue in full force and effect. Further, any court order striking any portion of this Agreement shall modify the stricken terms as narrowly as possible to give as much effect as possible to the intentions of the parties under this Agreement. 19. INDEMNIFICATION. The Company shall indemnify and hold Executive --------------- harmless to the maximum extent permitted by California Law and the Bylaws of the Company. 20. COUNTERPARTS. This Agreement may be executed in counterparts. ------------ 9 IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer, and the Executive has hereunto signed this Agreement, as of the date first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By_____________________________________ _______________________________________ STEVEN M. ABREU 10 EX-10.2 10 1997 EXECUTIVE AND NON-EMPLOYEE - JULY 22, 1997 EXHIBIT 10.2 ------------ HEADLANDS MORTGAGE COMPANY 1997 EXECUTIVE AND NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN (As Adopted Effective July 22, 1997) 1. GENERAL PURPOSE OF PLAN; DEFINITIONS. The name of this plan is the Headlands Mortgage Company 1997 Executive and Non-Employee Director Stock Option Plan (the "Plan"). The Plan was adopted by the Board effective as of July 22, 1997, subject to the approval of the Company stockholders. The purpose of the Plan is to enable the Company and its Subsidiaries to obtain and retain competent personnel who will contribute to the Company's success by their ability, ingenuity and industry, to give the Company's non-employee directors a proprietary interest in the Company and to provide incentives to the participating directors, officers and other key employees, and agents and consultants that are linked directly to increases in stockholder value and will therefore inure to the benefit of all stockholders of the Company. For purposes of the Plan, the following terms shall be defined as set forth below: (1) "Accrued DERs" means dividend equivalent rights with the accrual ------------ rights described in Section 5(11). (2) "Administrator" means the Board, or if the Board does not administer ------------- the Plan, the Committee in accordance with Section 2. (3) "Board" means the Board of Directors of the Company. ----- (4) "Code" means the Internal Revenue Code of 1986, as amended from time ---- to time, or any successor thereto. (5) "Committee" means the Compensation Committee of the Board, which shall --------- be composed entirely of individuals who meet the qualifications to be a "Non- Employee Director" as defined in Rule 16b-3 ("Rule 16b-3") as promulgated by the Securities and Exchange Commission (the "Commission") under the Securities Exchange Act of 1934 (the "Act"), and as such Rule may be amended from time to time, or any successor definition adopted by the Commission, or any other Committee the Board may subsequently appoint to administer the Plan. If at any time the Board shall not administer the Plan, then the functions of the Board specified in the Plan shall be exercised by the Committee. 1 (6) "Company" means Headlands Mortgage Company, a corporation organized ------- under the laws of the State of California (or any successor corporation). (7) "Current-pay DERs" means dividend equivalent rights with the current- ---------------- pay rights described in Section 5(11). (8) "DERs" shall mean Accrued DERs and Current-pay DERs. ---- (9) "Deferred Stock" means an award granted pursuant to Section 7 of the -------------- right to receive Stock at the end of a specified deferral period. (10) "Disability" means permanent and total disability as determined under ---------- the Company's disability program or policy. (11) "Effective Date" shall mean the date provided pursuant to Section 12. -------------- (12) "Eligible Employee" means an employee of the Company or any Subsidiary ----------------- eligible to participate in the Plan pursuant to Section 4. (13) "Eligible Non-Employee Director" means a member of the Board or the ------------------------------ board of directors of any Subsidiary who is not a bona fide employee of the Company or any Subsidiary and who is eligible to participate in the Plan pursuant to Section 5A. (14) "Fair Market Value" means, as of any given date, with respect to any ----------------- awards granted hereunder, at the discretion of the Administrator and subject to such limitations as the Administrator may impose, (A) the closing sale price of the Stock on the next preceding business day as reported in the Western Edition of the Wall Street Journal Composite Tape, or (B) the average of the closing price of the Stock on each day on which the Stock was traded over a period of up to twenty trading days immediately prior to such date, or (C) if the Stock is not publicly traded, the fair market value of the Stock as otherwise determined by the Administrator in the good faith exercise of its discretion. (15) "Incentive Stock Option" means any Stock Option intended to be ---------------------- designated as an "incentive stock option" within the meaning of Section 422 of the Code. (16) "Limited Stock Appreciation Right" means a Stock Appreciation Right -------------------------------- that can be exercised only in the event of a "Change of Control" (as defined in Section 10 below). (17) "Non-Employee Director" shall have the meaning set forth in Rule 16b- --------------------- 3. (18) "Non-Qualified Stock Option" means any Stock Option that is not an -------------------------- Incentive Stock Option, including any Stock Option that provides (as of the time such option is granted) that it will not be treated as an Incentive Stock Option. 2 (19) "Parent Corporation" means any corporation (other than the Company) in ------------------ an unbroken chain of corporations ending with the Company, if each of the corporations in the chain (other than the Company) owns stock possessing 50% or more of the combined voting power of all classes of stock in one of the other corporations in the chain. (20) "Participant" means any Eligible Employee or any consultant or agent ----------- of the Company or any Subsidiary selected by the Committee, pursuant to the Administrator's authority in Section 2, to receive grants of Stock Options, DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted Stock awards, Deferred Stock awards, Performance Shares or any combination of the foregoing, or any Eligible Non-Employee Director eligible to receive grants of Non-Qualified Stock Options and DERs pursuant to Section 5A below. (21) "Performance Share" means an award of shares of Stock granted pursuant ----------------- to Section 7 that is subject to restrictions based upon the attainment of specified performance objectives. (22) "Restricted Stock" means an award granted pursuant to Section 7 of ---------------- shares of Stock subject to restrictions that will lapse with the passage of time. (23) "Stock" means the Common Stock of the Company. ----- (24) "Stock Appreciation Right" means the right pursuant to an award ------------------------ granted under Section 6 to receive an amount equal to the difference between (A) the Fair Market Value, as of the date such Stock Appreciation Right or portion thereof is surrendered, of the shares of Stock covered by such right or such portion thereof, and (B) the aggregate exercise price of such right or such portion thereof. (25) "Stock Option" means an option to purchase shares of Stock granted ------------ pursuant to Section 5 or Section 5A. (26) "Subsidiary" means any corporation (other than the Company) either (i) ---------- in an unbroken chain of corporations beginning with the Company, if each of the corporations (other than the last corporation) in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in the chain or (ii) organized to act as the mortgage loan conduit for the Company. 2. ADMINISTRATION. The Plan shall be administered by the Board or by the Committee appointed by the Board, which shall serve at the pleasure of the Board; provided, however, -------- ------- that at all times following the closing of an initial public offering of the Stock, the Plan shall be administered by the Committee appointed by the Board. 3 The Administrator shall have the power and authority to grant to Eligible Employees and consultants or agents of the Company or any Subsidiary, pursuant to the terms of the Plan: (a) Stock Options (with or without DERs), (b) Stock Appreciation Rights or Limited Stock Appreciation Rights, (c) Restricted Stock, (d) Deferred Stock, (e) Performance Shares or (f) any combination of the foregoing. In particular, the Administrator shall have the authority: (a) to select those employees of the Company or any Subsidiary who shall be Eligible Employees; (b) to determine whether and to what extent Stock Options (with or without DERs), Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted Stock, Deferred Stock, Performance Shares or a combination of the foregoing, are to be granted to Eligible Employees or any consultant or agent of the Company or any Subsidiary hereunder; (c) to determine the number of shares to be covered by each such award granted hereunder; (d) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder (including, but not limited to, (x) the restricted period applicable to Restricted or Deferred Stock awards and the date or dates on which restrictions applicable to such Restricted or Deferred Stock shall lapse during such period, and (y) the performance goals and periods applicable to the award of Performance Shares); and (e) to determine the terms and conditions, not inconsistent with the terms of the Plan, which shall govern all written instruments evidencing the Stock Options, DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted Stock, Deferred Stock, Performance Shares or any combination of the foregoing. The Administrator shall have the authority, in its discretion, to adopt, alter and repeal such administrative rules, guidelines and practices governing the Plan as it shall from time to time deem advisable; to interpret the terms and provisions of the Plan and any award issued under the Plan (and any agreements relating thereto); and to otherwise supervise the administration of the Plan. All decisions made by the Administrator pursuant to the provisions of the Plan shall be final and binding on all persons, including the Company, any Subsidiaries and the Participants. 3. STOCK SUBJECT TO PLAN. The total number of shares of Stock reserved and available for issuance under the Plan shall be 50; provided, however, that from and after such time as -------- ------- the Company closes an initial public offering of the Stock, the total number of shares of Stock reserved and available for 4 issuance (inclusive of shares already issued) under the Plan shall automatically be increased so as to equal ten percent (10%) of the number of then outstanding shares of Stock, and provided further, that no more than 1,000,000 shares of -------- ------- Stock shall be cumulatively available for Incentive Stock Options. At all times, the number of shares reserved and available for issuance hereunder as so determined from time to time shall be decreased by virtue of awards granted and outstanding or exercised hereunder. To the extent that (i) a Stock Option or DER expires or is otherwise terminated without being exercised, or (ii) any shares of Stock subject to any Restricted Stock, Deferred Stock or Performance Share award granted hereunder are forfeited, such shares shall again be available for issuance in connection with future awards under the Plan. If any shares of Stock have been pledged as collateral for indebtedness incurred by a Participant in connection with the exercise of a Stock Option and such shares are returned to the Company in satisfaction of such indebtedness, such shares shall again be available for issuance in connection with future awards under the Plan. In the event of any merger, reorganization, consolidation, recapitalization, Stock dividend, or other change in corporate structure affecting the Stock, a substitution or adjustment may be made in (i) the aggregate number of shares reserved for issuance under the Plan, and (ii) the kind, number and option price of shares subject to outstanding Stock Options and DERs granted under the Plan as may be determined by the Administrator, in its sole discretion, provided that the number of shares subject to any award shall always be a whole number. Such other substitutions or adjustments shall be made as may be determined by the Administrator, in its sole discretion; provided, -------- however, that with respect to Incentive Stock Options, such adjustment shall be - ------- made in accordance with Section 424 of the Code. An adjusted option price shall also be used to determine the amount payable by the Company upon the exercise of any Stock Appreciation Right or Limited Stock Appreciation Right associated with any Stock Option. The aggregate number of shares of Stock for which Stock Options or Stock Appreciation Rights may be granted to any individual during any calendar year may not, subject to adjustment as provided in this Section 3, exceed 75% of the shares of Stock reserved for the purposes of the Plan in accordance with the provisions of this Section 3. 4. ELIGIBILITY. Officers of the Company with the rank of senior vice present or above who are responsible for or contribute to the management, growth and/or profitability of the business of the Company or its Subsidiaries shall be eligible to be granted Stock Options, DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted Stock awards, Deferred Stock awards or Performance Shares hereunder; provided, however, that Peter T. Paul shall not be -------- ------- eligible for any grants or awards hereunder. The Participants under the Plan shall be selected from time to time by the Administrator, in its sole discretion, from among the Eligible Employees recommended by the senior management of the Company, and the Administrator shall determine, in its sole discretion, the number of shares covered by each award; provided, -------- 5 however, that Eligible Non-Employee Directors shall only be eligible to receive - ------- Stock Options as provided in Section 5A. 5. STOCK OPTIONS. Stock Options may be granted alone or in addition to other awards granted under the Plan, including DERs as described in Section 5(11). Any Stock Option granted under the Plan shall be in such form as the Administrator may from time to time approve, and the provisions of Stock Option awards need not be the same with respect to each optionee. Recipients of Stock Options shall enter into a stock option agreement with the Company, in such form as the Administrator shall determine, which agreement shall set forth, among other things, the exercise price of the option, the term of the option and provisions regarding exercisability of the option granted thereunder. The Stock Options granted under the Plan may be of two types: (i) Incentive Stock Options and (ii) Non-Qualified Stock Options. The Administrator shall have the authority under this Section 5 to grant any optionee (except Eligible Non-Employee Directors) Incentive Stock Options, Non-Qualified Stock Options, or both types of Stock Options (in each case with or without DERs, Stock Appreciation Rights or Limited Stock Appreciation Rights), provided, however, that Incentive Stock Options may not be granted to -------- ------- any individual who is not an employee of the Company or its Subsidiaries. To the extent that any Stock Option does not qualify as an Incentive Stock Option, it shall constitute a separate Non-Qualified Stock Option. More than one option may be granted to the same optionee and be outstanding concurrently hereunder. Stock Options granted under the Plan shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Administrator shall deem desirable: (1) Option Price. The option price per share of Stock purchasable under a ------------ Stock Option shall be determined by the Administrator in its sole discretion at the time of grant but shall not, in the case of Incentive Stock Options, be less than 100% of the Fair Market Value of the Stock on such date, and shall not, in any event, be less than the par value of the Stock, if any. The option price per share of Stock purchasable under a Non-Qualified Stock Option may be less than 100% of such Fair Market Value. If an employee owns or is deemed to own (by reason of the attribution rules applicable under Section 425(d) of the Code) more than 10% of the combined voting power of all classes of stock of the Company or any Parent Corporation or Subsidiary and an Incentive Stock Option is granted to such employee, the option price of such Incentive Stock Option (to the extent required by the Code at the time of grant) shall be no less than 110% of the Fair Market Value of the Stock on the date such Incentive Stock Option is granted. 6 (2) Option Term. The term of each Stock Option shall be fixed by the ----------- Administrator, but no Stock Option shall be exercisable more than ten years after the date such Stock Option is granted; provided, however, that if an -------- ------- employee owns or is deemed to own (by reason of the attribution rules of Section 425(d) of the Code) more than 10% of the combined voting power of all classes of stock of the Company or any Parent Corporation or Subsidiary and an Incentive Stock Option is granted to such employee, the term of such Incentive Stock Option (to the extent required by the Code at the time of grant) shall be no more than five years from the date of grant. (3) Exercisability. Stock Options shall be exercisable at such time or -------------- times and subject to such terms and conditions as shall be determined by the Administrator at or after grant; provided, however, that, except as provided -------- ------- herein or unless otherwise determined by the Administrator at or after grant, Stock Options shall become exercisable as to 25% of the shares subject to such Stock Option on the first anniversary of the date of grant of the Stock Option, and as to an additional 25% on each of the next three anniversaries of the date of grant. To the extent not exercised, installments shall accumulate and be exercisable in whole or in part at any time after becoming exercisable but not later than the date the Stock Option expires. The Administrator may provide, in its discretion, that any Stock Option shall be exercisable only in installments, and the Administrator may waive such installment exercise provisions at any time in whole or in part based on such factors as the Administrator may determine, in its sole discretion. (4) Method of Exercise. Subject to Section 5(3), Stock Options may be ------------------ exercised in whole or in part at any time during the option period, by giving written notice of exercise to the Company specifying the number of shares to be purchased, accompanied by payment in full of the purchase price in cash or its equivalent as determined by the Administrator. As determined by the Administrator, in its sole discretion, payment in whole or in part may also be made in the form of unrestricted Stock already owned by the optionee, or, in the case of the exercise of a Non-Qualified Stock Option, Restricted Stock or Performance Shares subject to an award hereunder (based, in each case, on the Fair Market Value of the Stock on the date the option is exercised); provided, -------- however, that in the case of an Incentive Stock Option, the right to make - ------- payment in the form of already owned shares may be authorized only at the time of grant. Any payment in the form of stock already owned by the optionee may be effected by use of an attestation form approved by the Administrator. If payment of the option exercise price of a Non-Qualified Stock Option is made in whole or in part in the form of Restricted Stock or Performance Shares, the shares received upon the exercise of such Stock Option (to the extent of the number of shares of Restricted Stock or Performance Shares surrendered upon exercise of such Stock Option) shall be restricted in accordance with the original terms of the Restricted Stock or Performance Share award in question, except that the Administrator may direct that such restrictions shall apply only to that number of shares equal to the number of shares surrendered upon the exercise of such option. An optionee shall generally have the rights to dividends and other rights of a stockholder with respect to shares subject to the option only after the optionee has given written notice of exercise, has paid in full for such shares, and, if requested, has given the representation described in paragraph (1) of Section 11. 7 The Administrator may require the voluntary surrender of all or a portion of any Stock Option granted under the Plan as a condition precedent to a grant of a new Stock Option. Subject to the provisions of the Plan, such new Stock Option shall be exercisable at the price, during such period and on such other terms and conditions as are specified by the Administrator at the time the new Stock Option is granted; provided, however, that should the Administrator so -------- ------- require, the number of shares subject to such new Stock Option shall not be greater than the number of shares subject to the surrendered Stock Option. Upon their surrender, Stock Options shall be canceled and the shares previously subject to such canceled Stock Options shall again be available for grants of Stock Options and other awards hereunder. (5) Loans. The Company may make loans available to Stock Option holders ----- in connection with the exercise of outstanding options granted under the Plan, as the Administrator, in its discretion, may determine. Such loans shall (i) be evidenced by promissory notes entered into by the Stock Option holders in favor of the Company, (ii) be subject to the terms and conditions set forth in this Section 5(5) and such other terms and conditions, not inconsistent with the Plan, as the Administrator shall determine, and (iii) bear interest, if any, at such rate as the Administrator shall determine. In no event may the principal amount of any such loan exceed the sum of (x) the exercise price less the par value of the shares of Stock covered by the option, or portion thereof, exercised by the holder, and (y) any federal, state, and local income tax attributable to such exercise. The initial term of the loan, the schedule of payments of principal and interest under the loan, the extent to which the loan is to be with or without recourse against the holder with respect to principal or interest and the conditions upon which the loan will become payable in the event of the holder's termination of employment shall be determined by the Administrator; provided, however, that the term of the loan, including -------- ------- extensions, shall not exceed seven years. Unless the Administrator determines otherwise, when a loan is made, shares of Stock having a Fair Market Value at least equal to the principal amount of the loan shall be pledged by the holder to the Company as security for payment of the unpaid balance of the loan, and such pledge shall be evidenced by a pledge agreement, the terms of which shall be determined by the Administrator, in its discretion; provided, however, that -------- ------- each loan shall comply with all applicable laws, regulations and rules of the Board of Governors of the Federal Reserve System and any other governmental agency having jurisdiction. (6) Limits on Transferability of Options. ------------------------------------ (a) Subject to Section 5(6)(b), no Stock Option shall be transferable by the optionee otherwise than by will or by the laws of descent and distribution or pursuant to a "qualified domestic relations order," as such term is defined in the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and all Stock Options shall be exercisable, during the optionee's lifetime, only by the optionee or in accordance with the terms of a qualified domestic relations order. (b) The Administrator may, in its discretion, authorize all or a portion of the options to be granted to an optionee to be on terms which permit transfer by such optionee to (i) the spouse, qualified domestic partner, children or grandchildren of the optionee and any other 8 persons related to the optionee as may be approved by the Administrator ("Immediate Family Members"), (ii) a trust or trusts for the exclusive benefit of such Immediate Family Members, (iii) a partnership or partnerships in which such Immediate Family Members are the only partners, or (iv) any other persons or entities as may be approved by the Administrator, provided that (x) there may be no consideration for any transfer unless approved by the Administrator, (y) the stock option agreement pursuant to which such options are granted must be approved by the Administrator, and must expressly provide for transferability in a manner consistent with this Section 5(6)(b), and (z) subsequent transfers of transferred options shall be prohibited except those in accordance with Section 5(6)(a) or expressly approved by the Administrator. Following transfer, any such options shall continue to be subject to the same terms and conditions as were applicable immediately prior to transfer, provided that, except for purposes of Sections 5(7), (8) and (9) and 11(3) hereof, the terms "optionee," Stock Option holder" and "Participant" shall be deemed to refer to the transferee. The events of termination of employment under Sections 5(7), (8) and (9) hereof shall continue to be applied with respect to the original optionee, following which the options shall be exercisable by the transferee only to the extent, and for the periods specified under such sections unless the option agreement governing such options otherwise provides. Notwithstanding the transfer, the original optionee will continue to be subject to the provisions of Section 11(3) regarding payment of taxes, including the provisions entitling the Company to deduct such taxes from amounts otherwise due to such optionee. Any transfer of a Stock Option that was originally granted with DERs related thereto shall automatically include the transfer of such DERs, any attempt to transfer such Stock Option separately from such DERs shall be void, and such DERs shall continue in effect according to their terms. "Qualified domestic partner" for the purpose of this Section 5(6)(b) shall mean a domestic partner living in the same household as the optionee and registered with, certified by or otherwise acknowledged by the county or other applicable governmental body as a domestic partner or otherwise establishing such status in any manner satisfactory to the Administrator. (7) Termination by Death. If an optionee's employment with the Company or -------------------- any Subsidiary terminates by reason of death, the Stock Option may thereafter be immediately exercised, to the extent then exercisable (or on such accelerated basis as the Administrator shall determine at or after grant), by the legal representative of the estate or by the legatee of the optionee under the will of the optionee, for a period of twelve months (or such shorter period as the Administrator shall specify at grant) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is shorter. (8) Termination by Reason of Disability. If an optionee's employment with ----------------------------------- the Company or any Subsidiary terminates by reason of Disability, any Stock Option held by such optionee may thereafter be exercised, to the extent it was exercisable at the time of such termination (or on such accelerated basis as the Administrator shall determine at the time of grant), for a period of twelve months (or such shorter period as the Administrator shall specify at grant) from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is shorter; provided, however, that, -------- ------- if the optionee dies within such twelve-month period (or such shorter period as the Administrator shall specify at grant) and prior to the expiration of the stated term of such Stock Option, any unexercised Stock 9 Option held by such optionee shall thereafter be exercisable to the extent to which it was exercisable at the time of termination for a period of twelve months (or such shorter period as the Administrator shall specify at grant) from the time of death or until the expiration of the stated term of such Stock Option, whichever period is shorter. In the event of a termination of employment by reason of Disability, if an Incentive Stock Option is exercised after the expiration of the applicable exercise periods under Section 422 of the Code, such Stock Option shall thereafter be treated as a Non-Qualified Stock Option. (9) Other Termination. Except as otherwise determined by the ----------------- Administrator, if an optionee's employment with the Company or any Subsidiary terminates for any reason other than death or Disability, the Stock Option may be exercised for a period of three months from the date of such termination, or until the expiration of the stated term of such Stock Option, whichever period is shorter. (10) Annual Limit on Incentive Stock Options. To the extent that the --------------------------------------- aggregate Fair Market Value (determined as of the date the Incentive Stock Option is granted) of shares of Stock with respect to which Incentive Stock Options granted to an Optionee under this Plan and all other option plans of the Company, its Parent Corporation or any Subsidiary become exercisable for the first time by the Optionee during any calendar year exceeds $100,000, such Stock Options shall be treated as Non-Qualified Stock Options. (11) DERs. The Administrator shall have the discretion to grant DERs in ---- conjunction with grants of Stock Options pursuant to this Section 5. DERs may be granted in either of two forms, "Current-pay DERs" and "Accrued DERs" and the Administrator may condition the payment or accrual of amounts in respect thereof subject to satisfaction of such performance objectives as the Administrator may specify at the time of grant. Assuming satisfaction of any applicable conditions, Current-pay DERs shall be paid concurrently with any dividends or distributions paid on the Stock during the time the related Stock Options are outstanding in an amount equal to the cash dividend (or Stock or other property hereby distributed) per share being paid on the Stock times the number of shares subject to the related Stock Options. Current-pay DERs are payable in cash, Stock or such other property in the same manner as may be distributed to shareholders. Accrued DERs may be accrued in respect of cash dividends only or cash dividends and the value of any Stock or other property distributed to shareholders, as the Administrator shall determine at the time of grant. Assuming satisfaction of any applicable conditions, Accrued DERs shall be accrued with respect to the related Stock Options outstanding as of the date dividends are declared on the Company's Stock in accordance with the following formula: (A x B) / C under which "A" equals the number of shares subject to such Stock Options, "B" equals the cash dividend per share or the value per share of the Stock or other property being distributed, as the case may be, and "C" equals the Fair Market Value per share of Stock on the dividend payment date. The Accrued DERs shall represent shares of Stock which shall be issuable to the holder of 10 the related Stock Option proportionately as the holder exercises the Stock Option to which the Accrued DERs relate, rounded down to the nearest whole number of shares. DERs shall expire upon the expiration of the Stock Options to which they relate. The Administrator shall specify at the time of grant whether dividends shall be payable or credited on Accrued DERs. Notwithstanding anything to the contrary herein, Accrued DERs granted with respect to Stock Options shall be accrued only to the extent of the number of shares of stock then reserved and available for issuance under the Plan in excess of the number of shares subject to issuance pursuant to outstanding Stock Option, Accrued DER, Stock Appreciation Right, Limited Stock Appreciation Right, Deferred Stock or Performance Share awards. 5A. STOCK OPTIONS FOR ELIGIBLE NON-EMPLOYEE DIRECTORS. This Section 5A shall apply only to automatic grants of Stock Options to Eligible Non-Employee Directors. (1) Following the closing of an initial public offering of the Stock, each Eligible Non-Employee Director serving at the time or thereafter duly elected or appointed shall automatically be granted a Non-Qualified Stock Option to purchase 10,000 shares of Stock. The option price per share of Stock purchasable under such Stock Option shall be 100% of the Fair Market Value on the date of grant. Such Stock Option shall become exercisable as to 25% of the shares subject to such Stock Option on the first anniversary of the date of grant of the Stock Option, and as to an additional 25% of the shares subject to such Stock Option on each of the next three anniversaries of the date of grant. To the extent not exercised, installments shall accumulate and be exercisable in whole or in part at any time after becoming exercisable but not later than the date the Stock Option expires. Exercise shall be by payment in full of the purchase price in cash and no stock option shall be exercisable more than ten years after the date of grant. The aggregate number of shares of Stock that may be granted to Eligible Non-Employee Directors pursuant to the Plan may not exceed 150,000 shares. (2) Eligible Non-Employee Directors who receive grants of Stock Options shall enter into a stock option agreement with the Company, which agreement shall set forth, among other things, the exercise price of the option, the term of the option and provisions regarding exercisability of the option granted thereunder. The Stock Options granted under this section shall be Non-Qualified Stock Options. (3) Non-Qualified Stock Options granted to Eligible Non-Employee Directors hereunder shall be transferable only to the extent provided in Sections 5(6)(a) and (b). (4) No DERs shall be paid with respect to such Non-Qualified Stock Options. (5) The Board may not amend, alter or discontinue the provisions of this Section 5A more than once every six months other than to comport with changes in the Code, ERISA and the rules thereunder or the federal securities laws and the rules thereunder. 11 6. STOCK APPRECIATION RIGHTS AND LIMITED STOCK APPRECIATION RIGHTS. (1) Grant and Exercise. Stock Appreciation Rights and Limited Stock ------------------ Appreciation Rights may be granted either alone ("Free Standing Rights") or in conjunction with all or part of any Stock Option granted under the Plan ("Related Rights"). In the case of a Non-Qualified Stock Option, Related Rights may be granted either at or after the time of the grant of such Stock Option. In the case of an Incentive Stock Option, Related Rights may be granted only at the time of the grant of the Incentive Stock Option. A Related Right or applicable portion thereof granted in conjunction with a given Stock Option shall terminate and no longer be exercisable upon the termination or exercise of the related Stock Option, except that, unless otherwise provided by the Administrator at the time of grant, a Related Right granted with respect to less than the full number of shares covered by a related Stock Option shall only be reduced if and to the extent that the number of shares covered by the exercise or termination of the related Stock Option exceeds the number of shares not covered by the Stock Appreciation Right. A Related Right may be exercised by an optionee, in accordance with paragraph (2) of this Section 6, by surrendering the applicable portion of the related Stock Option. Upon such exercise and surrender, the optionee shall be entitled to receive an amount determined in the manner prescribed in paragraph (2) of this Section 6. Stock Options which have been so surrendered, in whole or in part, shall no longer be exercisable to the extent the Related Rights have been so exercised. (2) Terms and Conditions. Stock Appreciation Rights shall be subject to -------------------- such terms and conditions, not inconsistent with the provisions of the Plan, as shall be determined from time to time by the Administrator, including the following: (a) Stock Appreciation Rights that are Related Rights ("Related Stock Appreciation Rights") shall be exercisable only at such time or times and to the extent that the Stock Options to which they relate shall be exercisable in accordance with the provisions of Section 5 and this Section 6; provided, -------- however, that no Related Stock Appreciation Right shall be exercisable during - ------- the first six months of its term, except that this additional limitation shall not apply in the event of death or Disability of the optionee prior to the expiration of such six-month period. (b) Upon the exercise of a Related Stock Appreciation Right, an optionee shall be entitled to receive up to, but not more than, an amount in cash or that number of shares of Stock (or in some combination of cash and shares of Stock) equal in value to the excess of the Fair Market Value of one share of Stock as of the date of exercise over the option price per share specified in the related Stock Option multiplied by the number of shares of Stock in respect of which the Related Stock Appreciation Right is being exercised, with the Administrator having the right to determine the form of payment. 12 (c) Related Stock Appreciation Rights shall be transferable or exercisable only when and to the extent that the underlying Stock Option would be transferable or exercisable under paragraph (6) of Section 5. (d) Upon the exercise of a Related Stock Appreciation Right, the Stock Option or part thereof to which such Related Stock Appreciation Right is related shall be deemed to have been exercised for the purpose of the limitation set forth in Section 3 on the number of shares of Stock to be issued under the Plan. (e) A Related Stock Appreciation Right granted in connection with an Incentive Stock Option may be exercised only if and when the Fair Market Value of the Stock subject to the Incentive Stock Option exceeds the exercise price of such Stock Option. (f) Stock Appreciation Rights that are Free Standing Rights ("Free Standing Stock Appreciation Rights") shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Administrator at or after grant; provided, however, that no Free Standing Stock -------- ------- Appreciation Right shall be exercisable during the first six months of its term, except that this limitation shall not apply in the event of death or Disability of the recipient of the Free Standing Stock Appreciation Right prior to the expiration of such six-month period. (g) The term of each Free Standing Stock Appreciation Right shall be fixed by the Administrator, but no Free Standing Stock Appreciation Right shall be exercisable more than ten years after the date such right is granted. (h) Upon the exercise of a Free Standing Stock Appreciation Right, a recipient shall be entitled to receive up to, but not more than, an amount in cash or that number of shares of Stock (or any combination of cash or shares of Stock) equal in value to the excess of the Fair Market Value of one share of Stock as of the date of exercise over the price per share specified in the Free Standing Stock Appreciation Right (which price shall be no less than 100% of the Fair Market Value of the Stock on the date of grant) multiplied by the number of shares of Stock with respect to which the right is being exercised, with the Administrator having the right to determine the form of payment. (i) Free Standing Stock Appreciation Rights shall be transferable or exercisable subject to the provisions governing the transferability and exercisability of Stock Options set forth in paragraphs (3) and (6) of Section 5. (j) In the event of the termination of an employee who has been granted one or more Free Standing Stock Appreciation Rights, such rights shall be exercisable to the same extent that a Stock Option would have been exercisable in the event of the termination of the optionee. 13 (k) Limited Stock Appreciation Rights may only be exercised within the 30-day period following a "Change of Control" (as defined in Section 10 below), and, with respect to Limited Stock Appreciation Rights that are Related Rights ("Related Limited Stock Appreciation Rights"), only to the extent that the Stock Options to which they relate shall be exercisable in accordance with the provisions of Section 5 and this Section 6; provided, however, that no Related -------- ------- Limited Stock Appreciation Right shall be exercisable during the first six months of its term, except that this additional limitation shall not apply in the event of death or Disability of the optionee prior to the expiration of such six-month period. (l) Upon the exercise of a Limited Stock Appreciation Right, the recipient shall be entitled to receive an amount in cash equal in value to the excess of the "Change of Control Price" (as defined in Section 10) of one share of Stock as of the date of exercise over (A) the option price per share specified in the related Stock Option, or (B) in the case of a Limited Stock Appreciation Right which is a Free Standing Stock Appreciation Right, the price per share specified in the Free Standing Stock Appreciation Right, such excess to be multiplied by the number of shares in respect of which the Limited Stock Appreciation Right shall have been exercised. (m) For the purpose of the limitation set forth in Section 3 on the number of shares to be issued under the Plan, the grant or exercise of Free Standing Stock Appreciation Rights shall be deemed to constitute the grant or exercise, respectively, of Stock Options with respect to the number of shares of Stock with respect to which such Free Standing Stock Appreciation Rights were so granted or exercised. 7. RESTRICTED STOCK, DEFERRED STOCK AND PERFORMANCE SHARES. (1) General. Restricted Stock, Deferred Stock or Performance Share awards ------- may be issued either alone or in addition to other awards granted under the Plan. The Administrator shall determine the Eligible Employees to whom, and the time or times at which, grants of Restricted Stock, Deferred Stock or Performance Share awards shall be made; the number of shares to be awarded; the price, if any, to be paid by the recipient of Restricted Stock, Deferred Stock or Performance Share awards; the Restricted Period (as defined in Section 7(3)) applicable to Restricted Stock or Deferred Stock awards; the performance objectives applicable to Performance Share or Deferred Stock awards; the date or dates on which restrictions applicable to such Restricted Stock or Deferred Stock awards shall lapse during such Restricted Period; and all other conditions of the Restricted Stock, Deferred Stock and Performance Share awards. The Administrator may also condition the grant of Restricted Stock, Deferred Stock awards or Performance Shares upon the exercise of Stock Options, or upon such other criteria as the Administrator may determine, in its sole discretion. The provisions of Restricted Stock, Deferred Stock or Performance Share awards need not be the same with respect to each recipient. (2) Awards and Certificates. The prospective recipient of a Restricted ----------------------- Stock, Deferred Stock or Performance Share award shall not have any rights with respect to such award, unless and until such recipient has executed an agreement evidencing the award (a "Restricted 14 Stock Award Agreement," "Deferred Stock Award Agreement," or "Performance Share Award Agreement," as appropriate) and delivered a fully executed copy thereof to the Company, within a period of sixty days (or such other period as the Administrator may specify) after the award date. Except as otherwise provided below in this Section 7(2), (i) each Participant who is awarded Restricted Stock or Performance Shares shall be issued a stock certificate in respect of such shares of Restricted Stock or Performance Shares; and (ii) such certificate shall be registered in the name of the Participant, and shall bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such award, substantially in the following form: "The transferability of this certificate and the shares of stock represented hereby are subject to the terms and conditions (including forfeiture) of the Headlands Mortgage Company 1997 Executive and Non-Employee Director Stock Option Plan and a Restricted Stock Award Agreement or Performance Share Award Agreement entered into between the registered owner and Headlands Mortgage Company. Copies of such Plan and Agreement are on file in the offices of Headlands Mortgage Company." The Company shall require that the stock certificates evidencing such shares be held in the custody of the Company until the restrictions thereon shall have lapsed, and that, as a condition of any Restricted Stock award or Performance Share award, the Participant shall have delivered a stock power, endorsed in blank, relating to the Stock covered by such award. (3) Restrictions and Conditions. The Restricted Stock, Deferred Stock and --------------------------- Performance Share awards granted pursuant to this Section 7 shall be subject to the following restrictions and conditions: (a) Subject to the provisions of the Plan and the Restricted Stock, Deferred Stock or Performance Share award agreement, during such period as may be set by the Administrator commencing on the grant date (the "Restricted Period"), the Participant shall not be permitted to sell, transfer, pledge or assign shares of Restricted Stock, Performance Shares or Deferred Stock awarded under the Plan; provided, however, that the Administrator may, in its sole -------- ------- discretion, provide for the lapse of such restrictions in installments and may accelerate or waive such restrictions in whole or in part based on such factors and such circumstances as the Administrator may determine, in its sole discretion, including, but not limited to, the attainment of certain performance related goals, the Participant's termination, death or Disability or the occurrence of a "Change of Control" as defined in Section 10. (b) Except as provided in paragraph (3)(a) of this Section 7, the Participant shall have, with respect to the shares of Restricted Stock or Performance Shares, all of the rights of a stockholder of the Company, including the right to vote the shares, and the right to receive any dividends thereon during the Restricted Period. With respect to Deferred Stock awards, the Participant shall generally not have the rights of a shareholder of the Company, including the right to vote the shares during the Restricted Period; provided, -------- however, that dividends declared during the Restricted Period with respect to - ------- the number of shares covered by a Deferred Stock 15 award shall be paid to the Participant. Certificates for shares of unrestricted Stock shall be delivered to the Participant promptly after, and only after, the Restricted Period shall expire without forfeiture in respect of such shares covered by the award of Restricted Stock, Performance Shares or Deferred Stock, except as the Administrator, in its sole discretion, shall otherwise determine. (c) Subject to the provisions of the Restricted Stock, Deferred Stock or Performance Share award agreement and this Section 7, upon termination of employment for any reason during the Restricted Period, all shares subject to any restriction as of the date of such termination shall be forfeited by the Participant, and the Participant shall only receive the amount, if any, paid by the Participant for such Restricted Stock or Performance Shares, plus simple interest on such amount at the rate of 8% per year. 8. AMENDMENT AND TERMINATION. Subject to the provisions of Section 5A(5), the Board may amend, alter or discontinue the Plan, but no amendment, alteration, or discontinuation shall be made that would impair the rights of a Participant under any award theretofore granted without such Participant's consent, or that without the approval of the stockholders (as described below) would: (1) except as provided in Section 3, increase the total number of shares of Stock reserved for the purpose of the Plan; (2) change the employees or class of employees eligible to participate in the Plan; or (3) extend the maximum option period under paragraph (2) of Section 5 of the Plan. Notwithstanding the foregoing, stockholder approval under this Section 8 shall only be required at such time and under such circumstances as stockholder approval would be required under (a) Rule 16b-3 of the Act with respect to any material amendment to any employee benefit plan of the Company or (b) Sections 162(m), 280G or 422 of the Code. The Administrator may amend the terms of any award theretofore granted, prospectively or retroactively, but, subject to Section 3, no such amendment shall impair the rights of any holder without his or her consent. 16 9. UNFUNDED STATUS OF PLAN. The Plan is intended to constitute an "unfunded" plan for incentive compensation. With respect to any payments not yet made to a Participant or optionee by the Company, nothing contained herein shall give any such Participant or optionee any rights that are greater than those of a general creditor of the Company. 10. CHANGE OF CONTROL. The following acceleration and valuation provisions shall apply in the event of a "Change of Control" as defined in paragraph (2) of this Section 10: (1) In the event of a "Change of Control," unless otherwise determined by the Administrator or the Board in writing at or after grant (including under any individual agreement), but prior to the occurrence of such Change of Control: (a) any Stock Appreciation Rights outstanding for at least six months and any Stock Options, including Stock Options granted under Section 5A, awarded under the Plan not previously exercisable and vested shall become fully exercisable and vested; (b) the restrictions applicable to any Restricted Stock, Deferred Stock or Performance Share awards under the Plan shall lapse, and such shares and awards shall be deemed fully vested; and (c) the value of all outstanding Stock Options (except Stock Options granted under Section 5A), DERs, Stock Appreciation Rights, Limited Stock Appreciation Rights, and Restricted Stock, Deferred Stock and Performance Share awards shall, to the extent determined by the Administrator at or after grant, be cashed out by a payment in cash or other property, as the Administrator may determine, on the basis of the "Change of Control Price" (as defined in paragraph (3) of this Section 10) as of the date the Change of Control occurs or such other date as the Administrator may determine prior to the Change of Control. (2) For purposes of paragraph (1) of this Section 10, a "Change of Control" shall be deemed to have occurred if, at any time following an initial public offering of the Stock by the Company: (a) any "person," as such term is used in Sections 13(d) and 14(d) of the Act (other than the Company; any trustee or other fiduciary holding securities under an employee benefit plan of the Company; or any company owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of Stock of the Company) is or becomes after the Effective Date the "beneficial owner" (as defined in Rule 13d-3 under the Act), directly or indirectly, of securities of the Company (not including in the securities beneficially owned by such person any securities acquired directly from the Company 17 or its affiliates) representing 25% or more of the combined voting power of the Company's then outstanding securities; or (b) during any period of two consecutive years (not including any period prior to the Effective Date), individuals who at the beginning of such period constitute the Board, and any new director (other than a director designated by a person who has entered into an agreement with the Company to effect a transaction described in clause (a), (c) or (d) of this Section 10(2)) whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute at least a majority thereof; or (c) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than (A) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of the Company, at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation or (B) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or (d) the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets. (3) For purposes of this Section 10, "Change of Control Price" means the higher of (i) the highest price per share paid or offered in any transaction related to a Change of Control of the Company or (ii) the highest price per share paid in any transaction reported on the exchange or national market system on which the Stock is listed, at any time during the preceding sixty day period as determined by the Administrator, except that, in the case of Incentive Stock Options and Stock Appreciation Rights or Limited Stock Appreciation Rights relating to Incentive Stock Options, such price shall be based only on transactions reported for the date on which the Administrator decides to cash out such options. 11. GENERAL PROVISIONS. (1) The Administrator may require each person purchasing shares pursuant to a Stock Option to represent to and agree with the Company in writing that such person is acquiring the shares without a view to distribution thereof. The certificates for such shares may include any legend which the Administrator deems appropriate to reflect any restrictions on transfer. 18 All certificates for shares of Stock delivered under the Plan shall be subject to such stock-transfer orders and other restrictions as the Administrator may deem advisable under the rules, regulations, and other requirements of the Commission, any stock exchange upon which the Stock is then listed, and any applicable federal or state securities law, and the Administrator may cause a legend or legends to be placed on any such certificates to make appropriate reference to such restrictions. (2) Nothing contained in the Plan shall prevent the Board from adopting other or additional compensation arrangements, subject to stockholder approval if such approval is required; and such arrangements may be either generally applicable or applicable only in specific cases. The adoption of the Plan shall not confer upon any employee of the Company or any Subsidiary any right to continued employment with the Company or a Subsidiary, as the case may be, nor shall it interfere in any way with the right of the Company or a Subsidiary to terminate the employment of any of its employees at any time. (3) Each Participant shall, no later than the date as of which the value of an award first becomes includable in the gross income of the Participant for federal income tax purposes, pay to the Company, or make arrangements satisfactory to the Administrator regarding payment of, any federal, state, or local taxes of any kind required by law to be withheld with respect to the award. The obligations of the Company under the Plan shall be conditional on the making of such payments or arrangements, and the Company (and, where applicable, its Subsidiaries) shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the Participant. (4) No member of the Board or the Administrator, nor any officer or employee of the Company acting on behalf of the Board or the Administrator, shall be personally liable for any action, determination, or interpretation taken or made in good faith with respect to the Plan, and all members of the Board or the Administrator and each and any officer or employee of the Company acting on their behalf shall, to the extent permitted by law, be fully indemnified and protected by the Company in respect of any such action, determination or interpretation. 12. EFFECTIVE DATE OF PLAN. The Plan became effective (the "Effective Date") on September 15, 1997, the date the Company's stockholders formally approved the Plan. 13. TERM OF PLAN. No Stock Option, Stock Appreciation Right, Limited Stock Appreciation Right, Restricted Stock, Deferred Stock or Performance Share award shall be granted pursuant to the Plan on or after the tenth anniversary of the Effective Date, but awards theretofore granted may extend beyond that date. 19 EX-10.3 11 DESCRIPTION OF BONUS INCENTIVE PLAN EXHIBIT 10.3 ------------ HEADLANDS MORTGAGE COMPANY BONUS INCENTIVE COMPENSATION PLAN BONUS INCENTIVE COMPENSATION PLAN A. MANAGEMENT BY OBJECTIVES Headlands Mortgage Company's Bonus Incentive Compensation Plan is based on a systematic and logical method of planning by establishing objectives and standards of performance for all important areas of responsibility for key managerial positions. The objectives are in writing and agreed on by the immediate supervisor and the participant. B. BONUS PLAN ELIGIBILITY Eligibility for the incentive bonus program is based on both corporate title and individual responsibility. Employees eligible for this program are Headlands Mortgage Company employees with qualifying corporate titles and which have management positions meeting the following criteria: Management positions requiring initiative and independent judgment with responsibilities which include interpreting, administering or setting broad policies, exercising overall responsibility for large segments of the corporation, division or department operations which have significant and clear impact on corporate growth and profitability. Employees with corporate titles of [Assistant Vice President] and above are considered to fit the general criteria for participation in the Bonus Plan, but in no way does a corporate title insure participation in the Bonus Plan. No commitment should be made to any employee or prospective employee prior to approval of both the corporate title and the bonus plan. Upon the discretion of the hiring manager, a new hire may wait ninety (90) days before bonus plan participation is determined. C. SELECTING AND WEIGHTING INDIVIDUAL OBJECTIVES A number of specific objectives are selected. The selection is made after specific objectives have been established and discussed with each participant. Selected objectives are weighted for priority in relation to each other. The selected objectives and their weights are put in writing, approved by the immediate supervisor, division manager and then discussed and approved with each participant. A copy of each participant's Goals & Objectives form is forwarded to Human Resources each plan year. If any changes are incurred during the year, a revised copy is to be sent to Human Resources. 2 D. DETERMINATION OF AWARDS Bonus Plan payouts are generally determined semi-annually according to individual performance and company performance and are at the sole and absolute discretion of the Company. Individual Performance ---------------------- Individual performance is determined by an assessment of success in meeting goals and objectives. Company Performance ------------------- Company performance is generally measured by the change in enterprise value of the Company over the plan year. A target bonus pool will be established by the Board of Directors at the beginning of each plan year based upon target corporate profits and other goals. In order for any bonuses to be paid, a bonus pool must be generated. Individual awards will be prorated both based on individual performance ratings and based on the percentage of bonus pool the Company achieves. Notwithstanding, however, any achievement of Company targets or the generation of a bonus pool, the payment of bonuses is not guaranteed and is solely at the discretion of the Company. E. GENERAL GUIDELINES In case of a voluntary termination, in order to receive the bonus, employees must be employed on the date of bonus payout. The Company, with approval by the Board of Directors, has the right to revoke, change or abolish the Plan or bonus payout at any time. Situations not covered by these guidelines will be reviewed and final decision will be made by the Board of Directors as it deems appropriate. It should be understood by all that anything not expressly permitted by this policy is prohibited without prior approval by the Board of Directors of Headlands Mortgage Company. 2 EX-10.4 12 AMENDED AND RESTATED MORTGAGE LOAN EXHIBIT 10.4 ------------ AMENDED AND RESTATED MORTGAGE LOAN WAREHOUSING AGREEMENT THIS AMENDED AND RESTATED MORTGAGE LOAN WAREHOUSING AGREEMENT (the "Agreement") is made and dated as of the 29th day of August, 1997, by and among HEADLANDS MORTGAGE COMPANY, a California corporation (the "Company"), THE FIRST NATIONAL BANK OF CHICAGO, a national banking association ("FNBC"), BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, GUARANTY FEDERAL BANK, a federal savings bank, FIRST UNION NATIONAL BANK, a national banking association, THE BANK OF NEW YORK, a banking corporation organized under the laws of the State of New York, COMERICA BANK-CALIFORNIA, a California banking corporation, any other lenders from time to time party hereto, together with their respective successors and assigns (each a "Lender" and collectively the "Lenders"), and FNBC as administrative agent for the Lenders (in such capacity, the "Administrative Agent") and FIRST CHICAGO NATIONAL PROCESSING CORPORATION, a Delaware corporation, as collateral agent for the Administrative Agent and the Lenders (in such capacity, the "Collateral Agent"). RECITALS A. Pursuant to that certain Mortgage Loan Warehousing Agreement dated as of October 24, 1994 by and among the Company, the Administrative Agent, the Collateral Agent and the Lenders party thereto (as amended to date, the "Existing Credit Agreement"), such Lenders agreed to extend credit to the Company on the terms and subject to the conditions set forth therein. B. The Company, the Administrative Agent, the Collateral Agent and the Lenders currently party to the Existing Credit Agreement desire to amend the Existing Credit Agreement and the documents, instruments and agreements relating thereto in certain respects and, for convenience of reference, to restate the Existing Credit Agreement in its entirety herein. NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto agree as follows: AGREEMENT 1. Tranche A Credit Facility (Standard Pricing). -------------------------------------------- 1(a) Tranche A Lending Limit. On the terms and subject to the ----------------------- conditions set forth herein, the Tranche A Lenders severally agree that they shall, from time to time up to but not including the Maturity Date, advance their respective Tranche A Percentage 1 Shares of loans (the "Tranche A Loans" or a "Tranche A Loan") to the Company in amounts not to exceed, in the aggregate at any one time outstanding, the lesser of: (1) The Tranche A Credit Limit; and (2) The lesser of: (i) the Aggregate Credit Limit, and (ii) the Collateral Value of the Borrowing Base, minus, in each case, the aggregate dollar amount of: all Tranche B Loans outstanding, all Tranche C Loans outstanding, all Tranche D Loans outstanding, all Tranche E Loans outstanding (including all Tranche B Loans, Tranche C Loans, Tranche D Loans and Tranche E Loans to be funded on the proposed date of funding of the requested Tranche A Loan), and all Funding Checks outstanding; provided, however, that (x) in calculating the amount of Loans outstanding under Paragraph 1(a)(2) above at any date, the aggregate amount of Loans outstanding shall not include any Loans which will be repaid with Loans to be advanced on such date in accordance with the terms of this Agreement, and (y) following the funding of any requested Tranche A Loan, the aggregate dollar amount of each Lender's Primary Loans outstanding shall not exceed such Lender's Maximum Commitment. 1(b) Interest Rates Applicable to Tranche A Loans. Tranche A -------------------------------------------- Loans shall be made and/or maintained, at the election of the Company made from time to time as permitted herein, as Federal Funds Rate Loans and/or Eurodollar Loans. 1(c) Calculation of Interest. The Company shall pay to the ----------------------- Administrative Agent for distribution to each Tranche A Lender interest on Tranche A Loans outstanding hereunder from the date disbursed to but not including the date of payment, calculated on such Tranche A Lender's Tranche A Percentage Share of the principal amount of Tranche A Loans outstanding from time to time hereunder during the interest calculation period, at a rate per annum equal to, at the option of and as selected by the Company from time to time (subject to the provisions of Paragraphs 6(a), 6(b) and 6(c) below): (i) with respect to each Eurodollar Loan, the Applicable Eurodollar Rate for the applicable Eurodollar Interest Period, and (ii) with respect to each Federal Funds Rate Loan, a fluctuating rate per annum equal to the Applicable Federal Funds Rate during the applicable computation period. 1(d) Payment of Interest. Interest accruing on Tranche A Loans ------------------- which are Federal Funds Rate Loans shall be payable monthly, in arrears, as provided in Paragraph 7(d) below and, in the case of Tranche A Loans which are Eurodollar Loans, at the end of the applicable Eurodollar Interest Period. 2. Tranche B Credit Facility (Balance Sensitive Pricing). ----------------------------------------------------- 2(a) Tranche B Lending Limit. On the terms and subject to the ----------------------- conditions set forth herein, the Tranche B Lenders severally agree that they shall, on each Tranche B Borrowing Date up to but not including the Maturity Date, advance their respective Tranche B Percentage Shares of loans (the "Tranche B Loans" or a "Tranche B Loan") to the Company in amounts not to exceed, in the aggregate at any one time outstanding, the lesser of: 2 (1) The Tranche B Aggregate Credit Allocation at such Tranche B Borrowing Date; and (2) The lesser of: (i) the Aggregate Credit Limit, and (ii) the Collateral Value of the Borrowing Base, minus, in each case, the aggregate dollar amount of: all Tranche A Loans outstanding, all Tranche C Loans outstanding, all Tranche D Loans outstanding, all Tranche E Loans outstanding (including all Tranche A Loans, Tranche C Loans, Tranche D Loans and Tranche E Loans to be funded on the proposed date of funding of the requested Tranche B Loan), and all Funding Checks outstanding; provided, however, that (x) in calculating the amount of Loans outstanding under Paragraph 2(a)(2) above at any date, the aggregate amount of Loans outstanding shall not include any Loans which will be repaid with Loans to be advanced on such date in accordance with the terms of this Agreement, and (y) following the funding of any requested Tranche B Loan, the aggregate dollar amount of each Lender's Primary Loans outstanding shall not exceed such Lender's Maximum Commitment. 2(b) Calculation of Interest. The Company shall pay to the ----------------------- Administrative Agent for distribution to each Tranche B Lender interest on Tranche B Loans outstanding hereunder from the date disbursed to but not including the date of payment calculated on such Tranche B Lender's Tranche B Percentage Share of Tranche B Loans outstanding from time to time hereunder during any Tranche B Interest Period, at a rate per annum equal to the Buy-Down Rate. 2(c) Payment of Interest. Interest accruing on Tranche B Loans ------------------- during any Tranche B Interest Period shall be payable in arrears on the last day of such Tranche B Interest Period as provided in Paragraph 7(d) below. The Administrative Agent, in rendering any interest billing relating to Tranche B Loans, shall have no obligation to verify the amount of any Buy-Down Deposits supporting the pricing of Tranche B Loans. 2(d) Balance Requirements and Deficiency Fees. The Company agrees ---------------------------------------- to maintain during each calendar month Buy-Down Deposits in non-interest bearing accounts with each Tranche B Lender in an amount not less than one hundred percent (100%) of the daily average amount of such Tranche B Lender's Tranche B Percentage Share of Tranche B Loans outstanding during such monthly period. In the event the Company shall fail to maintain the Buy-Down Deposits with any Tranche B Lender required hereunder during any monthly period, the Company shall pay to such Tranche B Lender upon demand such deficiency fees as may be established pursuant to a Buy-Down Letter between such Tranche B Lender and the Company from time to time. Any Tranche B Lender may elect not to make demand for the payment of deficiency fees accruing in respect of Buy-Down Deposits or Tranche B Loans from time to time and it is expressly agreed and understood that: (1) such deficiency fee or fees shall not, by reason of such failure of such Tranche B Lender or otherwise, be deemed to have been waived by such Tranche B Lender (except as such waiver is expressly acknowledged in writing by such Tranche B Lender from time to time), and (2) all deficiency fees accrued and unpaid hereunder 3 and not so expressly waived, whether or not previously declared due and owing by any such Tranche B Lender, shall automatically be due and payable in full on the Maturity Date. 2(e) Initial and Monthly Allocation; Reordering of Outstanding --------------------------------------------------------- Obligations among Lenders. On or before the third Business Day preceding the - ------------------------- date on which the first Loan(s) are to be funded hereunder, and on or before the fifth Business Day preceding the first Business Day of each calendar month thereafter up to but not including the Maturity Date, the Company shall deliver to the Administrative Agent, the Collateral Agent and each Lender a Commitment Schedule and Allocation Notice. Such Commitment Schedule and Allocation Notice shall specify the dollar amount of the Tranche B Allocation for each Tranche B Lender and the Tranche B Aggregate Credit Allocation and, based upon such Tranche B Allocations, the resultant Tranche A Credit Limit and Tranche A Percentage Share of each Tranche A Lender for the duration of the next succeeding calendar month (or portion thereof in the event the Maturity Date falls on a date other than the last day of a calendar month). Any reallocation of Loans outstanding on the first day of each calendar month necessitated by any change in a Lender's Tranche B Allocation pursuant to a Commitment Schedule and Allocation Notice shall be effected on and as of the first Business Day of such calendar month by the purchase and sale among the Lenders of the Obligations outstanding on such date in such manner as the Administrative Agent shall direct. 3. Tranche C Credit Facility (Swing Line). -------------------------------------- 3(a) Tranche C Lending Limit. On the terms and subject to the ----------------------- conditions set forth herein, the Tranche C Lender agrees that it shall, from time to time to but not including the Maturity Date, make loans (the "Tranche C Loans" or a "Tranche C Loan") to the Company in amounts not to exceed, in the aggregate at any one time outstanding, the lesser of: (1) The Tranche C Credit Limit; and (2) The lesser of: (i) the Aggregate Credit Limit, and (ii) the Collateral Value of the Borrowing Base, minus, in each case, the aggregate dollar amount of: all Tranche A Loans outstanding, all Tranche B Loans outstanding, all Tranche D Loans outstanding, all Tranche E Loans outstanding (including all Tranche A Loans, Tranche B Loans, Tranche D Loans and Tranche E Loans to be funded on the proposed date of funding of the requested Tranche C Loan), and all Funding Checks outstanding; provided, however, that (x) in calculating the availability of Loans under Paragraph 3(a)(2) above at any date, the aggregate amount of Loans outstanding shall not include any Loans which will be repaid with Loans to be advanced on such date in accordance with the terms of this Agreement, and (y) following the funding of any requested Tranche C Loan, the aggregate dollar amount of the Tranche C Lender's Primary Loans outstanding shall not exceed such Lender's Maximum Commitment. 3(b) Interest Rates Applicable to Tranche C Loans. Tranche C -------------------------------------------- Loans shall be made and/or maintained, at the election of the Company made from time to time as 4 permitted herein, at (i) the Overnight Transaction Loan Rate and/or (ii) to the extent permitted pursuant to Paragraph 3(e) below, the Buy-Down Rate. 3(c) Calculation of Interest. The Company shall pay to the ----------------------- Administrative Agent for distribution to the Tranche C Lender interest on Tranche C Loans outstanding hereunder from the date disbursed to but not including the date of payment calculated on the principal amount of Tranche C Loans outstanding from time to time hereunder during the interest calculation period, at a rate per annum equal to, at the option of and as selected by the Company from time to time (subject to the provisions of Paragraph 3(e) below): (i) a fluctuating rate per annum equal to the Overnight Transaction Loan Rate during the applicable computation period, and (ii) to the extent permitted pursuant to Paragraph 3(e) below, the Buy-Down Rate during the applicable computation period. 3(d) Payment of Interest. Interest accruing on Tranche C Loans ------------------- shall be payable monthly, in arrears, as provided in Paragraph 7(d) below. The Administrative Agent, in rendering any interest billing relating to Tranche C Loans, shall have no obligation to verify the amount of any Buy-Down Deposits supporting the pricing of Tranche C Loans. 3(e) Balance Pricing and Deficiency Fees. At the request of the ----------------------------------- Company, and with the prior written consent of the Tranche C Lender (which consent shall not be unreasonably withheld), the Company may maintain during each calendar month Buy-Down Deposits in non-interest bearing accounts with the Tranche C Lender in such amounts as may be established from time to time pursuant to a Buy-Down Letter between the Tranche C Lender and the Company. In the event that the Company is permitted to maintain the required amounts of Buy- Down Deposits with the Tranche C Lender hereunder during any monthly period, the Company shall pay to the Tranche C Lender interest at the Buy-Down Rate with respect to an aggregate principal amount of Tranche C Loans outstanding during such monthly period equal to the aggregate daily average balance of Buy-Down Deposits maintained with the Tranche C Lender during such monthly period. In the event the Company shall fail to maintain sufficient Buy-Down Deposits with the Tranche C Lender required pursuant to the Buy-Down Letter between them during any monthly period, the Company shall pay to the Tranche C Lender upon demand such deficiency fees (or additional interest accrued at an alternate interest rate) as may be established in such Buy-Down Letter. The Tranche C Lender may elect not to make demand for the payment of deficiency fees (or additional interest) accruing in respect of Buy-Down Deposits or Tranche C Loans from time to time and it is expressly agreed and understood that: (1) such deficiency fee or fees (or additional interest) shall not, by reason of such failure of the Tranche C Lender or otherwise, be deemed to have been waived by the Tranche C Lender (except as such waiver is expressly acknowledged in writing by the Tranche C Lender from time to time), and (2) all deficiency fees (or additional interest) accrued and unpaid hereunder and not so expressly waived, whether or not previously declared due and owing by the Tranche C Lender, shall automatically be due and payable in full on the Maturity Date. Any Tranche C Loans outstanding which are not matched by Buy-Down Deposits maintained with the Tranche C Lender during the applicable monthly computation period pursuant to a Buy-Down Letter shall accrue interest at the Overnight Transaction Loan Rate, as provided in Paragraph 3(c) above. 5 3(f) Reallocation of Tranche C Loans. The Tranche C Lender may at ------------------------------- any time (and in any event no less frequently than weekly) in its sole and absolute discretion request the Tranche A Lenders to advance Tranche A Loans, pro rata in accordance with their respective Tranche A Percentage Shares, in the aggregate amounts specified by the Tranche C Lender to repay all or any portion of the Tranche C Loans outstanding. Subject to the provisions of Paragraph 15(n) below, the Tranche A Lenders absolutely and unconditionally agree to advance such Tranche A Loans, the proceeds of which shall be delivered directly to the Tranche C Lender in same day funds at the office of the Tranche C Lender located at One First National Plaza, Chicago, Illinois 60670 no later than 12:00 noon (Los Angeles time) on the same Business Day as request therefor by the Tranche C Lender if such request is made at or before 11:00 a.m. (Los Angeles time) or no later than 12:00 noon (Los Angeles time) on the Business Day following request therefor if such request is made after 11:00 a.m. (Los Angeles time), and such proceeds shall be promptly applied against Tranche C Loans outstanding. 4. Tranche D Credit Facility (Shipped/Gestation). --------------------------------------------- 4(a) Tranche D Lending Limit. On the terms and subject to the ----------------------- conditions set forth herein, the Tranche D Lenders severally agree that they shall, from time to time up to but not including the Maturity Date, advance their respective Tranche D Percentage Shares of loans (the "Tranche D Loans" or a "Tranche D Loan") to the Company in amounts not to exceed, in the aggregate at any one time outstanding, the least of: (1) The Tranche D Credit Limit; (2) The Collateral Value of the Borrowing Base consisting of Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans; and (3) The lesser of: (i) the Aggregate Credit Limit, and (ii) the Collateral Value of the Borrowing Base, minus, in each case, the aggregate dollar amount of all Tranche A Loans outstanding, all Tranche B Loans outstanding, all Tranche C Loans outstanding, all Tranche E Loans outstanding (including all Tranche A Loans, Tranche B Loans, Tranche C Loans and Tranche E Loans to be funded on the proposed date of funding of the requested Tranche D Loan), and all Funding Checks outstanding; provided, however, that (x) in calculating the amount of Loans outstanding under Paragraph 4(a)(3) above at any date, the aggregate amount of Loans outstanding shall not include any Loans which will be repaid with Loans to be advanced on such date in accordance with the terms of this Agreement, and (y) following the funding of any requested Tranche D Loan, the aggregate dollar amount of each Lender's Primary Loans outstanding shall not exceed such Lender's Maximum Commitment. 4(b) Interest Rate Applicable to Tranche D Loans. Tranche D Loans ------------------------------------------- shall be made and/or maintained as Federal Funds Rate Loans. 4(c) Calculation of Interest. The Company shall pay to the ----------------------- Administrative Agent for distribution to each Tranche D Lender interest on Tranche D Loans 6 outstanding hereunder from the date disbursed to but not including the date of payment calculated on such Tranche D Lender's Tranche D Percentage Share of the principal amount of Tranche D Loans outstanding from time to time hereunder during the interest calculation period, at a rate per annum equal to a fluctuating rate per annum equal to the Applicable Federal Funds Rate during the applicable computation period. 4(d) Payment of Interest. Interest accruing on Tranche D Loans ------------------- shall be payable monthly, in arrears, as provided in Paragraph 7(d) below. 5. Tranche E Credit Facility (Negotiated Loan). ------------------------------------------- 5(a) Tranche E Lending Limit. On the terms and subject to the ----------------------- conditions set forth herein, any Lender may from time to time to but not including the Maturity Date in its sole and absolute discretion offer to make loans ("Tranche E Loans" or a "Tranche E Loan") to the Company in such amounts, at such interest rates and for such terms that are not less than seven (7) and not more than ninety (90) days and not to extend beyond the Maturity Date as such Lender and the Company may agree; provided, however, that in no event will any Lender advance any Tranche E Loan to the Company nor will the Company accept the proceeds of any Tranche E Loan if upon the funding thereof the aggregate amount of Tranche E Loans outstanding would exceed the lesser of: (1) the Aggregate Credit Limit, and (2) the Collateral Value of the Borrowing Base, minus, in each case, the aggregate dollar amount of all Tranche A Loans outstanding, all Tranche B Loans outstanding, all Tranche C Loans outstanding, all Tranche D Loans outstanding (including all Tranche A Loans, Tranche B Loans, Tranche C Loans and Tranche D Loans to be funded on the proposed date of funding of such Tranche E Loan), and all Funding Checks outstanding; provided, however, that in calculating the amount of Loans outstanding under this Paragraph 5(a) at any date, the aggregate amount of Loans outstanding shall not include any Loans which will be repaid with Loans to be advanced on such date in accordance with the terms of this Agreement. 5(b) Interest Rate Applicable to Tranche E Loans. Tranche E Loans ------------------------------------------- shall be made and/or maintained at the Tranche E Loan Rate applicable thereto. The Company and the Lenders acknowledge and agree that any Lender may utilized Buy-Down Deposits to the extent such Buy-Down Deposits do not support Tranche B Loans or Tranche C Loans, in determining such Lender's Tranche E Loan Rate. 5(c) Calculation of Interest. The Company shall pay to the ----------------------- Administrative Agent for distribution to each applicable Lender interest on each Tranche E Loan outstanding hereunder extended by such Lender from the date disbursed to but not including the date of payment, calculated on the principal amount of such Tranche E Loan outstanding hereunder during the interest calculation period, at a rate per annum equal to the Tranche E Loan Rate applicable thereto. 5(d) Payment of Interest. Interest accruing on each Tranche E ------------------- Loan shall be payable monthly, in arrears, as provided in Paragraph 7(d) below, and at the end of the applicable Tranche E Interest Period relating thereto. 7 5(e) Primary Loan Obligation. The agreement of a Lender to make a ----------------------- Tranche E Loan hereunder shall not to any extent reduce such Lender's obligation to fund Primary Loans to the extent of such Lender's Maximum Commitment, it being expressly acknowledged and agreed that the agreement to make Tranche E Loans is optional on the part of such Lender and in addition to its Maximum Commitment. 6. Eurodollar Provisions. --------------------- 6(a) Procedures for Interest Rate Election. ------------------------------------- (1) The Company may elect from time to time to have Tranche A Loans funded as Eurodollar Loans or to convert Tranche A Loans outstanding as Federal Funds Rate Loans to Eurodollar Loans by giving the Administrative Agent at least three Eurodollar Business Days' prior irrevocable notice of such election. All such elections shall be made by delivery of a Loan Request by the Company to the Administrative Agent within the required time period. The Company may elect from time to time to convert Tranche A Loans outstanding as Eurodollar Loans to Federal Funds Rate Loans effective upon the last day of the applicable Eurodollar Interest Period. No Loan shall be funded as a Eurodollar Loan and no Federal Funds Rate Loan shall be converted into a Eurodollar Loan if an Event of Default or Potential Default has occurred and is continuing on the day occurring three Eurodollar Business Days prior to the date of, or on the date of, any requested funding or conversion. (2) All or any part of Tranche A Loans may be funded or converted as provided herein, provided that partial fundings or conversions shall be in a principal amount of $5,000,000.00 or whole multiples of $1,000,000.00 in excess thereof. (3) Any Eurodollar Loan may be continued as such upon the expiration of the Eurodollar Interest Period with respect thereto by the Company giving the Administrative Agent at least three Eurodollar Business Days' prior irrevocable notice of such election as set forth in a Loan Request; provided, however, that no Eurodollar Loan may be continued as such when any Event of Default or Potential Default has occurred and is continuing, but shall be automatically converted to a Federal Funds Rate Loan on the last day of the then current Eurodollar Interest Period applicable thereto, and the Administrative Agent shall notify the applicable Lenders and the Company promptly that such automatic conversion will occur. If the Company shall fail to give notice as provided above, the Company shall be deemed to have elected to convert any affected Eurodollar Loan to a Federal Funds Rate Loan on the last day of the applicable Eurodollar Interest Period. 6(b) Inability to Determine Rate. In the event that the --------------------------- Administrative Agent shall have reasonably determined (which determination shall be conclusive and binding upon the Company) that by reason of circumstances affecting the interbank market adequate and reasonable means do not exist for ascertaining the Eurodollar Rate for any Eurodollar Interest 8 Period, the Administrative Agent shall forthwith give telex notice of such determination, confirmed in writing, to each affected Lender and to the Company. If such notice is given: (1) no Loan may be funded as a Eurodollar Loan, (2) any Federal Funds Rate Loan that was to have been converted to a Eurodollar Loan shall, subject to the provisions hereof, be continued as a Federal Funds Rate Loan and (3) any outstanding Eurodollar Loan shall be converted, on the last day of the then current Eurodollar Interest Period applicable thereto, to a Federal Funds Rate Loan. Until such notice has been withdrawn by the Administrative Agent, the Company shall not have the right to convert a Federal Funds Rate Loan to a Eurodollar Loan or to fund any Loan as a Eurodollar Loan or to continue a Eurodollar Loan. The Administrative Agent shall withdraw such notice in the event that the circumstances giving rise thereto no longer pertain and that adequate and reasonable means exist for ascertaining the Eurodollar Rate for the Eurodollar Interest Period requested by the Company, and following withdrawal of such notice by the Administrative Agent, the Company shall have the right to have any Tranche A Loan funded as a Eurodollar Loan or convert a Federal Funds Rate Loan to a Eurodollar Loan or to continue a Eurodollar Loan in accordance with the terms and conditions of this Agreement. 6(c) Illegality. Notwithstanding any other provisions herein, if ---------- any law, regulation, treaty or directive or any change therein or in the interpretation or application thereof, shall make it unlawful for any Lender to make or maintain Eurodollar Loans as contemplated by this Agreement: (1) the commitment of such Lender hereunder to make or to continue Eurodollar Loans or to convert Federal Funds Rate Loans to Eurodollar Loans shall forthwith be cancelled and (2) such Lender's Loans then outstanding as Eurodollar Loans, if any, shall be converted automatically to Federal Funds Rate Loans at the end of their respective Eurodollar Interest Periods or within such earlier period as required by law. In the event of a conversion of any such Loan prior to the end of its applicable Eurodollar Interest Period, the Company hereby agrees promptly to pay any Lender affected thereby, upon demand, the amounts required pursuant to Paragraph 6(e) below, it being agreed and understood that such conversion shall constitute a prepayment for all purposes hereof. The provisions hereof shall survive the termination of this Agreement and payment of all other Obligations. 6(d) Funding. Each Lender shall be entitled to fund all or any ------- portion of its share of Loans in any manner it may determine in its sole discretion, including, without limitation, in the Grand Cayman inter-bank market, the London inter-bank market and within the United States, but all calculations and transactions hereunder shall be conducted as though all Lenders actually fund all Eurodollar Loans through the purchase of offshore dollar deposits in the amount of the relevant Eurodollar Loan in maturities corresponding to the applicable Eurodollar Interest Period. 6(e) Funding Indemnification. In addition to all other payment ----------------------- obligations hereunder, in the event: (1) any Eurodollar Loan is prepaid prior to the last day of the applicable Eurodollar Interest Period, whether following a voluntary prepayment, mandatory prepayment (including but not limited to application of proceeds from the sale of Collateral or in connection with a reallocation of Tranche B Allocations pursuant to Paragraph 2(e) above or in connection with an increase in availability under Paragraph 15(k) below), or otherwise, or (2) the Company shall fail to borrow a Eurodollar Loan or shall fail to continue or to make a conversion 9 to a Eurodollar Loan after the Company has given notice thereof as required hereunder, then the Company shall immediately pay to each Lender holding the Loans prepaid or not borrowed, continued or converted, through the Administrative Agent, (x) a processing fee in the amount of $150.00 and (y) an additional premium sum compensating such Lender for losses, costs and expenses incurred by such Lender in connection with such prepayment or such failure to borrow, continue or convert a Loan, including, without limitation, such as may arise out of re-employment of funds obtained by such Lender and from fees payable to terminate the deposits from which such funds were obtained, such losses, actual costs and expenses and the method of calculation thereof being set forth in reasonable detail in a statement delivered to the Company by such Lender. Under no circumstances shall any Lender have any obligation to remit monies to the Company upon prepayment of any Eurodollar Loan, even under circumstances which do not result in the necessity for the payment by the Company of any amount hereunder. The provisions hereof shall survive termination of this Agreement and payment of all other Obligations. 7. Miscellaneous Lending Provisions. -------------------------------- 7(a) Use of Proceeds. The proceeds of all Loans shall be --------------- utilized by the Company solely for the purposes of: (1) originating and/or acquiring Mortgage Loans; (2) repaying Tranche C Loans; and (3) refinancing Eligible Mortgage Loans inventory originated by the Company using its own funds. 7(b) Request For Loans; Making of Loans. ---------------------------------- (1) If the Company desires to borrow hereunder the Company shall: (i) in the case of a Tranche A Loan that is to be funded as a Federal Funds Rate Loan or a Tranche D Loan, deliver a Loan Request to the Administrative Agent no later than 9:00 a.m. (Los Angeles time) on the proposed funding date, which Loan Request shall be forwarded promptly by the Administrative Agent to the Tranche A Lenders and/or Tranche D Lenders, as applicable, (ii) in the case of a Tranche A Loan which is to be funded as a Eurodollar Loan, deliver a Loan Request to the Administrative Agent no later than 9:00 a.m. (Los Angeles time) not less than three Eurodollar Business Days prior to the proposed funding date, which Loan Request shall be forwarded promptly by the Administrative Agent to the Tranche A Lenders, (iii) in the case of a Tranche B Loan, deliver a Loan Request to the Administrative Agent no later than 10:00 a.m. (Los Angeles time) on the related Tranche B Borrowing Date, which Loan Request shall be forwarded promptly by the Administrative Agent to the Tranche B Lenders, (iv) in the case of a Tranche E Loan, deliver a Loan Request to the Administrative Agent no later than 12:00 noon (Los Angeles time) on the proposed funding date, which Loan Request shall be forwarded promptly by the Administrative Agent to the applicable Lender, and (v) in the case of a Tranche C Loan, deliver a Loan Request to the Administrative Agent no later than 1:30 p.m. (Los Angeles time) on the proposed funding date, which Loan Request shall be forwarded promptly by the Administrative Agent to the Tranche C Lender. All Loan Requests to be forwarded by the Administrative Agent to the Lenders shall be forwarded by facsimile transmission. With respect to any Loan Request, the 10 Company shall specify the principal amounts of the Loans requested, subject to the provisions of Paragraphs 1(a), 2(a), 3(a), 4(a) and 5(a) above, and in the case of any Eurodollar Loans, the respective Eurodollar Interest Periods applicable thereto, and with respect to any Tranche E Loan, the Lender which has agreed to fund such Tranche E Loan. The applicable Lenders shall make available their respective percentage shares, as applicable, of the proposed Loans by crediting the amount thereof, in immediately available same day funds, to the Pre-Disbursement Account (x) in the case of Loans other than Tranche C Loans and Tranche E Loans, no later than 12:30 p.m. (Los Angeles time) on the funding date and (y) in the case of Tranche C Loans or Tranche E Loans, no later than 2:00 p.m. (Los Angeles time) on the funding date, such funds to be held pending disbursement as provided in subparagraph (5) below. (2) With respect to the conversion or continuation of any Eurodollar Loan as provided in Paragraph 6(a) above, the Company shall deliver a Loan Request to the Administrative Agent no later than 9:00 a.m. (Los Angeles time) on the day occurring at least three Eurodollar Business Days prior to the date of the conversion or continuation requested therein, and the Administrative Agent shall promptly notify the appropriate Lenders of the contents of such Loan Request. (3) In addition to the provisions of subparagraph (1) above regarding the delivery of Loan Requests, (i) in the case of a Loan that is to be utilized to fund an Eligible Mortgage Loan includable in the Borrowing Base pursuant to a Collateral Confirmation Agreement, the Company shall deliver the Collateral Confirmation Agreement related to such Eligible Mortgage Loan to the Collateral Agent no later than 8:00 a.m. (Los Angeles time) on the proposed funding date, and (ii) in the case of a Tranche C Loan that is to be utilized to fund an Eligible Mortgage Loan includable in the Borrowing Base pursuant to a Collateral Confirmation Agreement, the Company shall deliver the Collateral Confirmation Agreement related to such Eligible Mortgage Loan to the Collateral Agent no later than 1:00 p.m. (Los Angeles time) on the proposed funding date; provided, however, that no Loan requested to fund a Mortgage Loan includable in the Borrowing Base pursuant to a Collateral Confirmation Agreement shall be made prior to receipt of the applicable Collateral Confirmation Agreement. (4) The failure of any Lender to make the Loan (or portion thereof) to be made by it as part of any borrowing shall not relieve any other Lender of its obligation hereunder to advance its applicable portion of the principal amount thereof, but no Lender shall be responsible for the failure of any other Lender to make any such Loan. (5) Subject to the conditions set forth in Paragraph 7(b)(1) above and Paragraphs 7(o) and 9(b) below, the Administrative Agent shall disburse amounts held in the Pre-Disbursement Account to the Funding Account no later than 1:00 p.m. (Los Angeles time) in the case of a Tranche A Loan, a Tranche B Loan or a Tranche D Loan and no later than 3:00 p.m. (Los Angeles time) in the case of a Tranche 11 C Loan or a Tranche E Loan. Disbursements out of the Funding Account and/or such other account chosen by the Company shall be controlled by the Company, unless the Administrative Agent shall elect at any time and in its sole discretion to control disbursements out of such accounts and shall notify the Company of such election. The Company shall fully cooperate with the Administrative Agent to effectuate such change of control. Amounts held in the Pre-Disbursement Account which cannot be disbursed to the Company because the conditions set forth in Paragraph 9(b) below are not met shall constitute cash collateral for the Obligations and shall be transferred to the Settlement Account prior to the opening of business of the Administrative Agent on the Business Day following the date deposited in the Pre-Disbursement Account and disbursed to the Company only at such time as such conditions are met. Such amounts shall constitute "Loans" to the Company for all purposes of the Loan Documents and shall be payable, with interest from the date first deposited in the Pre-Disbursement Account to the same extent as if such amounts had been fully disbursed. (6) Concurrently with submitting any Loan Request to the Administrative Agent hereunder, the Company shall provide information to the Administrative Agent and the Collateral Agent as to Funding Checks outstanding as of the time of submission of such Loan Request. 7(c) Notes. The obligation of the Company to repay the Loans ----- shall be evidenced by promissory notes, which promissory notes shall be issued in substitution and replacement of the "Notes" issued under the Existing Credit Agreement, payable to the order of each Lender, as applicable, in the forms of those attached hereto as Exhibit A-1 (the "Tranche A Notes"), Exhibit A-2 (the ----------- ----------- "Tranche B Notes"), Exhibit A-3 (the "Tranche C Note"), Exhibit A-4 (the ----------- ----------- "Tranche D Notes") and Exhibit A-5 (the "Tranche E Notes"). The Administrative ---- Agent shall deliver a monthly statement of account to the Company setting forth the unpaid principal balance of Loans outstanding hereunder, and each Lender's interest therein, which statement shall (absent clerical error) be deemed conclusively correct and accepted by the Company unless the Company notifies the Administrative Agent to the contrary within fifteen (15) Business Days following delivery of such statement. Each Lender is hereby authorized to record the date and amount of each advance, conversion and continuation and the date and amount of each such payment or prepayment of principal of each Loan made by such Lender, the applicable Eurodollar Interest Period, if any, and the interest rate with respect thereto, on the schedules annexed to and constituting a part of its respective Note or Notes (or by any analogous method any Lender may elect consistent with its customary practices), and any such recordation shall constitute conclusive evidence of the accuracy of the information so recorded absent manifest error. The failure of any Lender to make any such notation shall not affect in any manner or to any extent the Company's obligation to pay and perform the Obligations. 7(d) Interest and Fee Billing and Payment. The Administrative ------------------------------------ Agent shall, on or before the fifth Business Day of each month for Tranche A Loans funded as Federal Funds Rate Loans, Tranche D Loans and fees, and three Business Days prior to the last day of the applicable Eurodollar Interest Period for Tranche A Loans funded as Eurodollar Loans, deliver to the Company an interest and fee billing for the immediately preceding month or then- 12 ending Eurodollar Interest Period, as the case may be, which billing shall set forth interest accrued and payable on Loans and fees payable hereunder for such period to be collected by the Administrative Agent, and the Company shall pay the full amount of such interest and fee billing no later than (y) five Business Days after receipt thereof in the case of Tranche A Loans funded as Federal Funds Rate Loans, Tranche D Loans and fees, and (z) on the last day of the applicable Eurodollar Interest Period for Tranche A Loans funded as Eurodollar Loans. Prior to the occurrence of the Maturity Date, interest accruing on Tranche B Loans, Tranche C Loans and Tranche E Loans shall be payable in accordance with such billing and interest procedures as the Company and each Tranche B Lender, the Tranche C Lender and each Tranche E Lender, respectively, shall agree. Following the occurrence of the Maturity Date, interest accruing on all Loans shall be billed by the Administrative Agent based, to the extent deemed necessary in the case of Tranche B Loans, Tranche C Loans and Tranche E Loans and without independent verification of the accuracy thereof, on information provided to the Administrative Agent by the respective Lenders holding such Loans. Whether or not any such interest or fee billing is delivered to the Company, the Administrative Agent is hereby authorized to, and shall unless the Company is otherwise notified in advance of a different method and/or time of payment, debit the Operating Account in the amount of such interest and fees billed by the Administrative Agent hereunder. In any event and both prior to and following the Maturity Date, any deficiency fees payable by the Company to a Tranche B Lender in respect of Tranche B Loans or to the Tranche C Lender in respect of Tranche C Loans shall be paid directly to such Tranche B Lender or the Tranche C Lender, respectively, pursuant to the terms of the applicable Buy- Down Letter. 7(e) Repayment of Principal. Subject to the prepayment ---------------------- requirements of Paragraphs 7(f) and 7(p) below, and the required application of proceeds from the sale or other disposition of Collateral as provided in the Security Agreement, the Company shall pay the principal amount of each Eurodollar Loan (unless continued or converted pursuant to Paragraph 6(a) above) on the last day of the applicable Eurodollar Interest Period relating thereto, shall pay the principal amount of each Tranche B Loan on the last day of the applicable Tranche B Interest Period, shall pay the principal amount of each Tranche E Loan on the last day of the applicable Tranche E Interest Period relating thereto, and shall pay the principal amount of all other Loans on the Maturity Date; provided, however, the Company shall pay the principal amount of any Loan no earlier than one (1) Business Day after the advance thereof. 7(f) Borrowing Base Conformity. ------------------------- (1) In support of its obligation to repay Loans, the Company shall cause the Collateral Value of the Borrowing Base and, if so required by the Majority Lenders in writing from time to time in their sole and absolute discretion, the Fair Market Value of the Borrowing Base, to be not less than, at any date, the aggregate principal amount of outstanding Loans and Funding Checks outstanding. (2) In support of its obligation to repay Tranche D Loans, the Company shall cause the Collateral Value of the Borrowing Base consisting of Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans to be not less than, at any date, the aggregate principal amount of all outstanding Tranche D Loans. 13 (3) The Company shall immediately prepay the applicable Loans to the Administrative Agent on behalf of the Lenders, upon telephonic demand by the Administrative Agent, on any day in the amount by which (i) the aggregate principal amount of outstanding Loans and Funding Checks exceeds the limitation of subparagraph (1) above and (ii) the aggregate principal amount of outstanding Tranche D Loans exceeds the limitation of subparagraph (2) above. (4) If, but only if, at such time as the Company shall be required to prepay Loans under this Paragraph 7(f) there shall not have occurred and be continuing an Event of Default or Potential Default, in lieu of prepaying the Loans as required above, the Company may deliver to the Collateral Agent for the benefit of the Lenders additional Eligible Mortgage Loans (and as applicable, additional Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans for the benefit of the Tranche D Lenders), such that the Collateral Value of the Borrowing Base or the Fair Market Value of the Borrowing Base, as applicable, after giving effect to the inclusion of such Eligible Mortgage Loans in the Borrowing Base (and as applicable, the Collateral Value of the Borrowing Base consisting of Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans, after giving effect to the inclusion of such Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans in the Borrowing Base), shall be in compliance with the requirements of subparagraphs (1) and (2) above. 7(g) Nature and Place of Payments. All payments made on account ---------------------------- of the Obligations (other than amounts required to be paid to Tranche B Lenders pursuant to Paragraph 2(d) above and their respective Buy-Down Letters with the Company or amounts required to be paid to the Tranche C Lender pursuant to Paragraph 3(e) above and its Buy-Down Letter with the Company) shall be made to the Administrative Agent for prompt distribution to the Lenders. All payments made on account of the Obligations shall be made without setoff or counterclaim in lawful money of the United States of America in immediately available same day funds, free and clear of and without deduction for any taxes, fees or other charges of any nature whatsoever imposed by any taxing authority and must be received by the Administrative Agent by 10:00 a.m. (Los Angeles time) on the date of payment, it being expressly agreed and understood that if a payment is received after 10:00 a.m. (Los Angeles time) by the Administrative Agent, such payment will be considered to have been made on the next succeeding Business Day and interest thereon shall be payable at the then applicable rate during such extension; provided, however, that upon the request of the Company, and with the consent of the Tranche C Lender, the Administrative Agent shall apply payments made after 10:00 a.m. (Los Angeles time) and before 1:30 p.m. (Los Angeles time) to the repayment of Tranche C Loans outstanding without such payment being considered to have been made on the next succeeding Business Day. All payments on account of the Obligations shall be made to the Administrative Agent through its office located at One First National Plaza, Chicago, Illinois 60670. If any payment required to be made by the Company hereunder becomes due and payable on a day other than a Business Day, the due date thereof shall be extended to the next succeeding Business Day and interest thereon shall be payable at the then applicable rate during such extension. 14 7(h) Post-Maturity Interest. Any Obligations not paid when due ---------------------- (whether at stated maturity, upon acceleration or otherwise) shall bear interest from the date due until paid in full at a per annum rate equal to three percent (3%) above the Corporate Base Rate. 7(i) Computations. All computations of interest and fees payable ------------ hereunder shall be based upon a year of 360 days for the actual number of days elapsed. 7(j) Prepayments. ----------- (1) The Company may prepay Loans hereunder (other than Eurodollar Loans) in whole or in part at any time; provided, however, that any such voluntary prepayment shall be in the amount of $100,000.00 or an integral multiple of $100,000.00 in excess thereof. (2) Loans hereunder are subject to mandatory prepayment pursuant to Paragraphs 7(f) above and 7(p) below, and in addition, by application of proceeds of the sale or other disposition of Collateral as provided in the Security Agreement. (3) The Company shall prepay Loans hereunder in an amount equal to any and all payments received by the Company from Obligors on account of any Eligible HELOC Assets included in the Borrowing Base within one (1) Business Day of receipt of such amounts by the Company. Concurrently with such prepayment, the Company shall provide written notice to the Collateral Agent of such prepayment identifying the dollar amount thereof and the Eligible HELOC Asset to which such prepayment related, and the Collateral Agent shall thereafter recalculate the Unit Collateral Value of such Eligible HELOC Asset for purposes of all subsequent Collateral Value Determinations made by the Collateral Agent. (4) The Company shall pay in connection with any prepayment hereunder all interest accrued but unpaid on Loans to which such prepayment is applied pursuant to Paragraph 7(k) below concurrently with payment to the Administrative Agent of any principal amounts and, in addition, any amounts payable on account thereof pursuant to Paragraph 6(e) above. 7(k) Distribution of Amounts Held In Settlement Account; Post- --------------------------------------------------------- Default Distributions. - --------------------- (1) Prior to the occurrence of an Event of Default and acceleration of the Obligations, upon request by the Company, the Administrative Agent shall release any cash held in the Settlement Account at such time (the "Available Cash Proceeds") to the Company as long as the Borrowing Base requirements pursuant to Paragraphs 7(f)(1) and 7(f)(2) are met. In addition, upon delivery of a Loan Request to the Administrative Agent, the Company may request that the Administrative Agent determine the Available Cash Proceeds and that the Administrative Agent: 15 (i) Transfer from the Settlement Account to the Funding Account Available Cash Proceeds in an amount equal to the lesser of: a. the aggregate dollar amount of Loans requested pursuant to such Loan Request (the "Requested Loans") and b. the aggregate dollar amount of such Available Cash Proceeds; and (ii) Reduce the aggregate dollar amount of Requested Loans by an amount equal to the amount transferred pursuant to subparagraph (i) above (with such reduction being against such Requested Loans as the Company may indicate in such Loan Request). If but only if the Administrative Agent determines that upon such transfer pursuant to subparagraph (i) above and following the funding of the Requested Loans, as reduced pursuant to subparagraph (ii) above, the aggregate dollar amount of outstanding Loans and Funding Checks outstanding will not exceed the Collateral Value of the Borrowing Base, and, in the case of Tranche D Loans, that the aggregate dollar amount of outstanding Tranche D Loans will not exceed the Collateral Value of the Borrowing Base consisting of Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans, the Administrative Agent will effect such transfer and notify each Lender pursuant to Paragraph 7(b) above of the Loans, if any, to be funded by such Lender pursuant to such Loan Request. (2) Prior to the occurrence of an Event of Default and acceleration of the Obligations, the Company may direct the Administrative Agent in writing to distribute amounts held in the Settlement Account or any portion thereof to the Lenders on account of the Loans in such order as the Company may elect (subject only to the requirements that: (i) any payment on account of Tranche A Loans, Tranche B Loans and/or Tranche D Loans be allocated pro rata among the Tranche A Lenders, the Tranche B Lenders and/or the Tranche D Lenders, as applicable, in accordance with their Tranche A Percentage Shares, Tranche B Percentage Shares and/or Tranche D Percentage Shares, as applicable, and (ii) no payment be made on account of a Tranche C Loan on the date funded. Any direction for a distribution to the Tranche A Lenders, the Tranche B Lenders, the Tranche D Lenders and/or any Lender which advanced Tranche E Loans must be received by the Administrative Agent by 10:00 a.m. (Los Angeles time) on the proposed distribution date, and any direction for a distribution to the Tranche C Lender must be received by the Administrative Agent by 2:45 p.m. (Los Angeles time) on the proposed distribution date. (3) Following the occurrence of an Event of Default and acceleration of the Obligations: (i) All amounts received by the Administrative Agent on account of the Obligations other than the Tranche D Obligations, including funds deposited from time to time in the Settlement Account and proceeds of the sale or other disposition of all Collateral except Collateral in the Borrowing Base 16 relating to Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans used to support Tranche D Loans and except the Pledged Collateral, shall be allocated by the Administrative Agent as follows: a. First, to the payment of expenses incurred by the Administrative Agent and Collateral Agent in the performance of their duties and enforcement of their rights under the Loan Documents in respect of the Obligations other than the Tranche D Obligations, including, without limitation, all costs and expenses of collection, reasonable attorneys' fees, court costs and foreclosure expenses; b. Then, to the Lenders, pro rata in accordance with their respective Outstanding Percentage Shares, until the Obligations are paid in full; and c. Then, to such Persons as may be legally entitled thereto. (ii) All amounts received by the Administrative Agent on account of the Tranche D Obligations, including the proceeds of the sale or other disposition of all Collateral in the Borrowing Base relating to Eligible Shipped Mortgage Loans and Eligible Gestation Mortgage Loans used to support Tranche D Loans but excepting the Pledged Collateral, shall be allocated by the Administrative Agent as follows: a. First, to the payment of expenses incurred by the Administrative Agent and Collateral Agent in the performance of their duties and enforcement of their rights under the Loan Documents in respect of the Tranche D Obligations, including, without limitation, all costs and expenses of collection, attorneys' fees, court costs and foreclosure expenses; b. Then, to the Tranche D Lenders, pro rata in accordance with their respective Tranche D Percentage Shares, until the Tranche D Obligations are paid in full; c. Then, to the Lenders, pro rata in accordance with their respective Outstanding Percentage Shares, until the Obligations are paid in full; and d. Then, to such Persons as may be legally entitled thereto. 17 (iii) All amounts received by the Administrative Agent upon the sale or other disposition of the Pledged Collateral shall be allocated by the Administrative Agent as follows: a. First, to the payment of expenses incurred by the Administrative Agent and the Collateral Agent in the performance of their duties and enforcement of their rights under the Pledge Agreement and the other Stock Pledge Documents; b. Then, to the Lenders and the "Lenders" under (and as the term "Lenders" is defined in) the Servicing Secured Credit Agreement, pro rata in accordance with their respective Combined Percentage Shares, until the Secured Obligations are paid in full; and c. Then, to such Persons as may be legally entitled thereto. 7(l) Fees. The Company shall pay the following fees: ---- (1) To the Administrative Agent for the account of each Lender, quarterly in advance, a non-refundable commitment fee equal to the product of (i) one fifth of one percent (0.20%) per annum times (ii) such Lender's Maximum Commitment on the Effective Date and on the first Business Day of each calendar quarter thereafter, said fee to be payable on the Effective Date for the period from such date to but not including October 1, 1997 and on the first Business Day of each January, April, July and October thereafter for the applicable calendar quarter (or portion thereof). (2) To the Administrative Agent for the account of each Lender which provides its written consent to an amendment, waiver or other modification of the Loan Documents on or before the date such amendment, waiver or other modification becomes effective as a result of the written approval thereof by the requisite number of Lenders required by the Loan Documents, a processing fee of $1,500.00, said fee to be payable promptly following such effective date; provided, however, that such fee shall not apply to the first two such amendments, waivers or other modifications hereunder during any continuous one year period (calculated from the date of this Agreement). (3) To the Administrative Agent and the Collateral Agent, such fees in such amounts and payable at such times as the Company and the Administrative Agent and the Company and the Collateral Agent, as applicable, may from time to time agree in writing. 7(m) Requirements of Law; Increased Costs. In the event that any ------------------------------------ applicable law, order, regulation, treaty or directive issued by any central bank or other Governmental Authority, or in the governmental or judicial interpretation or application thereof, 18 or compliance by any Lender with any request or directive (whether or not having the force of law) issued subsequent to the date hereof by any central bank or other Governmental Authority: (1) Does or shall subject any Lender to any tax of any kind whatsoever with respect to this Agreement or any Loans made hereunder, or change the basis of taxation of payments to such Lender of principal, fee, interest or any other amount payable hereunder (except for change in the rate of tax on the overall net income of such Lender imposed by the jurisdiction in which such Lender maintains its principal office); (2) Does or shall impose, modify or hold applicable any reserve, capital requirement, special deposit, compulsory loan or similar requirements against assets held by, or deposits or other liabilities in or for the account of, advances or loans by, or other credit extended by, or any other acquisition of funds by, any office of such Lender which are not otherwise included in the determination of the Applicable Eurodollar Rate, the Federal Funds Funding Rate, the Buy-Down Rate, the Overnight Transaction Loan Rate or the Tranche E Loan Rate; or (3) Does or shall impose on such Lender any other condition; and the result of any of the foregoing is to increase the cost to such Lender of making, renewing or maintaining any Loan or to reduce any amount receivable in respect thereof or to reduce the rate of return on the capital of such Lender or any Person controlling such Lender, then, in any such case, the Company shall promptly pay to the Administrative Agent for remittance to such Lender, upon its written demand made through the Administrative Agent, any additional amounts necessary to compensate such Lender for such additional cost or reduced amounts receivable or rate of return as reasonably determined by such Lender with respect to this Agreement or Loans made hereunder. If a Lender becomes entitled to claim any additional amounts pursuant to this Paragraph 7(m), it shall promptly notify the Company through the Administrative Agent of the event by reason of which it has become so entitled. In conjunction with such notification, such Lender shall provide the Company with a certificate specifying any additional amounts payable pursuant to the foregoing sentence, which certificate shall set forth the calculation of such amounts in sufficient detail and according to reasonable and customary computation methods. The provisions hereof shall survive the termination of this Agreement and payment of all other Obligations. 7(n) Reduction in Aggregate Credit Limit. The Company may from ----------------------------------- time to time, effective as of any Eurodollar Business Day, permanently reduce, in whole or in part, the Aggregate Credit Limit on a pro rata basis among the Lenders, in an amount not less than $5,000,000.00 (and integral multiples of $1,000,000.00 in excess thereof) upon not less than four Business Days prior written notice to the Administrative Agent, the Collateral Agent and the Lenders; provided, however, that on or before the effective date of any such reduction the Company will pay to the Administrative Agent for distribution to the applicable Lenders that dollar amount of Loans outstanding which, after giving effect to such permanent reduction, will 19 exceed the Aggregate Credit Limit (and related Tranche A Credit Limit, Tranche B Aggregate Credit Allocation, Tranche C Credit Limit and/or Tranche D Credit Limit, as applicable). 7(o) Assumption of Funding. The Administrative Agent may (but --------------------- shall not be obligated to) assume that each Lender has made its Tranche A Percentage Share, Tranche B Percentage Share or Tranche D Percentage Share, as applicable, of Tranche A Loans, Tranche B Loans or Tranche D Loans available on the funding date therefor and may, in reliance on such assumption, make available to the Company on such date a corresponding amount. If and to the extent any Lender shall not have made such amount available, such Lender and the Company jointly and severally agree to repay to the Administrative Agent forthwith on demand such amount together with interest thereon for each date from the date such amount is funded by the Administrative Agent until the date such amount is repaid to the Administrative Agent at the Federal Funds Funding Rate. If such Lender shall repay to the Administrative Agent such amount, such amount shall constitute such Lender's Tranche A Percentage Share, Tranche B Percentage Share or Tranche D Percentage Share of such Tranche A Loan, Tranche B Loan or Tranche D Loan, as applicable, for all purposes of the Loan Documents. 7(p) Mark-to-Market Requirement. At any time on the Business Day -------------------------- following telephonic request therefor by the Administrative Agent at the request of any Lender from time to time, the Company will provide to each Lender a Borrowing Base Certificate setting forth the Fair Market Value of the Borrowing Base as of the end of the preceding Business Day and the aggregate dollar amount of Loans outstanding on such date. In the event the aggregate dollar amount of Loans outstanding exceeds the Fair Market Value of the Borrowing Base, the Company shall immediately pay to the Administrative Agent for distribution to the Lenders as provided in Paragraph 7(k)(2) above the full amount of such excess. 8. Reaffirmation of Security Agreement; Pledge Agreement; Additional ----------------------------------------------------------------- Documents. - --------- 8(a) Security Agreement. As collateral security for the ------------------ Obligations of the Company under (and as the term "Obligations" is defined in) the Existing Credit Agreement, the Company executed and delivered to the Collateral Agent that certain Security and Collateral Agency Agreement dated as of October 24, 1994 (as amended from time to time, the "Existing Security Agreement"). The Company hereby confirms that the first priority, perfected security interest of the Collateral Agent for the benefit of the Lenders participating in the Existing Credit Agreement shall continue in full force and effect with respect to all Obligations hereunder. On or before the Effective Date, the Existing Security Agreement shall be amended and, for convenience of reference, restated in its entirety with a replacement security agreement in the form of that attached hereto as Exhibit B (as amended, extended or replaced from --------- time to time, the "Security Agreement"), which Security Agreement shall continue the perfection and priority of the security interest of the Collateral Agent for the benefit of the Lenders in the Collateral thereunder. 20 8(b) Pledge Agreement. As additional collateral security for the ---------------- Obligations and the Obligations of the Company under (and as the term "Obligations" is defined in) the Servicing Secured Credit Agreement, the Company shall execute and deliver to the Collateral Agent: (1) a pledge agreement in the form of that attached hereto as Exhibit C (as amended, extended or replaced --------- from time to time, the "Pledge Agreement") pursuant to which the Company shall assign, transfer and pledge to the Collateral Agent for the benefit of the Lenders a first priority security interest in and lien upon all now owned and hereafter issued or acquired stock of all now existing and hereafter formed or acquired Subsidiaries of the Company, including, without limitation, all outstanding capital stock of HMSI, (2) stock certificates evidencing all outstanding capital stock of Subsidiaries of the Company existing on the Effective Date and blank stock transfer powers therefor, and (3) such UCC-1 financing statements as the Administrative Agent shall require (collectively, the "Stock Pledge Documents"). 8(c) Further Documents. The Company agrees to execute and ----------------- deliver or to cause to be executed and delivered to the Administrative Agent on behalf of the Lenders from time to time such confirmatory or supplementary security agreements, financing statements, acknowledgments, consents and notices to third parties and other documents, instruments or agreements as the Administrative Agent on behalf of the Lenders may reasonably request, which are in the Administrative Agent's reasonable judgment necessary or desirable to obtain for the Lenders the benefit of the Loan Documents and the Collateral and the Pledged Collateral. 9. Conditions to Making of Loans. ----------------------------- 9(a) Effectiveness. As conditions precedent to the effectiveness ------------- of this Agreement and the other Loan Documents: (1) The Company shall have delivered or shall have had delivered to the Administrative Agent, in form and substance satisfactory to the Lenders and their counsel, each of the following (with sufficient copies for each of the Lenders): (i) A duly executed copy of this Agreement; (ii) Duly executed copies of the Notes; (iii) A duly executed copy of the Security Agreement; (iv) A duly executed copy of the Pledge Agreement and the other Stock Pledge Documents; (v) Duly executed copies of all financing statements and other documents, instruments and agreements, properly executed, deemed necessary or appropriate by the Administrative Agent, in its reasonable discretion, to obtain and maintain in favor of the Collateral Agent for the benefit of the Lenders a perfected security interest in and lien upon the Collateral and the Pledged Collateral; 21 (vi) Such credit applications, financial statements, authorizations and information concerning the Company and its business, operation and condition (financial and otherwise) as any Lender may reasonably request; (vii) Certified copies of resolutions of the Board of Directors of the Company approving the execution and delivery of the Loan Documents, the performance of the Obligations and the consummation of the transactions contemplated thereby; (viii) A certificate of the Secretary or an Assistant Secretary of the Company certifying the names and true signatures of the officers of the Company authorized to execute and deliver the Loan Documents; (ix) An opinion of counsel for the Company in form and substance satisfactory to the Administrative Agent and the Lenders; (x) A certificate of an executive officer of the Company in the form of that attached hereto as Exhibit D dated as of --------- the date of this Agreement; (xi) Evidence satisfactory to the Administrative Agent that each of the Funding Account, the Operating Account and the Settlement Account has been opened; (xii) A schedule of the current Approved Investors, Approved Repo Lenders, Approved Non-Agency Investors, Approved HELOC Investors, Approved High LTV Investors, Acceptable States and Acceptable Manufactured Housing States, duly approved by the Majority Lenders; (xiii) A Borrowing Base Certificate, certified by the chief financial officer, treasurer or controller of the Company, demonstrating that the Company is in compliance with the requirements of Paragraph 7(f) above (and assuming that all "Loans" outstanding under the Existing Credit Agreement are Loans outstanding hereunder) it being agreed and understood that on the Effective Date such "Loans" and all other "Obligations" under (and as defined in) the Existing Credit Agreement shall automatically be deemed to be Loans and Obligations hereunder; and (xiv) The current Commitment Schedule and Allocation Notice. (2) All acts and conditions (including, without limitation, the obtaining of any necessary regulatory approvals and the making of any required filings, recordings or registrations) required to be done and performed and to have happened precedent to the execution, delivery and performance of the Loan Documents and to 22 constitute the same legal, valid and binding obligations, enforceable in accordance with their respective terms, shall have been done and performed and shall have happened in due and strict compliance with all applicable laws. (3) All documentation, including without limitation, documentation for corporate and legal proceedings in connection with the transactions contemplated by the Loan Documents, shall be reasonably satisfactory in form and substance to the Administrative Agent and its counsel. (4) All fees required to be paid pursuant to Paragraph 7(l) above on or before the Effective Date shall have been paid prior to (or will be paid concurrently with) the making of the initial Loans hereunder. 9(b) All Loans. As conditions precedent to each Lender's --------- obligation to make any Loan hereunder, including the initial Loans and including the conversion of any Loan to another type of Loan or the continuation of any Eurodollar Loan after the end of its Eurodollar Interest Period, at and as of the date of the funding, conversion or continuation thereof: (1) There shall have been delivered to the Administrative Agent a Loan Request therefor; (2) The representations and warranties of the Company contained in the Loan Documents shall be accurate and complete in all respects as if made on and as of the date of such funding, conversion or continuance; (3) There shall not have occurred an Event of Default or Potential Default; (4) If the proceeds of a requested Loan are to be utilized to make a progress or construction payment relating to an Eligible Manufactured Housing Mortgage Loan, there shall have been delivered to the Administrative Agent a certification from the Company representing and warranting that all work associated with the construction and permanent attachment of the related Manufactured Home has been completed on schedule and in compliance with all specifications, and that such work has met all necessary inspection standards to allow a certificate of occupancy to be issued for such Manufactured Home upon completion; and (5) Following the funding of the requested Loan: (i) the aggregate principal amount of Primary Loans outstanding advanced by any Lender will not exceed its respective Maximum Commitment, (ii) the aggregate principal amount of Loans outstanding advanced by all Lenders will not exceed the Aggregate Credit Limit, and (iii) the aggregate principal amount of Loans outstanding will not exceed the applicable limitations of Paragraphs 1(a), 2(a), 3(a), 4(a) and 5(a) above. 23 By delivering a Loan Request to the Administrative Agent hereunder, the Company shall be deemed to have represented and warranted the accuracy and completeness of the statements set forth in subparagraphs (b)(2) through (b)(5) above. 10. Representations and Warranties of the Company. --------------------------------------------- As an inducement to the Agents and each Lender to enter into this Agreement and to make Loans as provided herein, the Company represents and warrants to the Agents and each Lender that: 10(a) Financial Condition. The financial statements, dated the ------------------- Statement Date and the Interim Date, copies of which have heretofore been furnished to each Lender, are complete and correct and present fairly in accordance with GAAP, the financial condition of the Company and its consolidated Subsidiaries, at such dates and the consolidated results of their operations and changes in financial position for the fiscal periods then ended. 10(b) No Change. Since each of the Statement Date and the Interim --------- Date, there has been no material adverse change in the business, operations, assets or financial or other condition of the Company or the Company and its consolidated Subsidiaries taken as a whole. 10(c) Corporate Existence; Compliance with Law. The Company and ---------------------------------------- each of its Subsidiaries: (1) is duly organized, validly existing and in good standing as a corporation under the laws of the State of California and is qualified to do business in each jurisdiction where its ownership of property or conduct of business requires such qualification and where failure to qualify could have a material adverse effect on the Company or its property and/or business or on the ability of the Company to pay or perform the Obligations, (2) has the corporate power and authority and the legal right to own and operate its property and to conduct business in the manner in which it does and proposes so to do, and (3) is in compliance with all Requirements of Law and Contractual Obligations, the failure to comply with which could have a material adverse effect on the business, operations, assets or financial or other condition of the Company or the Company and its consolidated Subsidiaries taken as a whole or on the Collateral or the Fair Market Value thereof. 10(d) Corporate Power; Authorization; Enforceable Obligations. ------------------------------------------------------- The Company has the corporate power and authority and the legal right to execute, deliver and perform the Loan Documents and borrow thereunder, and has taken all necessary corporate action to authorize the execution, delivery and performance of the Loan Documents and borrowing thereunder. The Loan Documents have been duly executed and delivered on behalf of the Company and constitute legal, valid and binding obligations of the Company enforceable against the Company in accordance with their respective terms, subject to the effect of applicable bankruptcy and other similar laws affecting the rights of creditors generally and the effect of equitable principles whether applied in an action at law or a suit in equity. 10(e) No Legal Bar. The execution, delivery and performance of ------------ the Loan Documents, the borrowing thereunder and the use of the proceeds thereof, will not violate 24 any Requirement of Law or any Contractual Obligation of the Company or any of its Subsidiaries or create or result in the creation of any Lien (except the Liens created by the Security Agreement and the Pledge Agreement) on any assets of the Company or any of its Subsidiaries. 10(f) No Material Litigation. Except as disclosed on Exhibit E ---------------------- --------- attached hereto, no litigation, investigation or proceeding of or before any arbitrator or Governmental Authority or any other Person is pending or, to the knowledge of the Company, threatened by or against the Company or any of its Subsidiaries or against any of such Persons' properties or revenues which (1) is likely to be adversely determined and which, if adversely determined, is likely to have a material adverse effect on the business, operations, property or financial or other condition of the Company or any of its Subsidiaries or (2) questions the validity or enforceability of any of the Loan Documents. 10(g) Taxes. The Company and each of its Subsidiaries have filed ----- or caused to be filed all tax returns that are required to be filed and have paid all taxes shown to be due and payable on said returns or on any assessments made against them or any of their property other than taxes which are being contested in good faith by appropriate proceedings and as to which the Company or applicable Subsidiary has established adequate reserves in conformity with GAAP. 10(h) Investment Company Act. The Company is not an "investment ---------------------- company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended. 10(i) Subsidiaries. Attached hereto as Exhibit F is an accurate ------------ --------- and complete list of all presently existing Subsidiaries of the Company, their respective jurisdictions of incorporation and the percentage of their capital stock owned by the Company or other Subsidiaries of the Company. All of the issued and outstanding shares of capital stock of such Subsidiaries have been duly authorized and issued and are fully paid and non-assessable. 10(j) Federal Reserve Board Regulations. Neither the Company nor --------------------------------- any of its Subsidiaries is engaged or will engage, principally or as one of its important activities, in the business of extending credit for the purpose of "purchasing" or "carrying" any "margin stock" within the respective meanings of such terms under Regulation U. No part of the proceeds of any Loan made hereunder will be used for "purchasing" or "carrying" "margin stock" as so defined or for any purpose which violates, or which would be inconsistent with, the provisions of the Regulations of the Board of Governors of the Federal Reserve System. 10(k) ERISA. The Company and each of its ERISA Affiliates are in ----- compliance in all respects with the requirements of ERISA and no Reportable Event has occurred under any Plan maintained by the Company or any of its ERISA Affiliates which is likely to result in the termination of such Plan for purposes of Title IV of ERISA. 10(l) Assets. The Company and each of its Subsidiaries has good ------ and marketable title to all property and assets reflected in the financial statements referred to in 25 Paragraph 10(a) above, including without limitation, the Collateral, except property and assets sold or otherwise disposed of in the ordinary course of business subsequent to the respective dates thereof. Neither the Company nor any of its Subsidiaries has outstanding Liens on any of its properties or assets, including, without limitation, the Collateral and the Pledged Collateral, nor are there any security agreements to which the Company or any of its Subsidiaries is a party, or title retention agreements, whether in the form of leases or otherwise, of any personal property except as reflected in the financial statements referred to in Paragraph 10(a) above or as permitted under Paragraph 12(a) below. 10(m) Securities Acts. The Company has not issued any --------------- unregistered securities in violation of the registration requirements of Section 5 of the Securities Act of 1933, as amended, or any other law, and is not violating any rule, regulation or requirement under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended. The Company is not required to qualify an indenture under the Trust Indenture Act of 1939, as amended, in connection with its execution and delivery of the Notes. 10(n) Consents, etc. No consent, approval or authorization of, or ------------- registration, declaration or filing with, any Governmental Authority or any other Person is required on the part of the Company in connection with the execution and delivery of the Loan Documents (other than filings to perfect the Liens granted pursuant to the Security Agreement) or the performance of or compliance with the terms, provisions and conditions hereof or thereof or any borrowing hereunder or to assure the validity and enforceability of any of the Loan Documents. 10(o) Hedging Program. The Company's Hedging Program represents a --------------- reasonable means for the Company to hedge certain interest rate risks associated with the mortgage banking business, and is a customary and standard Hedging Program comparable to that of other mortgage banking companies. The Company shall not alter or modify its Hedging Program without the consent of the Majority Lenders; provided, however, that consent shall be deemed given to any new Hedging Program proposed in writing by the Company to the Lenders if the Company is not notified of the objection to such new Hedging Program by Lenders holding at least 33.3333% of the Aggregate Percentage Shares within five (5) Business Days of receipt of notice thereof from the Company. 11. Affirmative Covenants. The Company hereby covenants and agrees --------------------- with the Administrative Agent and each Lender that, as long as any Obligations remain unpaid or any Lender has any obligation to make Loans hereunder, the Company shall: 11(a) Financial Statements. Furnish or cause to be furnished to -------------------- the Administrative Agent and each Lender directly: (1) Within ninety-one (91) days after the last day of each fiscal year of the Company, consolidated and consolidating statements of income and cash flows for such year and balance sheets as of the end of such year of the Company and its Subsidiaries presented fairly in accordance with GAAP and accompanied by an unqualified report of a firm of independent certified public accountants acceptable to the 26 Administrative Agent and including therewith a copy of any management letter from such certified public accountants; and (2) Within thirty (30) days after the last day of each calendar month, consolidated and consolidating statements of income and cash flows for such month and balance sheets as of the end of such month of the Company and its Subsidiaries, accompanied in each case by a certificate of the chief financial officer, treasurer or controller of the Company in the form of that attached hereto as Exhibit G, stating that such financial --------- statements are prepared fairly in accordance with GAAP and demonstrating in detail satisfactory to the Administrative Agent the Company's compliance with the financial covenants set forth in Paragraphs 12(f), 12(j), 12(k), 12(l), 12(m) and 12(n) below as of and at the end of such month, and indicating whether the Company has been audited by any of FNMA or FHLMC. 11(b) Certificates; Reports; Other Information. Furnish or cause ---------------------------------------- to be furnished to the Collateral Agent, the Administrative Agent and each of the Lenders directly: (1) (i) No later than thirty (30) days after the last day of each calendar month (setting forth information as of the last day of the immediately preceding month), and at such other times as the Administrative Agent or Majority Lenders may reasonably request, a. a Borrowing Base -- Certificate (which shall be in addition to the Borrowing Base Certificates delivered pursuant to Paragraph 7(p) above), and b. a pipeline report, -- commitment position report, servicing delinquency report and production report; (ii) No later than 10:00 a.m. on the first Business Day of each calendar week, and at such other times as the Administrative Agent or Majority Lenders may reasonably request, a certificate in form and substance satisfactory to each Lender, setting forth: (A) the aggregate outstanding principal balance of all Eligible HELOC Assets included in the Borrowing Base as of such date with a Loan-to-Value Ratio equal to or less than ninety percent (90%), (B) the aggregate outstanding principal balance of all Eligible HELOC Assets included in the Borrowing Base as of such date with a Loan-to-Value Ratio greater than ninety percent (90%), (C) the aggregate Unit Collateral Values of all Eligible HELOC Assets included in the Borrowing Base as of such date secured by Property which is encumbered by Liens in an amount greater than $300,000.00 but less than $650,000.00, and (D) the aggregate Unit Collateral Values of all Eligible HELOC assets included in the Borrowing Base as of such date secured by Property which is encumbered by Liens in an amount equal to or greater than $650,000.00 but less than $1,000,000.00; provided, however, that unless expressly so requested by a Lender in writing, such certificate need not be delivered to any Lender; and (iii) In any calendar month in which there is a material change in the Hedging Program, a written description of such change; all of the foregoing to be in 27 form and substance satisfactory to the Administrative Agent and certified as accurate and complete by a financial officer of the Company; (2) Within five (5) Business Days of submission thereof by the Company, copies of all documents submitted in connection with any audits by any of FNMA or FHLMC (or GNMA if the Company becomes an approved GNMA issuer), and, within ten (10) Business Days of receipt thereof by the Company, copies of all compliance and audit reports received from any of FNMA or FHLMC (or GNMA if the Company becomes an approved GNMA issuer), and, within two (2) Business Days of receipt thereof by the Company, copies of all notices received from FNMA or FHLMC (or GNMA if the Company becomes an approved GNMA issuer), of any change in agency status or notices of any withdrawal of approval of the Company as an issuer of Mortgage-Backed Securities or a servicer of Mortgage Loans; (3) No later than the last Business Day of the first month following the end of each calendar quarter, and at such other times as the Administrative Agent may reasonably request, a Servicing Contract Report demonstrating to the satisfaction of the Administrative Agent that the Mortgage Loans which are included in the Eligible Servicing Portfolio have an outstanding principal balance of not less than the amount required by Paragraph 12(l) below; (4) Prior to the consummation thereof, notice of any bulk sale of servicing rights owned by the Company with an outstanding principal balance in excess of $50,000,000.00; (5) On or before the first Business Day of each calendar month, the Weighted Average Take-Out Price for each Type of Collateral as of the last day of the immediately preceding calendar month and showing the basis for the calculation thereof in detail satisfactory to the Administrative Agent; (6) Promptly, such additional financial and other information, including, without limitation, financial statements of the Company and information regarding the Collateral, as any Lender, through the Administrative Agent, may from time to time reasonably request, including, without limitation, such information as is necessary for any Lender to assign or participate out any of its interests in the Loans hereunder or to enable other financial institutions to become signatories hereto; and (7) Promptly, and on a best efforts basis only, such additional financial and other information regarding any Affiliate of the Company, any Approved Investor (other than FNMA or FHLMC) or any Approved Repo Lender as any Lender, through the Administrative Agent, may from time to time reasonably request. 11(c) Payment of Indebtedness. And shall cause each of its ----------------------- Subsidiaries to, pay, discharge or otherwise satisfy at or before maturity or before it becomes delinquent, defaulted or accelerated, as the case may be, all its Indebtedness (including taxes), except Indebtedness being contested in good faith by appropriate proceedings and for which provision is 28 made to the satisfaction of the Administrative Agent for the payment thereof in the event the Company is found to be obligated to pay such Indebtedness and which Indebtedness is thereupon promptly paid by the Company. 11(d) Maintenance of Existence and Properties. And shall cause each of --------------------------------------- its Subsidiaries to, maintain its corporate existence and obtain and maintain all rights, privileges, licenses, approvals, franchises, properties and assets necessary or desirable in the normal conduct of its business, including but not limited to all approvals with respect to FNMA, FHLMC, FHA and VA, as applicable, and comply with all Contractual Obligations and Requirements of Law, the failure to comply with which could have a material adverse effect on the business, operations, property or financial or other condition of the Company or any of its Subsidiaries or on the Collateral. The Company will at all times be a FNMA and FHLMC approved Seller/Servicer. 11(e) Inspection of Property; Books and Records; Audits. And shall ------------------------------------------------- cause each of its Subsidiaries to: (1) Keep proper books of record and account in which full, true and correct entries in conformity with GAAP and all Requirements of Law shall be made of all dealings and transactions in relation to its business and activities; and (2) Permit representatives of the Administrative Agent or any Lender (at no cost or expense to the Company or any Subsidiary unless there shall have occurred and be continuing an Event of Default), upon the giving of reasonable prior written notice to: (i) visit and inspect any of its properties and examine and make abstracts from any of its books and records at any reasonable time and as often as may reasonably be desired by the Administrative Agent or any Lender, (ii) discuss the business, operations, properties and financial and other condition of the Company and any of its Subsidiaries with officers and employees of such Persons, and with their independent certified public accountants and (iii) conduct periodic operational audits of the Company's and its Subsidiaries' business and/or operations. 11(f) Notices. Promptly give written notice to each Lender of: ------- (1) The occurrence of any Potential Default or Event of Default and the proposed method of cure thereof; (2) Any litigation or proceeding affecting the Company or any of its Subsidiaries or the Collateral which (i) could have a material adverse effect on the Collateral or the business, operations, property, or financial or other condition of the Company or any of its Subsidiaries or (ii) questions the validity or enforceability of the Loan Documents; (3) A material adverse change in the business, operations, property or financial or other condition of the Company or any of its Subsidiaries; 29 (4) Any changes in the following senior management positions of the Company: chief executive officer, manager of operations, manager of production, manager of secondary marketing, chief financial officer, and manager of servicing; and (5) Any loss of delegated underwriting status with any Approved Investor. 11(g) Expenses. Pay all reasonable out-of-pocket costs and expenses -------- (including fees and disbursements of counsel): (1) of the Administrative Agent and the Collateral Agent incident to the preparation, negotiation and administration of the Loan Documents, any amendments or waivers thereto, and the protection of the rights of the Lenders, the Administrative Agent and the Collateral Agent under the Loan Documents, and (2) of the Administrative Agent, the Collateral Agent and each of the Lenders incident to the enforcement of payment of the Obligations, whether by judicial proceedings or otherwise, including, without limitation, in connection with bankruptcy, insolvency, liquidation, reorganization, moratorium or other similar proceedings involving the Company or a "workout" of the Obligations. Notwithstanding any provision herein to the contrary, the obligations of the Company under this Paragraph 11(g) shall be effective and enforceable whether or not any Loan is advanced by any Lender hereunder and shall survive payment of all other Obligations. 11(h) Loan Documents. Comply with and observe all terms and -------------- conditions of the Loan Documents. 11(i) Insurance. And shall cause each of its Subsidiaries to, obtain --------- and maintain insurance with responsible companies in such amounts and against such risks as are usually carried by corporations engaged in similar businesses similarly situated, including, without limitation, errors and omissions coverage and fidelity coverage in form and substance acceptable under FNMA or FHLMC guidelines, and furnish the Administrative Agent on request full information as to all such insurance. 11(j) Tax Refund. Contribute any tax refund received by the Company ---------- in any fiscal year towards the capital of the Company. 12. Negative Covenants. The Company hereby covenants and agrees with the ------------------ Administrative Agent and each Lender that, as long as any Obligations remain unpaid or any Lender has any obligation to make Loans hereunder, the Company shall not at any time, directly or indirectly: 12(a) Liens. And shall not permit any of its Subsidiaries to, create, ----- incur, assume or suffer to exist any Lien upon the Collateral or the Pledged Collateral except as contemplated by the Security Agreement and the Pledge Agreement, respectively, or create, incur, assume or suffer to exist any Lien upon any of its other property and assets (including servicing rights) except: (1) Liens or charges for current taxes, assessments or other governmental charges which are not delinquent or which remain payable without penalty, 30 or the validity of which are contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof, provided that the Company or such Subsidiary shall have set aside on its books and shall maintain adequate reserves for the payment of same in conformity with GAAP; (2) Liens, deposits or pledges made to secure statutory obligations, surety or appeal bonds, or bonds for the release of attachments or for stay of execution, or to secure the performance of bids, tenders, contracts (other than for the payment of borrowed money) or leases or for purposes of like general nature in the ordinary course of the Company's or such Subsidiary's business; (3) Purchase money security interests for property (except Mortgage Loans) hereafter acquired, conditional sale agreements, or other title retention agreements, with respect to property hereafter acquired; provided, however, that no such security interest or agreement shall affect any servicing rights or extend to any property other than the property acquired; and (4) Liens securing Permitted Other Secured Debt. 12(b) Indebtedness. And shall not permit any of its Subsidiaries to, ------------ create, incur, assume or suffer to exist, or otherwise become or be liable in respect of, any Indebtedness except: (1) The Obligations and the "Obligations" under (and as defined in) the Servicing Secured Credit Agreement; (2) Indebtedness reflected in the financial statements referred to in Paragraph 10(a) above; (3) Trade debt incurred in the ordinary course of business, paid within forty-five (45) days after the same has become due and payable or which is being contested in good faith, provided provision is made to the satisfaction of the Administrative Agent for the eventual payment thereof in the event it is found that such contested trade debt is payable by the Company; (4) Indebtedness secured by Liens permitted under Paragraph 12(a) above; and (5) Permitted Other Debt. 12(c) Mandatory Commitments. Hold Take-Out Commitments and/or Hedge --------------------- Contracts in less than an aggregate amount necessary to provide for the sale and/or coverage of one hundred percent (100%) of all closed Mortgage Loans owned by the Company and held for sale. 31 12(d) Consolidation and Merger. And shall not permit any of its --------------------- -- Subsidiaries to: (1) Liquidate or dissolve or enter into any consolidation or merger except: (i) consolidations or mergers of a Subsidiary into the Company, with the Company being the surviving corporation and (ii) the merger of Headlands Mortgage LLC into HMSI, with HMSI being the surviving corporation; provided, however, that both before and after giving effect to such transaction there shall not exist an Event of Default or Potential Default; or (2) Enter into any partnership, joint venture, syndicate or other combination which involves a material amount of the assets of, or could have a material effect on the business, operation, property or financial or other condition of, the Company or such Subsidiary. 12(e) Acquisitions. And shall not permit any of its Subsidiaries to, ------------ purchase or acquire or incur liability for the purchase or acquisition of any or all of the assets or business of any Person, other than in the normal course of business for mortgage banking companies (it being expressly agreed and understood that the acquisition of servicing is a normal course of business activity). 12(f) Payment of Dividends. (1) Declare or pay any dividends upon any -------------------- shares of the Company's stock now or hereafter outstanding, except dividends payable in the capital stock of the Company, or (2) make any distribution of assets to its stockholders as such, whether in cash, property or securities, or (3) set aside any of its property for the purpose of doing any of the foregoing; provided, however, that the Company may pay dividends (i) if the Company maintains its status as a Subchapter S Corporation under the Code, for the purpose of payment of shareholder level taxes then due and payable in amounts no greater than necessary to allow each of its shareholders to pay his, her or its actual tax liabilities attributable to the inclusion of income of the Company in such shareholder's taxable income as set forth in his, her or its annual tax returns, and provided that the Company shall on a timely basis supply on request of the Administrative Agent or any Lender evidence demonstrating that (x) the amount of any such dividend does not exceed such actual tax liabilities and (y) the proceeds of any such dividend will be applied exclusively to the payment of such actual tax liabilities, and (ii) during any fiscal year of the Company, additional dividends and distributions in an aggregate amount not to exceed twenty percent (20%) of Pre-Tax Income of the Company for such fiscal year (calculated on a quarterly basis); and provided further, that no dividend payment otherwise permitted pursuant to subparagraph (i) or (ii) above shall be made if, immediately before or after giving effect to any such dividend payment, any Event of Default or Potential Default exists or would exist. 12(g) Purchase or Retirement of Stock. Acquire, purchase, redeem or ------------------------------- retire any shares of its capital stock now or hereafter outstanding. 12(h) Investments; Advances. And shall not permit any of its --------------------- Subsidiaries to, make or commit to make any advance, loan or extension of credit (other than 32 Mortgage Loans made in the ordinary course of the Company's business) or capital contribution to, or purchase any stocks, bonds, notes, debentures or other securities of, or make any other investment in, any Person; provided, however, that the Company and its Subsidiaries may make or maintain Permitted Investments. 12(i) Sale of Assets. And shall not permit any of its Subsidiaries to, -------------- sell, lease, assign, transfer or otherwise dispose of any of its assets which are material (individually or in the aggregate) (other than obsolete or worn out property), whether now owned or hereafter acquired, other than in the ordinary course of business as presently conducted and at fair market value (it being expressly agreed and understood that the sale or other disposition of Mortgage- Backed Securities and Mortgage Loans with or without servicing released and of mortgage servicing rights is in the ordinary course of business). 12(j) Liabilities to Net Worth Ratio. Permit its consolidated ratio ------------------------------ at any date of (1) Total Liabilities to Effective Net Worth to be more than 20.0:1.0, or (2) Total Liabilities to Adjusted Tangible Net Worth to be more than 8.0:1.0. 12(k) Minimum Net Worth. Permit at any date its consolidated: (1) ----------------- Effective Net Worth to be less than $12,000,000.00, or (2) Adjusted Tangible Net Worth to be less than $46,100,000.00. 12(l) Servicing Portfolio. Permit: ------------------- (1) The aggregate outstanding principal balance of the Company's Eligible Servicing Portfolio, minus the aggregate outstanding principal balance of the Company's Encumbered Eligible Servicing Portfolio, to be less than $1,000,000,000.00, or (2) The aggregate outstanding principal amount of Mortgage Loans which the Company services for, and has a direct obligation to repurchase from, the applicable investor pursuant to a recourse arrangement to exceed $10,000,000.00. 12(m) Current Ratio. Permit its consolidated Current Ratio at any date ------------- to be less than 1.03:1.0. 12(n) Maximum Total Liabilities. Permit its consolidated Total ------------------------- Liabilities at any date to exceed the sum of: (1) one hundred percent (100%) of Cash and/or cash equivalents (excluding restricted cash), plus (2) ninety-eight percent (98%) of the outstanding principal balance of all Eligible Mortgage Loans other than Eligible HELOC Assets, plus (3) ninety-five percent (95%) of the outstanding principal balance of all Eligible HELOC Assets, plus (4) eighty percent (80%) of: (i) the outstanding principal balance of all Mortgage Loans excluded from the definition of "Eligible Mortgage Loan," and (ii) REO net of reserves, plus (5) eighty percent (80%) of its current advances and receivables, plus (6) the lesser of: (i) seventy percent (70%) multiplied by the Quoted Market Value of the Eligible Servicing Portfolio, and (ii) one percent (1%) of the outstanding principal balance of the Eligible Servicing Portfolio, plus (7) seventy percent (70%) of all REMIC-related Mortgage-Backed Securities held for sale and 33 marked to market quarterly (as shown on the Company's financial statements), plus (8) fifty percent (50%) of: (i) all other securities held for investment (net of reserves), and (ii) excess servicing (as shown on the Company's financial statements). 12(o) Limitation on Other Business. And shall not permit any of its ---------------------------- Subsidiaries to, engage in any business other than mortgage banking and activities directly related thereto, or engage in the business of developing any real property. 13. Events of Default. Upon the occurrence of any of the following events ----------------- (an "Event of Default"): 13(a) The Company shall fail to pay any Obligation (including but not limited to any prepayment required pursuant to Paragraph 7(f) above) on the date when due; or 13(b) Any representation or warranty made or deemed made by the Company in any Loan Document or in connection with any Loan Document shall be inaccurate or incomplete in any respect on or as of the date made or deemed made; or 13(c) The Company shall fail to maintain its corporate existence or shall default in the observance or performance of any covenant or agreement contained in Paragraph 12 above or in the Security Agreement or the Pledge Agreement; or 13(d) The Company shall fail to observe or perform any other term or provision contained in the Loan Documents and such failure shall continue for thirty (30) days after the earlier to occur of (i) receipt by the Company of written notice of such failure, and (ii) the date the Company obtains knowledge of such failure; or 13(e) The Company or any of its Subsidiaries shall default in any payment of principal of or interest on any Indebtedness (other than the Obligations), or any other event shall occur, the effect of which other event is to permit such Indebtedness to be declared or otherwise to become due prior to its stated maturity; or 13(f) (1) The Company or any of its Subsidiaries shall commence any case, proceeding or other action (i) under any existing or future law of any jurisdiction, domestic or foreign, relating to bankruptcy, insolvency, reorganization or relief of debtors, seeking to have an order for relief entered with respect to it, or seeking to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, winding-up, liquidation, dissolution, composition or other relief with respect to it or its debts, or (ii) seeking appointment of a receiver, trustee, custodian or other similar official for it or for all or any substantial part of its assets, or the Company or any of its Subsidiaries shall make a general assignment for the benefit of its creditors; or (2) there shall be commenced against the Company or any of its Subsidiaries any case, proceeding or other action of a nature referred to in clause (1) above which (i) results in the entry of an order for relief or any such adjudication or appointment, or (ii) remains undismissed, undischarged or unbonded for a period of sixty (60) days; or (3) there shall be commenced against the Company or any of its Subsidiaries any case, proceeding or other action seeking issuance of a warrant of attachment, execution, distraint or similar process against all or 34 substantially all of its assets which results in the entry of an order for any such relief which shall not have been vacated, discharged, stayed, satisfied or bonded pending appeal within sixty (60) days from the entry thereof; or (4) the Company or any of its Subsidiaries shall take any action in furtherance of, or indicating its consent to, approval of, or acquiescence in (other than in connection with a final settlement), any of the acts set forth in clause (1), (2) or (3) above; or (5) the Company or any of its Subsidiaries shall generally not, or shall be unable to, or shall admit in writing its inability to, pay its debts as they become due; or 13(g) (1) Any Person shall engage in any "prohibited transaction" (as defined in Section 406 of ERISA or Section 4975 of the Code) involving any Plan, (2) any "accumulated funding deficiency" (as defined in Section 302 of ERISA), whether or nor waived, shall exist with respect to any Plan, (3) a Reportable Event shall occur with respect to, or proceedings shall commence to have a trustee appointed (or a trustee shall be appointed) to administer, or to terminate, any Single Employer Plan, which Reportable Event or institution of proceedings is, in the reasonable opinion of the Administrative Agent, likely to result in the termination of such Plan for purposes of Title IV of ERISA, and, in the case of a Reportable Event, the continuance of such Reportable Event unremedied for ten days after notice of such Reportable Event pursuant to Section 4043(a), (c) or (d) of ERISA is given or the continuance of such proceedings for ten days after commencement thereof, as the case may be, (4) any Single Employer Plan shall terminate for purposes of Title IV of ERISA, (5) any withdrawal liability to a Multiemployer Plan shall be incurred by the Company or any of its ERISA Affiliates or (6) any other event or condition shall occur or exist; and in each case in clauses (1) through (6) above, such event or condition, together with all other such events or conditions, if any, is likely to subject the Company or any of its ERISA Affiliates to any tax, penalty or other liabilities in the aggregate material in relation to the business, operations, property or financial or other condition of the Company or any of its ERISA Affiliates; or 13(h) One or more judgments or decrees in an aggregate amount in excess of $50,000.00 shall be entered against the Company or any of its Subsidiaries and all such judgments or decrees shall not have been vacated, discharged, stayed, satisfied or bonded pending appeal within sixty (60) days from the entry thereof; or 13(i) Peter Paul and Dennis Hart shall collectively cease to own at least fifty-one percent (51%) of the outstanding shares of capital stock of the Company; or 13(j) There shall occur a material adverse change in the business, operations, assets or financial or other conditions of the Company or the Company and its Subsidiaries taken as a whole from the condition thereof at the Effective Date; or 13(k) Any Person who is the holder of Subordinated Debt shall fail to perform such Person's obligations under or shall cease to comply with the terms of the subordination agreement covering such Subordinated Debt, or such Person shall attempt to terminate, rescind or revoke any such subordination agreement; THEN, automatically upon the occurrence of an Event of Default under Paragraph 13(f) above, and in all other cases, at the option of the Majority Lenders, the obligation of the 35 Lenders to make Loans hereunder shall terminate and/or the principal balance of outstanding Loans and interest accrued but unpaid thereon and all other Obligations shall become immediately due and payable, without demand upon or presentment to the Company, which are expressly waived by the Company. 14. The Agents. ---------- 14(a) Appointment. Each Lender hereby irrevocably designates and ----------- appoints the Administrative Agent and the Collateral Agent (jointly and severally, the "Agents" or, individually, an "Agent") as the agent of such Lender under the Loan Documents and each Lender hereby irrevocably authorizes each Agent to take such action on its behalf under the provisions of the Loan Documents and to exercise such powers and perform such duties as are expressly delegated to such Agent by the terms of the Loan Documents, together with such other powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary elsewhere in the Loan Documents, no Agent shall have any duties or responsibilities except those expressly set forth in the Loan Documents or any fiduciary relationship with any Lender, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into the Loan Documents or otherwise exist against any Agent. The Company shall pay to each Agent such fees as each Agent and the Company may from time to time agree in writing. 14(b) Delegation of Duties. Each Agent may execute any of its duties -------------------- under the Loan Documents by or through agents or attorneys-in-fact and shall be entitled to advice of counsel concerning all matters pertaining to such duties. No Agent shall be responsible for the negligence or misconduct of any agents or attorneys-in-fact selected by it with reasonable care. 14(c) Exculpatory Provisions. No Agent nor any of its officers, ---------------------- directors, employees, agents, attorneys-in-fact or affiliates shall be (1) liable for any action lawfully taken or omitted to be taken by it or such Person under or in connection with the Loan Documents (except for its or such Person's own gross negligence or willful misconduct), or (2) responsible in any manner to any of the Lenders for any recitals, statements, representations or warranties made by the Company or any officer thereof contained in the Loan Documents or in any certificate, report, statement or other document referred to or provided for in, or received by any Agent under or in connection with, the Loan Documents or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of the Loan Documents or for any failure of the Company to perform its obligations thereunder. No Agent shall be under any obligation to any Lender to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, the Loan Documents or to inspect the properties, books or records of the Company. 14(d) Reliance. Each Agent shall be entitled to rely, and shall be -------- fully protected in relying, upon any note, writing, resolution, notice, consent, certification, affidavit, letter, cablegram, telegram, telecopy, telex or teletype message, statement, order or other document or telephone call or conversation reasonably believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons and upon advice and 36 statements of legal counsel (including, without limitation, counsel to the Company), independent accountants and other experts selected by such Agent. Each Agent may deem and treat the payee of any Note as the owner thereof for all purposes until notified of an assignment pursuant to Paragraph 15(h) below. As to the Lenders: (1) each Agent shall be fully justified in failing or refusing to take any action under the Loan Documents unless it shall first receive such advice or concurrence of the Majority Lenders or all of the Lenders, as appropriate, or it shall first be indemnified to its satisfaction by the Lenders ratably in accordance with their respective Aggregate Percentage Shares against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any action (except for liabilities and expenses resulting from such Agent's gross negligence or willful misconduct), and (2) each Agent shall in all cases be fully protected in acting, or in refraining from acting, under the Loan Documents in accordance with a request of the Majority Lenders or all of the Lenders, as appropriate, and such request and any action taken or failure to act pursuant thereto shall be binding upon all the Lenders. 14(e) Notice of Default. No Agent shall be deemed to have knowledge ----------------- or notice of the occurrence of any Potential Default or Event of Default unless such Agent has received notice from a Lender or the Company referring to the Loan Documents, describing such Potential Default or Event of Default and stating that such notice is a "notice of default." In the event that any Agent receives such a notice, such Agent shall give notice thereof to the Lenders and the other Agent. Each Agent shall take such action with respect to such Potential Default or Event of Default as shall be reasonably directed by the Majority Lenders or all Lenders, as applicable; provided that, unless and until an Agent shall have received such directions, such Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Potential Default or Event of Default as it shall deem advisable in the best interest of the Lenders. 14(f) Independent Decisions. Each Lender expressly acknowledges that --------------------- neither of the Agents nor any of their respective officers, directors, employees, agents, attorneys-in-fact or Affiliates has made any representations or warranties to it and that no act by any Agent hereafter taken, including any review of the affairs of the Company, shall be deemed to constitute any representation or warranty by either Agent to any Lender. Each Lender represents to the Agents that it has, independently and without reliance upon either of the Agents or any other Lender, and based on such documents and information as it has deemed appropriate, made its own appraisal of and investigation into the business, operations, property, financial and other condition and creditworthiness of the Company and made its own decision to make its Loans hereunder and enter into this Agreement. Each Lender also represents that it will, independently and without reliance upon either Agent 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 analysis, appraisals and decisions in taking or not taking action under this Agreement, and to make such investigation as it deems necessary to inform itself as to the business, operations, property, financial and other condition and creditworthiness of the Company. Except for notices, reports and other documents expressly required to be furnished to the Lenders by an Agent under the Loan Documents, neither Agent shall have any duty or responsibility to provide any Lender with any credit or other information concerning the business, operations, property, financial and other 37 condition or creditworthiness of the Company which may come into the possession of such Agent or any of its officers, directors, employees, agents, attorneys-in-fact or Affiliates. 14(g) Indemnification. The Lenders agree to indemnify each Agent in --------------- its capacity as such (to the extent not reimbursed by the Company and without limiting the obligation of the Company to do so), ratably according to the respective amounts of their Aggregate Percentage Shares, from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements (including, without limitation, attorneys fees) of any kind whatsoever which may at any time (including without limitation at any time following the payment of the Obligations) be imposed on, incurred by or asserted against such Agent in any way relating to or arising out of the Loan Documents or any documents contemplated by or referred to therein or the transactions contemplated thereby or any action taken or omitted by such Agent under or in connection with any of the foregoing; provided that no Lender shall be liable for the payment of any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from any Agent's gross negligence or willful misconduct. The provisions hereof shall survive the termination of this Agreement and the payment of the Obligations. 14(h) Agents in Their Individual Capacities. Each Agent and its ------------------------------------- Affiliates may make loans to, accept deposits from and generally engage in any kind of business with the Company as though such Agent were not an Agent hereunder. With respect to Loans made or renewed by them and any Note issued to them, the Agents shall have the same rights and powers under the Loan Documents as any Lender and may exercise the same as though they were not Agents hereunder and the terms "Lender" and "Lenders" shall include the Agents in their respective individual capacities if applicable. 14(i) Successor Agents. Either Agent may resign as an Agent under the ---------------- Loan Documents upon ninety (90) days' notice to the Lenders, the Company and the other Agent, and the Administrative Agent agrees that it will so resign in the event it ceases to hold any share of the Obligations. In addition, the Majority Lenders may, for cause, effective upon not less than ninety (90) days' notice to the Lenders, each Agent and the Company, remove and discharge either Agent from the performance of such Agent's duties under this Agreement and/or the Security Agreement. If any Agent shall resign or be removed, then within said ninety-day notice period the Majority Lenders shall appoint from among the Lenders a successor agent or if the Majority Lenders are unable to agree on the appointment of a successor agent, the applicable Agent shall appoint a successor agent for the Lenders (which successor agent, assuming that there does not exist a Potential Default or Event of Default, shall be reasonably acceptable to the Company), whereupon such successor agent shall succeed to the rights, powers and duties of the applicable Agent and the term "Administrative Agent" or "Collateral Agent" shall mean such successor agent, as applicable, effective upon its appointment, and the former Agent's rights, powers and duties as Agent shall be terminated, without any other or further act or deed on the part of such former Agent or any of the parties to this Agreement or any of the other Loan Documents or successors thereto. After any Agent's resignation or removal hereunder, the 38 provisions of this Paragraph 14 shall inure to its benefit as to any actions taken or omitted to be taken by it while it was an Agent under the Loan Documents. 15. Miscellaneous Provisions. ------------------------ 15(a) No Assignment. The Company may not assign its rights or ------------- obligations under this Agreement and/or the other Loan Documents without the prior written consent of one hundred percent (100%) of the Administrative Agent and the Lenders. Subject to the foregoing, all provisions contained in this Agreement or any document or agreement referred to herein or relating hereto shall inure to the benefit of each Lender, its successors and assigns, and shall be binding upon the Company, its successors and assigns. 15(b) Amendment. This Agreement and the other Loan Documents may not --------- be amended or terms or provisions hereof or thereof waived unless such amendment or waiver is in writing and signed by the Majority Lenders, the Administrative Agent and the Company; provided, however, that without the prior written consent of one hundred percent (100%) of the Lenders, the Administrative Agent and the Company, no amendment or waiver shall: (1) waive or amend any term or provision of Paragraph 12(f), 12(j), 12(k), 12(l), 12(m) or 12(n) above, (2) reduce the principal of, or rate of interest on, the Loans or fees, (3) except as expressly contemplated by Paragraphs 15(h) and 15(k) below, modify the Aggregate Credit Limit, the Tranche A Credit Limit, the Tranche B Aggregate Credit Allocation, the Tranche D Credit Limit or the Maximum Commitment of any Lender, (4) modify the definition of "Majority Lenders", (6) extend or waive any scheduled payment date for any principal, interest or fees, or the Maturity Date, (7) amend this Paragraph 15(b), or (8) amend any provision of the Loan Documents which by its terms requires the consent or approval of one hundred percent (100%) of the Lenders; provided, further, that without the prior written consent of one hundred percent (100%) of the Lenders, the Administrative Agent, the Collateral Agent and the Company, no amendment or waiver shall amend or waive the definition of the terms "Collateral Value of the Borrowing Base" or "Unit Collateral Value." It is expressly agreed and understood that the failure by the required Lenders to elect to accelerate amounts outstanding hereunder and/or to terminate the obligation of the Lenders to make Loans hereunder shall not constitute an amendment or waiver of any term or provision of this Agreement. 15(c) Cumulative Rights; No Waiver. The rights, powers and remedies ---------------------------- of the Lenders under the Loan Documents are cumulative and in addition to all rights, powers and remedies provided under any and all agreements among the Company and the Lenders relating hereto, at law, in equity or otherwise. Any delay or failure by the Administrative Agent, the Collateral Agent or the Lenders to exercise any right, power or remedy shall not constitute a waiver thereof and no single or partial exercise by the Administrative Agent, the Collateral Agent or the Lenders of any right, power or remedy shall preclude any other or further exercise thereof or any exercise of any other rights, powers or remedies. 15(d) Entire Agreement. The Loan Documents and the documents and ---------------- agreements referred to therein embody the entire agreement and understanding between the 39 parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof and thereof. 15(e) Survival. All representations, warranties, covenants -------- and agreements herein contained on the part of the Company shall survive the termination of this Agreement and shall be effective until the Obligations are paid and performed in full or longer as expressly provided herein. 15(f) Notices. All notices given by any party to the others ------- shall be in writing unless otherwise provided for herein, delivered personally or by depositing the same for delivery on the following Business Day, charges prepaid, addressed to such party at the address set forth on Schedule I attached ---------- hereto, or by telefacsimile (and except for Loan Requests, to be confirmed by mailed copy). Any party may change the address to which notices are to be sent by notice of such change to each other party given as provided herein. Such notices shall be effective on the date received or, if deposited for overnight delivery, on the Business Day following the date mailed. 15(g) Governing Law. This Agreement shall be governed by and ------------- construed in accordance with the laws of the State of California. 15(h) Assignment; Addition of New Lender. ---------------------------------- (1) The Company or any Lender may at any time propose that one or more commercial banks each of which is organized under the laws of the United States or any State thereof or organized under the laws of any other country, or a political subdivision thereof (provided that such foreign bank is acting through a branch or agency located in the United States, or is organized under the laws of a country that is a member of the Organization for Economic Cooperation and Development or a political subdivision of such country), is regularly engaged in the business of mortgage warehouse lending, and has capital and surplus of at least $300,000,000.00 (each, an "Applicant Financial Institution") become an additional Lender hereunder. At such time, the Company or such Lender, as applicable, shall notify the other parties hereto, including the Administrative Agent, of the identity of such Applicant Financial Institution and such Applicant Financial Institution's proposed Maximum Commitment (which must be not less than $10,000,000.00). The addition of any Applicant Financial Institution shall be subject to: (i) The prior written consent of the Administrative Agent (and if such Applicant Financial Institution is proposed for inclusion as a Lender hereunder by a Lender, the prior written consent of the Company), which consents shall not be unreasonably withheld or delayed and which, if given, shall be given in writing by the Administrative Agent (and, if applicable, the Company) to the other Lenders no later than the tenth day following receipt by the Administrative Agent (and, if applicable, the Company) of a written request for the inclusion of such Applicant Financial Institution as a Lender hereunder; 40 (ii) If such Applicant Financial Institution will be acquiring a portion of an existing Lender's Maximum Commitment by way of an assignment from such existing Lender, such existing Lender holding a Maximum Commitment of not less than $5,000,000.00 following the consummation of the contemplated assignment; and (iii) Delivery of each of the items and the occurrence of each of the events described in subparagraph (2) below. (2) Assuming delivery of any consents required pursuant to subparagraph (1)(i) above, the Administrative Agent and the Company shall mutually agree on the Adjustment Date on which such Applicant Financial Institution shall become a party hereto and a Lender hereunder. On such Adjustment Date: (i) The Company shall deliver to the Administrative Agent, the Collateral Agent and each of the Lenders a Commitment Schedule and Allocation Notice to be effective from such Adjustment Date, with such Commitment Schedule and Allocation Notice to reflect the Lenders' respective Maximum Commitments, Maximum Tranche B Commitments, Tranche B Allocations, Tranche D Commitments (if any), Tranche A Percentage Shares, Tranche B Percentage Shares and Tranche D Percentage Shares (if any), as applicable. (ii) Such Applicant Financial Institution shall pay to the Administrative Agent, no later than 12:00 noon (Los Angeles time), an amount equal to such Applicant Financial Institution's Tranche A Percentage Share of Tranche A Loans outstanding, such Applicant Financial Institution's Tranche B Percentage Share of Tranche B Loans outstanding, and such Applicant Financial Institution's Tranche D Percentage Share of Tranche D Loans outstanding (if any) to be funded on such Adjustment Date, as applicable. The Administrative Agent shall thereupon remit to the Lenders their respective shares of such funds, as applicable. Following such Adjustment Date, fees and interest accrued on Loans to but not including such Adjustment Date shall be payable to the Lenders in accordance with their respective Tranche A Percentage Shares, Tranche B Percentage Shares and Tranche D Percentage Shares prior to such Adjustment Date before giving effect to the readjustment thereof pursuant to the Commitment Schedule and Allocation Notice provided by the Company on such Adjustment Date. (iii) The Administrative Agent, the Company and such Applicant Financial Institution shall execute and deliver an agreement in the form of that attached hereto as Exhibit H (an --------- "Additional Lender Agreement"), which agreement shall constitute an amendment to this Agreement to the extent necessary to reflect the inclusion of such Applicant Financial Institution as a Lender hereunder. In addition, if in connection with the inclusion of such 41 Applicant Financial Institution as a Lender hereunder, the Aggregate Credit Limit will be increased, the parties hereto will execute any additional amendments to the Loan Documents as the Administrative Agent reasonably requests to reflect such increase. (iv) The Company shall execute and deliver new Notes, as applicable, to such Applicant Financial Institution. (v) Subject to the requirements described above, such Applicant Financial Institution shall become a party hereto and a Lender hereunder and shall be entitled to all rights, benefits and privileges accorded a Lender hereunder and under the other Loan Documents and shall be subject to all obligations of a Lender hereunder and under the other Loan Documents. (vi) The Applicant Financial Institution shall pay to the Administrative Agent a registration fee of $2,500.00 (said fee covering the admission of the Applicant Financial Institution into this Agreement). 15(i) Sub-Participations by Lenders. Any Lender may at any ----------------------------- time sell to one or more Persons (each of such Persons being herein called a "Participant") participating interests in any of the Obligations held by such Lender and its commitments hereunder; provided, however, that: (1) No participation contemplated by this Paragraph 15(i) shall relieve such Lender from its obligations hereunder or under any other Loan Document; (2) Such Lender shall remain solely responsible for the performance of such obligations and such Lender shall grant no voting rights to any Participant other than as to matters which require the approval of one hundred percent (100%) of the Lenders pursuant to Paragraph 15(b) above; and (3) The Company, the Administrative Agent, the Collateral 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 the Loan Documents; provided, however, that the Company acknowledges and agrees that each Participant shall be considered a Lender for purposes of Paragraphs 6(c), 6(d), 6(e) and 7(m) above. 15(j) Federal Reserve Bank. Notwithstanding the provisions -------------------- of Paragraphs 15(h) and 15(i) above, any Lender may at any time pledge or assign all or any portion of such Lender's rights under this Agreement and the other Loan Documents to a Federal Reserve Bank. 15(k) Increases in Availability. ------------------------- (1) From time to time the Company and any Lender (an "Increasing Lender") may agree, with the prior written consent of the Administrative 42 Agent, which consent shall not be unreasonably withheld or delayed, to permanently or temporarily increase such Increasing Lender's Maximum Commitment, the dollar amount of any such increase being subject to the limitations specified in the defined term "Aggregate Credit Limit". Any such increase shall be in the minimum dollar amount of, with respect to such Lender's Maximum Commitment, $5,000,000.00 and integral multiples of $5,000,000.00 in excess thereof. The Company, the Administrative Agent and the Increasing Lender shall agree upon the Adjustment Date for such increase and if such increase is a temporary rather than permanent increase, the date on which said increase shall terminate (the "Temporary Increase Termination Date"). (2) On the Adjustment Date for any increase in availability provided by an Increasing Lender and as a condition precedent thereto, the Company shall pay to the Administrative Agent for the benefit of such Increasing Lender the full amount of any fees due in respect of such increase, which fees shall be pro rated based upon the actual days from such Adjustment Date to the Maturity Date or the Temporary Increase Termination Date, as the case may be, and shall deliver to the Administrative Agent, the Collateral Agent and each Lender a revised Commitment Schedule and Allocation Notice specifying the Maximum Commitment, Maximum Tranche B Commitment, Tranche B Allocation, Tranche D Commitment (if any), Tranche A Percentage Share, Tranche B Percentage Share, and Tranche D Percentage Share, as applicable, for each of the Lenders from such Adjustment Date. Any reallocation of Loans outstanding on such Adjustment Date necessitated by an increase in an Increasing Lender's Maximum Commitment shall be effected on and as of such Adjustment Date by the purchase and sale among the Lenders of the Obligations outstanding on such date. (3) If said increase was a temporary rather than permanent increase, on the Temporary Increase Termination Date the aggregate amount of such Increasing Lender's Tranche A Percentage Share of Tranche A Loans outstanding, Tranche B Percentage Share of Tranche B Loans outstanding and/or Tranche D Percentage Share of Tranche D Loans outstanding in excess of its respective Maximum Commitment, Maximum Tranche B Commitment and/or Tranche D Commitment shall, if but only if at such Temporary Increase Termination Date there does not exist an Event of Default, be payable in full. If at such Temporary Increase Termination Date there exists an Event of Default, the temporary increase of the Increasing Lender shall continue in effect and, unless otherwise agreed by one hundred percent (100%) of the Lenders, shall be treated thereafter as a permanent increase in said Increasing Lender's Maximum Commitment. 15(l) Counterparts. This Agreement and the other Loan ------------ Documents may be executed in any number of counterparts, all of which together shall constitute one agreement. 15(m) Setoff; Sharing of Payments. Except as expressly --------------------------- provided in Paragraphs 2(e), 3(f) and 7(k) above prior to the occurrence of an Event of Default, and except as expressly provided in Paragraph 7(k) above following the occurrence and during the continuance of an Event of Default, if any Lender shall receive and retain any payment, whether by setoff, 43 application of deposit balance or security, or otherwise, in respect of the Obligations in excess of such Lender's Outstanding Percentage Share thereof, then such Lender shall purchase from the other Lenders for cash and at face value and without recourse, such participation in the Obligations held by them as shall be necessary to cause such excess payment to be shared ratably as aforesaid with each of them; provided, that if such excess payment or part thereof is thereafter recovered from such purchasing Lender, the related purchases from the other Lenders shall be rescinded ratably and the purchase price restored as to the portion of such excess payment so recovered, but without interest. Each Lender agrees to exercise any and all rights of setoff, counterclaim or bankers' lien first fully against the Obligations held by such Lender, and only then to any other Indebtedness of the Company to such Lender; provided, however, that to the extent any Lender has a right of set-off, counterclaim or bankers' lien which arises specifically out of a relationship of such Lender with the Company which is not related to the Obligations (excluding the relationship under the Servicing Secured Credit Agreement), such rights may be exercised first against any Indebtedness owing to such Lender arising out of such relationship and then against the Obligations held by such Lender. 15(n) Post Acceleration Adjustment. Following the occurrence ---------------------------- of an Event of Default and acceleration of the Obligations, the Lenders hereby absolutely and unconditionally agree to purchase or sell, as applicable, such participations in the Primary Loans outstanding as shall be required to assure that each Lender holds a percentage share of the principal amount of Primary Loans outstanding equal to its Aggregate Percentage Share. 15(o) Indemnification by the Company. ------------------------------ (1) In addition to the payment of expenses pursuant to Paragraph 11(g) above, whether or not the transactions contemplated hereby shall be consummated, the Company agrees to pay, and indemnify and hold harmless the Administrative Agent, the Collateral Agent and each Lender and any holder of any of the Obligations, and the shareholders, officers, directors, employees and agents of the Administrative Agent, the Collateral Agent, the Lenders and such holders (individually, an "Indemnitee" and collectively, the "Indemnitees") from and against, any and all other liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature whatsoever (including, without limitation, the reasonable fees and disbursements of counsel for any Indemnitee in connection with any investigative, administrative or judicial proceeding, whether or not such Indemnitee shall be designated a party thereto), which may be imposed on, incurred by, or asserted against such Indemnitee, in any manner relating to or arising out of (i) the use or intended use of the proceeds of Loans hereunder, or (ii) any of the Loan Documents or the transactions contemplated by the Loan Documents, (iii) any funding or proposed funding, or arrangements to obtain funding, made available or proposed to have been made available, to the Company, or (iv) any action taken or omitted to be taken by any such Indemnitee pursuant to the Loan Documents (collectively, the "Losses"); provided, however, that the Company shall not be liable for any Losses resulting directly from the gross negligence or willful misconduct of the applicable Indemnitee. Attorneys' fees and disbursements incurred in enforcing, or on appeal from, a judgment pursuant 44 hereto shall be recoverable separately from and in addition to any other amount included in such judgment, and this subparagraph is intended to be severable from the other provisions of this Agreement and to survive and not be merged into such judgment. (2) In the event that any Indemnitee asserts any Losses against the Company, such Indemnitee shall submit a proof of claim to the Company, and the Company shall promptly pay the full amount of such Losses in immediately available funds, or if such Losses have not yet been paid by such Indemnitee, such Indemnitee and the Company shall follow the procedures set forth in the next succeeding sentences of this subparagraph (2). If there is asserted any claim, liability or obligation that in the judgment of an Indemnitee may give rise to any Losses or if such Indemnitee determines the existence of the foregoing, whether or not the same shall have been asserted, such Indemnitee shall give the Company notice within thirty (30) Business Days in each case, of the assertion of any such claim, liability or obligation, or of receipt of notice of the filing or of any lawsuit based upon such assertion, or, with respect to a claim not yet asserted against such Indemnitee, of the determination by an executive officer of such Indemnitee of the existence of the same, and shall give Company a reasonable opportunity of assuming the defense of such claim, liability or obligation, using counsel acceptable to such Indemnitee; provided, however, that such Indemnitee shall have the right to participate in such defense, and to retain separate counsel. Failure by any Indemnitee to give timely notice pursuant to this subparagraph shall not relieve the Company of its obligations hereunder, except to the extent that the Company is actually prejudiced by such failure to give timely notice. No settlement or adjustment shall be made without the applicable Indemnitee's prior written consent, which consent will not be unreasonably withheld. If the Company fails to contest in good faith any such claim, liability or obligation, the applicable Indemnitee shall have the right to defend, settle or pay the same and pursue its remedies against the Company hereunder. Each Indemnitee shall cooperate with the Company in any such defense which the Company elects to assume in the event the Company makes such request to such Indemnitee and such request is reasonable, provided the Company will hold such Indemnitee harmless from all its out-of-pocket expenses, including attorneys' fees, incurred in connection with such cooperation. (3) The provisions of this Paragraph 15(o) shall survive the termination of this Agreement and payment of all other Obligations. Attorneys' fees and disbursements incurred in enforcing, or on appeal from, a judgment pursuant hereto shall be recoverable separately from and in addition to any other amount included in such judgment, and this Paragraph 15(o) is intended to be severable from the other provisions of this Agreement and to survive and not be merged into such judgment. 15(p) Confidentiality. Each of the Administrative Agent and --------------- each Lender agrees to take normal and reasonable precautions and exercise due care to maintain the confidentiality of all non-public information provided to it by the Company (or by the Administrative Agent on the Company's behalf) in connection with the Loan Documents. The Administrative Agent or any Lender may disclose such information: (1) at the request of any 45 Governmental Authority or in connection with an examination of the Administrative Agent or such Lender by any such Governmental Authority, (2) pursuant to subpoena or other court process, (3) when required to do so in accordance with the provisions of any Requirements of Law, (4) to the Administrative Agent's or such Lender's internal or independent auditors, counsel and other professional advisors, (5) if such information has become public other than through disclosure by the Administrative Agent or any Lender, (6) in connection with any litigation involving the Administrative Agent or any Lender, and (7) to any Affiliate of the Administrative Agent or such Lender. Notwithstanding the foregoing, the Company authorizes the Administrative Agent and each Lender to disclose to any Applicant Financial Institution or prospective or actual Participant such financial and other information in its possession (x) which has been delivered to the Administrative Agent and/or the Lenders pursuant to the Loan Documents or which has been delivered to any such Person by the Company prior to entering into the Loan Documents or (y) which is reasonably necessary to effectuate the purposes of this Agreement. 16. Definitions. For purposes of the Loan Documents, the terms set ----------- forth below shall have the following meanings: "Acceptable Manufactured Housing State" shall mean any state: (1) ------------------------------------- listed on a schedule of "Acceptable Manufactured Housing States" mutually agreed to by the Company and the Administrative Agent, with the consent of the Majority Lenders, from time to time, with the current such schedule attached hereto as Schedule II, and (2) as to which the Administrative Agent shall have received an - ----------- opinion of counsel to the Company in such state satisfactory in form and substance to the Lenders. "Acceptable State" shall mean any state listed on a schedule of ---------------- "Acceptable States" mutually agreed by the Company and the Administrative Agent, with the consent of the Majority Lenders, from time to time, with the current such schedule attached hereto as Schedule III. ------------ "Additional Lender Agreement" shall have the meaning given such term --------------------------- in Paragraph 15(h)(2)(iii) above. "Additional Required Documents" shall have the meaning given such term ----------------------------- in subparagraph (q)(2) of the definition of "Eligible Mortgage Loan." "Adjusted Tangible Net Worth" shall mean, at any date: --------------------------- (a) Effective Net Worth; plus (b) The lesser of (i) one percent (1.00%) of the Eligible Servicing Portfolio and (ii) the Quoted Market Value of the Eligible Servicing Portfolio; minus (c) All assets which would be classified as intangible assets under GAAP, including, without limitation, purchased and capitalized value of servicing rights, goodwill (whether representing the excess cost over book value of assets acquired or otherwise), 46 patents, trademarks, service marks, trade names, copyrights, franchises and deferred charges (including, without limitation, unamortized debt discount and expense, organization costs and research and product development costs). "Adjustment Date" shall mean, with respect to the assignment of --------------- Obligations by any Lender, or the addition of an Applicant Financial Institution as a Lender hereunder pursuant to Paragraph 15(h) above, or the increase in availability by an Increasing Lender pursuant to Paragraph 15(k) above, the effective date thereof. "Administrative Agent" shall have the meaning given such term in the -------------------- introductory paragraph hereof. "Affiliate" shall mean, as to any Person, any other Person directly or --------- indirectly controlling, controlled by or under direct or indirect common control with, such Person. "Control" as used herein means the power to direct the management and policies of such Person. "Agency Custodial Agreements" shall mean the FHLMC Custodial --------------------------- Agreement, the FNMA Custodial Agreement and the GNMA Custodial Agreement. "Agency Guide" shall mean the FHLMC Guide, the FNMA Guide or the GNMA ------------ Guide. "Agent" shall have the meaning given such term in Paragraph 14(a) ----- above. "Aggregate Credit Limit" shall mean the sum of the Maximum Commitments ---------------------- of all the Lenders, as set forth in the most recent Commitment Schedule and Allocation Notice delivered by the Administrative Agent to the Lenders and the Company, with the Aggregate Credit Limit on the Effective Date being $185,000,000.00; provided, however, that the Aggregate Credit Limit may be increased pursuant to Paragraph 15(h) or 15(k) above up to a maximum of $300,000,000.00 in the event any Lender or Lenders agree with the Company and the Administrative Agent to increase such Lender's or Lenders' Maximum Commitments and/or through the inclusion as a "Lender" hereunder of an Applicant Financial Institution approved by the Company and the Administrative Agent. "Aggregate Percentage Share" shall mean, for any Lender at any date, -------------------------- that percentage which (a) the dollar amount of such Lender's Maximum Commitment bears to (b) the Aggregate Credit Limit. "Agreement" shall mean this Agreement, as the same may be amended, --------- extended or replaced from time to time. "Applicable Eurodollar Rate" shall mean, with respect to any -------------------------- Eurodollar Loan for the Eurodollar Interest Period applicable to such Eurodollar Loan, the rate per annum (rounded upward, if necessary, to the next higher 1/16 of one percent (.06250%)) calculated in accordance with the following formula: 47 ER +ES ---- Eurodollar Rate = 1-ERP where ER = Eurodollar Rate ERP = Eurodollar Reserve Percentage ES = Eurodollar Spread "Applicable Federal Funds Rate" shall mean the Federal Funds Funding ----------------------------- Rate plus the Federal Funds Pricing Spread. "Applicant Financial Institution" shall have the meaning given such ------------------------------- term in Paragraph 15(h)(1) above. "Approved HELOC Investor" shall mean any Person pre-approved as such ----------------------- in writing by the Majority Lenders and which approval has not been revoked by the Majority Lenders in their sole discretion, any such revocation notice to be given no later than ten (10) days prior to its intended effective date; provided, however, than an Approved HELOC Investor shall be deemed to continue as such following such revocation as to any Collateral shipped to such Approved HELOC Investor by the Collateral Agent prior to or during such ten (10) day period. "Approved High LTV Investor" shall mean any Person pre-approved as -------------------------- such in writing by the Majority Lenders and which approval has not been revoked by the Majority Lenders in their sole discretion, any such revocation notice to be given no later than ten (10) days prior to its intended effective date; provided, however, than an Approved High LTV Investor shall be deemed to continue as such following such revocation as to any Collateral shipped to such Approved High LTV Investor by the Collateral Agent prior to or during such ten (10) day period. "Approved Investor" shall mean: FNMA, FHLMC, GNMA or any other Person ----------------- pre-approved as such in writing (which pre-approval may be limited in dollar amount, by type and otherwise) by the Majority Lenders and which approval has not been revoked by the Majority Lenders in their sole discretion, any such revocation notice to be given no later than ten (10) days prior to its intended effective date; provided, however, than an Approved Investor shall be deemed to continue as such following such revocation as to any Collateral shipped to such Approved Investor by the Collateral Agent prior to or during such ten (10) day period. "Approved Non-Agency Investor" shall mean any Person pre-approved as ---------------------------- such in writing by the Majority Lenders and which approval has not been revoked by the Majority Lenders in their sole discretion, any such revocation notice to be given no later than ten (10) days prior to its intended effective date; provided, however, than an Approved Non-Agency Investor shall be deemed to continue as such following such revocation as to any Collateral shipped to such Approved Non-Agency Investor by the Collateral Agent prior to or during such ten (10) day period. 48 "Approved Repo Lender" shall mean any Approved Investor or any other -------------------- Person pre-approved as such in writing by the Majority Lenders and which approval has not been revoked by the Majority Lenders in their sole discretion, any such revocation notice to be given no later than ten (10) days prior to its intended effective date. "Available Cash Proceeds" shall have the meaning given such term in ----------------------- Paragraph 7(k) above. "Book Net Worth" shall mean at any date consolidated net worth of the -------------- Company and its Subsidiaries determined in accordance with GAAP. "Borrowing Base" shall mean at any date all Eligible Mortgage Loans -------------- which have been designated by the Company for inclusion in the computation of the Collateral Value of the Borrowing Base, the Required Documents for which have been delivered to the Collateral Agent and have been reviewed and verified by the Collateral Agent as provided in Paragraph 5 of the Security Agreement (or, to the extent the Company is permitted to utilize Collateral Confirmation Agreements in connection with the delivery of Mortgage Loans to the Collateral Agent, which Mortgage Loans have been so designated on a duly executed Collateral Confirmation Agreement) and all cash in the Settlement Account (other than cash which will be transferred to the Settlement Account or distributed to the Lenders pursuant to Paragraph 7(k) above) on such date. "Borrowing Base Certificate" shall mean a certificate in the form of -------------------------- that attached hereto as Exhibit I. --------- "Business Day" shall mean any day other than a Saturday, a Sunday or a ------------ day on which banks in Los Angeles, California, Chicago, Illinois, or New York, New York are authorized or obligated to close their regular banking business. "Buy-Down Deposits" shall mean, with respect to any calendar month, ----------------- the average daily amount of free collected balances maintained in non-interest bearing accounts in the name of the Company (or held by the Company in trust for third parties) with a Tranche B Lender and/or the Tranche C Lender (after deducting float and balances required by such Lender under its normal practices to compensate such Lender for the maintenance of such accounts and taking into consideration reserve requirements (including but not limited to any FDIC premium) applicable to such accounts) and which balances are not included in determining "Buy-Down Deposits" or other similar classification under any other credit arrangements between such Lender and the Company. "Buy-Down Letter" shall mean a letter agreement (a) between the --------------- Company and each Tranche B Lender, individually, establishing the terms applicable to such Tranche B Lender's agreement to make Tranche B Loans hereunder, including fees, or (b) between the Company and the Tranche C Lender, establishing the terms under which the Buy-Down Rate may be applicable to Tranche C Loans hereunder. 49 "Buy-Down Rate" shall mean as to any Tranche B Loan or Tranche C Loan, ------------- such rate per annum as the Company and the Lender which agreed to advance such Tranche B Loan or Tranche C Loan shall have agreed. "Cash" shall mean the dollar amount of "Cash" of the Company set forth ---- in the most recent balance sheet of the Company. "Certificating Custodian" shall mean any Person, including, without ----------------------- limitation, the Collateral Agent, acting as the Company's "document custodian," "custodian" or "certificating custodian," as such terms are used in the applicable Agency Guide, for purposes of (a) certifying that the documentation relating to Mortgage Loans received by such Person from the Company (or the Collateral Agent) is complete and acceptable under the applicable Agency Guide for purposes of including such Mortgage Loan in a pool of Mortgage Loans in which Mortgage-Backed Securities will represent interests and (b) holding such documentation following formation of such pools and issuance of such Mortgage- Backed Securities. The Certificating Custodian shall at all times be party to the Agency Custodial Agreements. "Code" shall mean the Internal Revenue Code of 1986, as amended. ---- "Collateral" shall have the meaning given such term in Paragraph 4 of ---------- the Security Agreement. "Collateral Agent" shall have the meaning given such term in the ---------------- introductory paragraph hereof, or such other Person which may be designated as such in accordance with the terms of the Security Agreement. "Collateral Confirmation Agreement" shall have the meaning given such --------------------------------- term in subparagraph (q)(1) of the definition of "Eligible Mortgage Loan." "Collateral Value Determination" shall have the meaning given such ------------------------------ term in Paragraph 6 of the Security Agreement. "Collateral Value of the Borrowing Base" shall mean at any date (a) -------------------------------------- the sum of the Unit Collateral Values of all Eligible Mortgage Loans included in the Borrowing Base at such date, plus (b) without duplication, the total dollar amount of cash in the Settlement Account being held as cash collateral pursuant to Paragraph 7(k)(1) above. "Combined Percentage Shares" shall have the meaning given such term in -------------------------- Paragraph 2 of the Pledge Agreement. "Commitment Schedule and Allocation Notice" shall mean a notice in the ----------------------------------------- form of the Commitment Schedule and Allocation Notice in effect on the Effective Date attached hereto as Schedule IV. ----------- 50 "Commonly Controlled Entity" of a Person shall mean a Person, whether -------------------------- or not incorporated, which is under common control with such Person within the meaning of Section 414(c) of the Code. "Company" shall have the meaning given such term in the introductory ------- paragraph hereof. "Contractual Obligation" as to any Person shall mean any provision of ---------------------- any security issued by such Person or of any agreement, instrument or undertaking to which such Person is a party or by which it or any of its property is bound. "Corporate Base Rate" shall mean a rate per annum equal to the ------------------- corporate base rate of interest publicly announced by FNBC from time to time, changing when and as said corporate base rate changes. "Current Ratio" shall mean at any date the ratio of current assets to ------------- current liabilities of the Company and its Subsidiaries, determined on a consolidated basis in accordance with GAAP; provided, however, that in determining the Company's current assets for purposes hereof, the aggregate outstanding principal amount of all loans and advances outstanding to officers and employees of the Company and its Subsidiaries shall be excluded. "Current Weighted Average Take-Out Price" shall mean on any date the --------------------------------------- Weighted Average Take-Out Price shown on the certificate most recently delivered by the Company to the Administrative Agent as provided in Paragraph 11(b)(5) above, unless otherwise agreed in writing by the Majority Lenders, the Administrative Agent and the Collateral Agent. "Effective Date" shall mean the date on which all of the conditions -------------- set forth in Paragraph 9(a) above are satisfied and the initial Loans shall be funded. "Effective Net Worth" shall mean at any date, as to the Company and ------------------- its Subsidiaries, (a) Book Net Worth (including the value of excess servicing net of reserves), minus (b) the aggregate outstanding principal amount of all loans and advances outstanding to officers and employees of the Company and its Subsidiaries, plus (c) the aggregate outstanding principal amount of all Subordinated Debt, minus (d) the capitalized value of the Company's servicing portfolio, minus (e) fifteen percent (15%) of the aggregate unpaid principal balance of all Mortgage Loans held by the Company for long-term investment purposes, all determined on a consolidated basis in accordance with GAAP. "Eligible Conforming Mortgage Loan" shall mean a Mortgage Loan with --------------------------------- respect to which each of the following is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan but not an Eligible Shipped Mortgage Loan; 51 (b) Said Mortgage Loan is secured by a first priority deed of trust (or mortgage) on the related Property; (c) Said Mortgage Loan is insured by the FHA, guaranteed by the VA (or subject to a binding commitment to issue such insurance or guarantee) and/or conforms to all underwriting and other requirements of FNMA or FHLMC; (d) Said Mortgage Loan is not an Eligible Gestation Mortgage Loan; and (e) Said Mortgage Loan has not been included in the Borrowing Base for more than one hundred twenty (120) days; provided, however, that if said Mortgage Loan has previously been included in the Borrowing Base as an Eligible Manufactured Housing Mortgage Loan, said Mortgage Loan has not been included in the Borrowing Base as an Eligible Conforming Mortgage Loan for more than one hundred twenty (120) days. "Eligible Gestation Mortgage Loan" shall mean a Mortgage Loan with -------------------------------- respect to which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan meets all of the requirements in the definition of Eligible Conforming Mortgage Loan (except the requirement set forth in subparagraph (d) of such definition) and was included in the Borrowing Base as an Eligible Conforming Mortgage Loan prior to its inclusion as an Eligible Gestation Mortgage Loan; and (b) The documentation relating to said Mortgage Loan has been certified, on the Business Day immediately preceding the date said Mortgage Loan is to be included in the Borrowing Base as an Eligible Gestation Mortgage Loan (or at the sole discretion of the Collateral Agent, on the same Business Day said Mortgage Loan is to be included in the Borrowing Base as an Eligible Gestation Mortgage Loan), by a Certificating Custodian as complete and acceptable under the applicable Agency Guide for purposes of including said Mortgage Loan in a pool of Mortgage Loans in which a Mortgage-Backed Security will represent an interest. "Eligible HELOC Asset" shall mean a Mortgage Loan with respect to -------------------- which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan; (b) Said Mortgage Loan is secured by a first or second priority deed of trust (or mortgage) on the related Property; 52 (c) Said Mortgage Loan has not been previously included in the Borrowing Base; (d) Said Mortgage Loan is not a graduated payment Mortgage Loan and the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible HELOC Assets included in the Borrowing Base, does not exceed twenty percent (20%) of the Aggregate Credit Limit; (e) Said Mortgage Loan does not have a Loan-to-Value Ratio of greater than one hundred percent (100%); (f) Said Mortgage Loan has not been included in the Borrowing Base for more than one hundred twenty (120) days; (g) If the face amount of the promissory note relating to said Mortgage Loan is greater than $100,000, then the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other such Eligible HELOC Assets included in the Borrowing Base, does not exceed five percent (5%) of the Aggregate Credit Limit; (h) If the Loan-to-Value Ratio of said Mortgage Loan is greater than ninety percent (90%), then the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other such Eligible HELOC Assets included in the Borrowing Base, does not exceed six percent (6%) of the Aggregate Credit Limit; (i) (1) If the face amount of the promissory note relating to said Mortgage Loan plus the principal amount outstanding under the first priority deed of trust (or mortgage) on the related Property is greater than $300,000.00 but less than $650,000.00, then the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other such Eligible HELOC Assets included in the Borrowing Base, does not exceed ten percent (10%) of the Aggregate Credit Limit, and (2) if the face amount of the promissory note relating to said Mortgage Loan plus the principal amount outstanding under the first priority deed of trust (or mortgage) on the related Property is equal to or greater than $650,000.00 but less than $1,000,000.00, then the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other such Eligible HELOC Assets included in the Borrowing Base, does not exceed three percent (3%) of the Aggregate Credit Limit; and (j) Said Mortgage Loan generally conforms to all underwriting and other requirements of an Approved HELOC Investor. "Eligible High LTV Mortgage Loan" shall mean a Mortgage Loan with ------------------------------- respect to which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): 53 (a) Said Mortgage Loan is an Eligible Mortgage Loan; (b) The Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible High LTV Mortgage Loans included in the computation of the Collateral Value of the Borrowing Base, does not exceed five percent (5%) of the Aggregate Credit Limit; (c) Said Mortgage Loan is secured by a first or second priority deed of trust (or mortgage) on the related Property; (d) Said Mortgage Loan does not have a Loan-to-Value Ratio of greater than one hundred twenty-five percent (125%); (e) The Obligor on said Mortgage Loan had a FICO score of not less than 680 or, if the Obligor on said Mortgage Loan had a FICO score of less than 680, the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible High LTV Mortgage Loans the Obligor on which had a FICO score of less than 680 included in the computation of the Collateral Value of the Borrowing Base does not exceed one half of one percent (0.50%) of the Aggregate Credit Limit; (f) Said Mortgage Loan has not been included in the Borrowing Base for more than forty-five (45) days; (g) The original principal balance of said Mortgage Loan did not exceed $75,000.00; and (h) Said Mortgage Loan generally conforms to all underwriting and other requirements of an Approved High LTV Investor and, in addition, if the Obligor on said Mortgage Loan had a FICO score of less than 680, said Mortgage Loan generally conforms to all underwriting standards of FNMA or FHLMC. "Eligible Manufactured Housing Mortgage Loan" shall mean a Mortgage ------------------------------------------- Loan with respect to which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan; (b) Said Mortgage Loan is secured by a first priority deed of trust (or mortgage) on the related Property; (c) Said Mortgage Loan has not been previously included in the Borrowing Base; 54 (d) The face amount of the promissory note underlying said Mortgage Loan, when added to the face amount of all promissory notes underlying all other Eligible Manufactured Housing Mortgage Loans included in the Borrowing Base, does not exceed ten percent (10%) of the Aggregate Credit Limit; (e) Said Mortgage Loan does not have a Loan-to-Value Ratio of greater than ninety-seven percent (97%); (f) Said Mortgage Loan has not been included in the Borrowing Base for more than one hundred fifty (150) days; (g) The face amount of the promissory note underlying said Mortgage Loan does not exceed the maximum principal amount allowed by FNMA, FHLMC or FHA and VA, as applicable, and the proceeds of said Mortgage Loan are utilized by the related Obligor to facilitate the permanent attachment of a new Manufactured Home on the related Property; (h) All work required to be done in accordance with the timeframe set forth in the related construction loan agreement has been and will be completed on time and in conformance with all required specifications and standards necessary to allow a certificate of occupancy to be issued for the completed Manufactured Home on or before the completion date set forth in the related construction loan agreement; (i) The Property securing said Mortgage Loan is located in an Acceptable Manufactured Housing State; (j) Upon completion and attachment of the related Manufactured Home to the related Property, said Mortgage Loan will meet all underwriting and other criteria for purchase by FNMA, FHLMC or FHA and VA, as applicable, under the Take-Out Commitment relating to said Mortgage Loan; (k) The Manufactured Home financed with the proceeds of said Mortgage Loan is a new Manufactured Home which has not previously been financed; (l) The Company has advanced the Required Manufactured Housing Mortgage Loan Disbursement for said Mortgage Loan; and (m) All actions required to create a valid and enforceable first priority perfected security interest in and lien upon said Mortgage Loan, the related Manufactured Home, the related Property and all documents and instruments relating to said Mortgage Loan, in favor of the Collateral Agent for the benefit of the Lenders, have been taken. "Eligible Mortgage Loan" shall mean a Mortgage Loan with respect to ---------------------- which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): 55 (a) Said Mortgage Loan is a binding and valid obligation of the Obligor thereon, in full force and effect and enforceable in accordance with its terms; (b) Said Mortgage Loan is genuine in all respects as appearing on its face and as represented in the books and records of the Company, and all information set forth therein is true and correct; (c) Except to the extent permitted under subparagraph (d) below, said Mortgage Loan is free of any default of any party thereto (including the Company), counterclaims, offsets and defenses and from any rescission, cancellation or avoidance, and all right thereof, whether by operation of law or otherwise; (d) Unless said Mortgage Loan is an Eligible Manufactured Housing Mortgage Loan no payment under said Mortgage Loan is more than thirty (30) days past due the payment due date set forth in the underlying promissory note and deed of trust (or mortgage) and if said Mortgage Loan is an Eligible Manufactured Housing Mortgage Loan no payment under said Mortgage Loan is past due the payment due date set forth in the underlying promissory note and deed of trust (or mortgage); (e) Said Mortgage Loan contains the entire agreement of the parties thereto with respect to the subject matter thereof, has not been modified or amended in any respect and is free of concessions or understandings with the Obligor thereon of any kind not expressed in writing therein; (f) Said Mortgage Loan is in all respects as required by and in accordance with all applicable laws and regulations governing the same, including, without limitation, the federal Consumer Credit Protection Act and the regulations promulgated thereunder and all applicable usury laws and restrictions, and all notices, disclosures and other statements or information required by law or regulation to be given, and any other act required by law or regulation to be performed, in connection with said Mortgage Loan have been given and performed as required; (g) All advance payments and other deposits on said Mortgage Loan, which are represented as actually paid by the Obligor thereon, have been paid in cash, and no part of said sums has been loaned, directly or indirectly, by the Company to the Obligor thereon and, other than as disclosed to the Administrative Agent in writing, there have been no prepayments on said Mortgage Loan; (h) At all times said Mortgage Loan is free and clear of all Liens, except in favor of the Lenders; (i) The Property covered by said Mortgage Loan is insured against loss or damage by fire and all other hazards normally included within standard extended coverage in accordance with the provisions of said Mortgage Loan with the Company named as a loss payee thereon; 56 (j) The Property covered by said Mortgage Loan is free and clear of all Liens except in favor of the Company subject only to (1) the Lien of current real property taxes and assessments not yet due and payable; (2) covenants, conditions and restrictions, rights of way, easements and other matters of the public record, as of the date of recording, as are acceptable to mortgage lending institutions generally and specifically referred to in a lender's title insurance policy delivered to the originator of said Mortgage Loan and (i) referred to or otherwise considered in the appraisal made for the originator of said Mortgage Loan or (ii) which do not materially adversely affect the appraised value of such Property as set forth in such appraisal; (3) other matters to which like properties are commonly subject which do not materially interfere with the benefits of the security intended to be provided by said Mortgage Loan or the use, enjoyment, value or marketability of the related Property; and (4) a prior first Lien to the extent said Mortgage Loan is an Eligible HELOC Asset or an Eligible High LTV Mortgage Loan; (k) If said Mortgage Loan has been withdrawn from the possession of the Collateral Agent on terms and subject to conditions set forth in the Security Agreement: (1) If said Mortgage Loan was withdrawn by the Company for purposes of correcting clerical or other non-substantive documentation problems: (i) the promissory note and other documents relating to said Mortgage Loan were returned to the Collateral Agent within ten (10) calendar days from the date of withdrawal, (ii) said Mortgage Loan was released to the Company pursuant to the trust receipt procedure described in Paragraph 6 of the Security Agreement, and (iii) the Unit Collateral Value of said Mortgage Loan when added to the Unit Collateral Values of all other Mortgage Loans included in the Borrowing Base which have been similarly released to the Company does not exceed $1,000,000.00; (2) If said Mortgage Loan was shipped by the Collateral Agent directly to a permanent investor for purchase, the full purchase price therefor has been received by the Collateral Agent (or said Mortgage Loan has been returned to the Collateral Agent) within forty-five (45) days from the date of shipment by the Collateral Agent; provided, however, that if such permanent investor is FHLMC, FNMA or GNMA, then the purchase price therefor has been received by the Collateral Agent (or said Mortgage Loan has been returned to the Collateral Agent) within sixty (60) days from the date of shipment by the Collateral Agent; and (3) If said Mortgage Loan was shipped by the Collateral Agent directly to a custodian for purposes of formation of a pool supporting a Warehouse-Related MBS, the Warehouse-Related MBS is issued and sold and the purchase price therefor has been received by the Collateral Agent (or said Mortgage Loan has been returned to the Collateral Agent) within forty-five (45) days from the date of shipment by the Collateral Agent; provided, however, that if the guarantor or issuer of such Warehouse-Related MBS is GNMA, FNMA or FHLMC, then the purchase price therefor has been received by the Collateral Agent (or said Mortgage Loan has been returned to 57 the Collateral Agent) within sixty (60) days from the date of shipment by the Collateral Agent; (l) Unless said Mortgage Loan is an Eligible Manufactured Housing Mortgage Loan, said Mortgage Loan is covered by a Take-Out Commitment which is in full force and effect, the Company and said Mortgage Loan are in full compliance therewith and, if such Take-Out Commitment constitutes a delivery commitment, such Take-Out Commitment is for a price not less than the Take-Out Commitment under which the Unit Collateral Value of said Mortgage Loan was originally determined, or said Mortgage Loan is subject to a Hedging Program; provided, however, that if said Mortgage Loan is an Eligible Manufactured Housing Mortgage Loan, then upon completion and permanent attachment of the related Manufactured Home to the related Property, said Mortgage Loan is covered by a Take-Out Commitment which is in full force and effect and the Company and said Mortgage Loan are in full compliance therewith; (m) The date of the underlying promissory note is no earlier than one hundred eighty (180) days prior to the date said Mortgage Loan is first included in the Borrowing Base; provided, however, that if the date of the underlying promissory note is earlier than sixty (60) days prior to the date said Mortgage Loan is first included in the Borrowing Base, the Unit Collateral Value of said Mortgage Loan when added to the Unit Collateral Values of all other such Mortgage Loans included in the computation of the Collateral Value of the Borrowing Base, does not exceed one percent (1%) of the Aggregate Credit Limit and, provided further, that if said Mortgage Loan is an Eligible Repurchase Mortgage Loan, the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible Repurchase Mortgage Loans included in the Borrowing Base with a note date earlier than sixty (60) days prior to the date such other Eligible Repurchase Mortgage Loans were first included in the Borrowing Base, does not exceed $1,000,000.00; (n) If said Mortgage Loan is FHA insured or VA guaranteed, such insurance or guaranty (or a binding commitment to issue such insurance or guaranty) is in full force and effect; (o) The Property securing said Mortgage Loan is located in an Acceptable State; (p) The improvements on the related Property consist of a completed one-to-four family residence; provided, however, that if said Mortgage Loan is an Eligible Manufactured Housing Mortgage Loan, then upon completion and permanent attachment of the related Manufactured Home, the improvements on the related Property shall consist of a completed one-to-four family residence; (q) There has been delivered to the Collateral Agent for said Mortgage Loan: (1) Those items described on Exhibit J attached hereto (the --------- "Required Documents") prior to the inclusion of said Mortgage Loan in the Borrowing 58 Base or, if such items have not been delivered to the Collateral Agent, (i) the Collateral Agent has received an agreement in the form of that attached hereto as Exhibit K (a "Collateral Confirmation Agreement") relating to --------- said Mortgage Loan on or prior to the date said Mortgage Loan is first included in the Borrowing Base, (ii) such items are received by the Collateral Agent within eight (8) Business Days after said Mortgage Loan is first included in the Borrowing Base, (iii) the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Mortgage Loans included in the computation of the Collateral Value of the Borrowing Base for which the Required Documents have not been received by the Collateral Agent, does not exceed (x) during the period from the fifth Business Day preceding the last day of each calendar month to and including the fifth Business Day of the next calendar month, thirty percent (30%) of the Aggregate Credit Limit and (y) at all other times, twenty percent (20%) of the Aggregate Credit Limit; and (iv) if the Required Documents for said Mortgage Loan are received by the Collateral Agent later than five (5) Business Days after said Mortgage Loan is first included in the Borrowing Base, the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Mortgage Loans included in the computation of the Collateral Value of the Borrowing Base for which the Required Documents are received by the Collateral Agent later than five (5) Business Days after said Mortgage Loan is first included in the Borrowing Base, does not exceed $5,000,000.00; (2) If the Collateral Agent has so requested in writing, the additional items described on Exhibit L attached hereto (the "Additional --------- Required Documents"); and (3) If said Mortgage Loan is to be included in the Borrowing Base as an Eligible Gestation Mortgage Loan, a FHLMC Custodial Certification Schedule (Form 1034), a FNMA Schedule of Mortgages (Form 2005) or a GNMA Schedule of Pooled Mortgages (HUD Form 11706) (or any comparable or successor form thereto) listing said Mortgage Loan as a Mortgage Loan to be pooled in a Mortgage-Backed Security, in each case completed and duly executed by a Certificating Custodian on or prior to the inclusion of said Mortgage Loan in the Borrowing Base as an Eligible Gestation Mortgage Loan; provided, however, that the Collateral Agent may accept such other evidence satisfactory to it in its sole discretion, including, without limitation, FHLMC's "Contract Delivery Status" report, in lieu of an executed FHLMC Custodial Certification Schedule (Form 1034) for the purpose of including said Mortgage Loan in the Borrowing Base as an Eligible Gestation Mortgage Loan; (r) The Collateral Agent has had an opportunity to review for said Mortgage Loan the items delivered to the Collateral Agent referred to in subparagraph (q) above; (s) Said Mortgage Loan is not subject to any servicing arrangement with any Person other than the Company nor are any servicing rights relating to said Mortgage Loan subject to any Lien, claim, interest or negative pledge in favor of any Person, except for subservicing arrangements approved by the Majority Lenders; 59 (t) Unless said Mortgage Loan is an Eligible High LTV Mortgage Loan, the appraisal obtained by the Company in connection with the origination of said Mortgage Loan satisfies all appraisal requirements under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 for similar loans originated by federally insured depository institutions and if said Mortgage Loan is an Eligible High LTV Mortgage Loan: (1) the appraisal obtained by the Company in connection with the origination of said Mortgage Loan is in a form customarily required as a matter of prudent industry practice for similar Mortgage Loans and (2) in any event, the Company is not relying on the value of the underlying Property as the source of repayment of said Mortgage Loan; (u) The Loan-to-Value Ratio of said Mortgage Loan does not exceed the following limits: (i) if said Mortgage Loan is a No-Equity Mortgage Loan or an Eligible HELOC Asset, one hundred percent (100%); (ii) if said Mortgage Loan is an Eligible Conforming Mortgage Loan subject to a Take-Out Commitment from FNMA covering said Mortgage Loan, or if said Mortgage Loan is an Eligible Manufactured Housing Mortgage Loan, ninety-seven percent (97%); (iii) if said Mortgage Loan is an Eligible High LTV Mortgage Loan, one hundred twenty-five percent (125%), (iv) if said Mortgage Loan is an Eligible Non-Agency Mortgage Loan, ninety percent (90%) and (v) in all other cases, ninety-five percent (95%); (v) If said Mortgage Loan has a Loan-to-Value Ratio greater than eighty percent (80%) and: (i) is not an Eligible HELOC Asset, (ii) is not subject to a commitment by the VA or FHA to guarantee or insure repayment thereof, and (iii) is not to be included in the Borrowing Base as an Eligible Non-Agency Mortgage Loan, then said Mortgage Loan is covered by a policy of private mortgage insurance acceptable to FNMA or the Approved Investor issuing the Take-Out Commitment for said Mortgage Loan; and (w) Said Mortgage Loan is included in the Borrowing Base as only one Type of Mortgage Loan. In determining the eligibility of any Mortgage Loan, any of the requirements for eligibility (other than the requirements contained in subparagraphs (h), (i), (l), (n), (o) and (p) above) may be waived by the Administrative Agent in its sole discretion (with such waiver to be expressly given by the Administrative Agent to the Collateral Agent and notice of such waiver to be given by the Collateral Agent to all Lenders in the next collateral report provided to the Lenders pursuant to Paragraph 8 of the Security Agreement if such waiver is in force on the date of such collateral report); provided, however, that any Mortgage Loan which is accepted by the Administrative Agent as an Eligible Mortgage Loan pursuant to such waiver (an "Eligible Waiver Mortgage Loan") shall cease to be an Eligible Waiver Mortgage Loan upon written notice of the retraction of such waiver given to the Company by the Administrative Agent unless at the time of giving such notice the deficiency which originally required such waiver has been cured and such Eligible Waiver Mortgage Loan meets all other requirements for an Eligible Mortgage Loan; provided further, that the Unit Collateral Value of any Mortgage Loan accepted by the Administrative Agent as an Eligible Waiver Mortgage Loan, when added to the Unit Collateral Values of all other Eligible Waiver Mortgage Loans accepted by the Administrative Agent, does not exceed $10,000,000.00. Notwithstanding anything set forth herein, the Administrative Agent 60 may grant temporary waivers of strict compliance by the Company with the eligibility requirements regarding qualification of Mortgage Loans as Eligible Mortgage Loans or with any lending or Borrowing Base sublimits set forth herein when the Administrative Agent deems it appropriate, in its sole discretion, up to any amount for up to three (3) Business Days, if the satisfaction of such eligibility requirements or sublimits cannot be independently determined because of events beyond the reasonable control of the Company (i.e. natural disasters, transmission failures, etc.), provided that, if such determination cannot be made for more than one (1) Business Day, the Company certified in writing that all such eligibility requirements and sublimits are in fact satisfied. "Eligible Non-Agency Mortgage Loan" shall mean a Mortgage Loan with --------------------------------- respect to which each of the following is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan but not an Eligible Shipped Mortgage Loan, and if said Mortgage Loan has a Loan-to-Value Ratio greater than eighty-five percent (85%), said Mortgage Loan is covered by a policy of private mortgage insurance acceptable to the Approved Non-Agency Investor issuing the Take-Out Commitment for said Mortgage Loan; (b) Said Mortgage Loan is secured by a first priority deed of trust (or mortgage) on the related Property; (c) Said Mortgage Loan does not conform to the underwriting or other criteria for purchase by FNMA or FHLMC; (d) Said Mortgage Loan has not been previously included in the Borrowing Base; (e) Said Mortgage Loan is covered by a Take-Out Commitment under which said Mortgage Loan will be sold to the Approved Non-Agency Investor issuing such Take-Out Commitment on a non-recourse basis; (f) Said Mortgage Loan has been expressly pre-approved in writing by the Approved Non-Agency Investor issuing the Take-Out Commitment for said Mortgage Loan, or is underwritten by the Company pursuant to delegated underwriting authority granted to the Company by the Approved Non-Agency Investor issuing such Take-Out Commitment; (g) Said Mortgage Loan has not been included in the Borrowing Base for more than one hundred and twenty (120) days; and (h) The Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible Non-Agency Mortgage Loans, does not exceed fifteen percent (15%) of the Aggregate Credit Limit. 61 "Eligible Non-Conforming Mortgage Loan" shall mean a Mortgage Loan ------------------------------------- with respect to which each of the following is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan but not an Eligible Shipped Mortgage Loan; (b) Said Mortgage Loan is secured by a first priority deed of trust (or mortgage) on the related Property; (c) Said Mortgage Loan generally conforms to all underwriting and other requirements of FNMA or FHLMC with respect to credit quality, and otherwise conforms in all material respects to all underwriting and other requirements of the applicable Approved Investor; (d) Said Mortgage Loan has not been included in the Borrowing Base for more than: (1) if said Mortgage Loan has an original principal balance not in excess of $650,000.00, one hundred twenty (120) days; and (2) if said Mortgage Loan has an original principal balance in excess of $650,000.00, ninety (90) days; (e) If said Mortgage Loan had an original principal balance in excess of $650,000.00, said Mortgage Loan has been pre-approved in writing by an Approved Investor as acceptable for purchase under its Take-Out Commitment or, if an Approved Investor has granted the Company written delegated underwriting authority as to said Mortgage Loan, said Mortgage Loan complies with the underwriting standards specified by such Approved Investor; (f) If said Mortgage Loan had an original principal balance in excess of $650,000.00, the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Value of all other Eligible Non-Conforming Mortgage Loans with an original principal balance in excess of $650,000.00 included in the Borrowing Base, does not exceed ten percent (10%) of the Aggregate Credit Limit; (g) If said Mortgage Loan had an original principal balance in excess of $1,000,000.00 but less than $1,750,000.00, the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible Non-Conforming Mortgage Loans with an original principal balance in excess of $1,000,000.00 but less than $1,750,000.00 included in the Borrowing Base, does not exceed five percent (5%) of the Aggregate Credit Limit; (h) If said Mortgage Loan had an original principal balance in excess of $1,750,000.00, the Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible Non-Conforming Mortgage Loans with an original principal balance in excess of $1,750,000.00 included in the Borrowing Base, does not exceed three and one-half percent (3.5%) of the Aggregate Credit Limit; and 62 (i) The original principal balance of said Mortgage Loan does not exceed $3,000,000.00. "Eligible Repurchase Mortgage Loan" shall mean a Mortgage Loan with --------------------------------- respect to which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan but not an Eligible Shipped Mortgage Loan; (b) Said Mortgage Loan has been rejected for purchase by an Approved Investor or has been repurchased from an Approved Investor; (c) Said Mortgage Loan has not been included in the Borrowing Base for more than two hundred and seventy (270) days; and (d) The Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible Repurchase Mortgage Loans, does not exceed the lesser of: (i) $10,000,000.00 and (ii) five percent (5%) of the Aggregate Credit Limit. "Eligible Servicing Portfolio" shall mean the Company's mortgage/trust ---------------------------- deed servicing portfolio, exclusive of the following: (a) any servicing of Mortgage Loans owned by the Company, (b) any servicing performed pursuant to subservicing arrangements (other than that technically styled as subservicing but performed under a contract directly between the Company and FNMA, FHLMC or the master servicer under a private mortgage-related security program), (c) any servicing of Mortgage Loans which the Company has a direct obligation to repurchase from the applicable investor pursuant to a recourse arrangement, (d) any servicing subject to any Lien (other than the Liens in favor of the "Collateral Agent" for the benefit of the "Lenders" under the Servicing Secured Credit Agreement), (e) any servicing of Mortgage Loans in foreclosure or the payments in respect of which are past due more than sixty (60) days, and (f) any servicing of Mortgage Loans which are not first priority Mortgage Loans and which have an aggregate outstanding principal balance in excess of $350,000,000.00. "Eligible Shipped Mortgage Loan" shall mean a Mortgage Loan with ------------------------------ respect to which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan; and 63 (b) Said Mortgage Loan has been shipped by the Collateral Agent pursuant to a bailee letter directly to an Approved Investor for purchase and the purchase price therefor has not yet been received by the Collateral Agent. "Eligible Waiver Mortgage Loan" shall have the meaning given such term ----------------------------- in the last paragraph of the defined term "Eligible Mortgage Loan." "Encumbered Eligible Servicing Portfolio" shall mean that portion of --------------------------------------- the Eligible Servicing Portfolio consisting of all now existing and hereafter arising rights of the Company to service, collect and administer Mortgage Loans under all servicing contracts pledged from time to time as collateral security under the Servicing Secured Credit Agreement and the "Security Agreement" in connection therewith. "ERISA" shall mean the Employee Retirement Income Security Act of ----- 1974, as the same may from time to time be supplemented or amended. "ERISA Affiliate" shall mean, with respect to any Person, any trade or --------------- business (whether or not incorporated) that is a member of the group of which such Person is a member and which is treated as a single employer under Section 414 of the Code and the rules and regulations thereunder in effect from time to time. "Eurodollar Business Day" shall mean a Business Day on which ----------------------- commercial banks in London, England are open for domestic and international business. "Eurodollar Interest Period" shall mean with respect to any Eurodollar -------------------------- Loan, the period commencing on the date advanced and ending fourteen days, one month, two months or three months thereafter, as designated in the related Loan Request; provided, however, that (a) any Eurodollar Interest Period which would otherwise end on a day which is not a Eurodollar Business Day shall be extended to the next succeeding Eurodollar Business Day unless by such extension it would fall in another calendar month, in which case such Eurodollar Interest Period shall end on the immediately preceding Eurodollar Business Day; (b) any one- month, two-month or three-month Eurodollar Interest Period which begins on a day for which there is no numerically corresponding day in the calendar month during which such Eurodollar Interest Period is to end shall, subject to the provisions of clause (a) hereof, end on the last day of such calendar month; and (c) no Eurodollar Interest Period shall extend beyond the Maturity Date. "Eurodollar Loans" shall mean Tranche A Loans during such time as they ---------------- are being maintained at a rate of interest based upon the Eurodollar Rate. "Eurodollar Rate" shall mean: (a) with respect to any fourteen-day --------------- Eurodollar Interest Period, the rate determined by the Administrative Agent as the rate at which deposits in immediately available U.S. dollars in an amount equal to the aggregate amount of Eurodollar Loans proposed to be subject to such rate having a maturity approximately equal to such Eurodollar Interest Period are offered by FNBC to first-class banks in the interbank market at or about 10:00 a.m. (Chicago time) two Eurodollar Business Days prior to the first day of such Eurodollar Interest Period, for delivery on the first day of such Eurodollar Interest Period, or (b) 64 with respect to any one-month, two-month or three-month Eurodollar Interest Period, the rate at which deposits in immediately available U.S. dollars in an amount equal to the aggregate amount of Eurodollar Loans proposed to be subject to such rate and having a maturity approximately equal to such Eurodollar Interest Period are offered by FNBC to first-class banks in the London interbank market at approximately 11:00 a.m. (London time) two Eurodollar Business Days prior to the first day of such Eurodollar Interest Period, for delivery on the first day of such Eurodollar Interest Period. "Eurodollar Reserve Percentage" shall mean for any day, that ----------------------------- percentage, expressed as a decimal, which is in effect on such day, as specified by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum aggregate reserve requirement (including all basic, supplemental, marginal and other reserves) which is imposed on eurocurrency liabilities. "Eurodollar Spread" shall mean three-quarters of one percent (0.75%). ----------------- "Event of Default" shall have the meaning set forth in Paragraph 13 ---------------- above. "Existing Credit Agreement" shall have the meaning given such term in ------------------------- Recital A above. "Existing Security Agreement" shall have the meaning given such term --------------------------- in Paragraph 8(a) above. "Fair Market Value" shall mean at any date with respect to any ----------------- Mortgage Loan, the market price for thirty (30) day mandatory future delivery of such Mortgage Loan quoted by Telerate or, if not so quoted, the bid price quoted in writing to the Administrative Agent as of the computation date by any two nationally recognized dealers selected by the Administrative Agent who at the time are making a market in similar Mortgage Loans, multiplied, in any case, by the par amount thereof. "Fair Market Value of the Borrowing Base" shall mean at any date (a) --------------------------------------- the sum of the Fair Market Values of all Eligible Mortgage Loans included in the Borrowing Base at such date, plus (b) without duplication, the total dollar amount of cash in the Settlement Account being held as cash collateral pursuant to Paragraph 7(k)(1) above. "Federal Funds Funding Rate" shall mean for any Federal Funds Rate -------------------------- Loan on any day such Federal Funds Rate Loan is outstanding, the rate per annum equal to the consensus (or if no consensus exists, the arithmetic average) of the rates at which reserves are offered by first-class banks to other first- class banks at approximately 10:00 a.m. (Chicago time) on such day (or if such day is not a Business Day, on the immediately preceding Business Day) on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, received by the Administrative Agent from three Federal funds brokers of recognized standing selected by the Administrative Agent in its sole discretion. 65 "Federal Funds Pricing Spread" shall mean: (a) for any Tranche A Loan ---------------------------- maintained as a Federal Funds Rate Loan, seven-eighths of one percent (0.875%), and (b) for any Tranche D Loan, one-half of one percent (0.50%). "Federal Funds Rate Loans" shall mean Tranche A Loans and Tranche D ------------------------ Loans during such time as they are being maintained at the Applicable Federal Funds Rate. "FHA" shall mean the Federal Housing Administration and any successor --- agency. "FHLMC" shall mean the Federal Home Loan Mortgage Corporation and any ----- successor agency. "FHLMC Custodial Agreement" shall mean the agreement, as amended, ------------------------- modified or supplemented from time to time, among FHLMC, the Company and any Person meeting the eligibility requirements set forth in the FHLMC Guide to serve as a "custodian," as such term is used in the FHLMC Guide, pursuant to which such Person is authorized to act as a Certificating Custodian. "FHLMC Guide" shall mean the "Sellers & Servicers' Guide" published by ----------- FHLMC, as amended, modified or supplemented from time to time. "FNBC" shall have the meaning given such term in the introductory ---- paragraph hereof. "FNMA" shall mean the Federal National Mortgage Association and any ---- successor agency. "FNMA Custodial Agreement" shall mean the agreement, as amended, ------------------------ modified or supplemented from time to time, among FNMA, the Company and any Person meeting the eligibility requirements set forth in the FNMA Guide to serve as a "document custodian," as such term is used in the FNMA Guide, pursuant to which such Person is authorized to act as a Certificating Custodian. "FNMA Guide" shall mean, collectively, the "Selling Guide" and the ---------- "Servicing Guide" published by FNMA, as amended, modified or supplemented from time to time. "Funding Account" shall mean Account No. 5268192 maintained in the --------------- Company's name alone with the Administrative Agent at its office at One First National Plaza, Chicago, Illinois 60670. "Funding Check" shall mean a check issued by or on behalf of the ------------- Company the proceeds of which will be used to close the origination of a Mortgage Loan designated for inclusion in the Borrowing Base and which check has not been presented for payment and cleared. "GAAP" shall mean generally accepted accounting principles in the ---- United States of America in effect from time to time. 66 "Gestation Certificate" shall have the meaning given such term in --------------------- Paragraph 2(b) of the Security Agreement. "GNMA" shall mean the Government National Mortgage Association and any ---- successor agency. "GNMA Custodial Agreement" shall mean the agreement, as amended, ------------------------ modified or supplemented from time to time, among GNMA, the Company and any Person meeting the eligibility requirements set forth in the GNMA Guide to serve as a "certificating custodian," as such term is used in the GNMA Guide, pursuant to which such Person is authorized to act as a Certificating Custodian. "GNMA Guide" shall mean, collectively, the "GNMA I Mortgage-Backed ---------- Securities Guide" and the "GNMA II Mortgage-Backed Securities Guide" published by HUD, as amended, modified or supplemented from time to time. "Governmental Authority" shall mean any nation or government, any ---------------------- state or other political subdivision thereof, or any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Hedge Contract" shall mean a bona fide, existing contract to buy or -------------- sell an instrument on the futures market, the options market or the forward mortgage-backed securities market or an option or financial future purchased over the counter for future delivery of such instrument, each of the above issued in accordance with the requirements of a Hedging Program. "Hedging Program" shall mean a program for hedging interest rate risks --------------- of the Company, which program shall provide, without limitation, that all Hedge Contracts will be placed with futures commission merchants or clearing houses, if applicable, with whom the Company has written, assignable agreements. "HMSI" shall mean Headlands Mortgage Securities, Inc., a Delaware ---- corporation. "HUD" shall mean the Department of Housing and Urban Development and --- any successor thereto. "Increasing Lender" shall have the meaning given such term in ----------------- Paragraph 15(k) above. "Indebtedness" of any Person shall mean all items of indebtedness ------------ which, in accordance with GAAP and practices, would be included in determining liabilities as shown on the liability side of a statement of condition of such Person as of the date as of which indebtedness is to be determined, including, without limitation, all obligations for money borrowed and capitalized lease obligations, and shall also include all indebtedness and liabilities of others assumed or guaranteed by such Person or in respect of which such Person is secondarily or contingently liable (other than by endorsement of instruments in the course of collection) 67 whether by reason of any agreement to acquire such indebtedness or to supply or advance sums or otherwise. "Interim Date" shall mean July 31, 1997. ------------ "Lender" shall have the meaning given such term in the introductory ------ paragraph hereof. "Lien" shall mean any security interest, mortgage, pledge, lien, claim ---- on property, charge or encumbrance (including any conditional sale or other title retention agreement), any lease in the nature thereof, and the filing of or agreement to give any financing statement under the Uniform Commercial Code of any jurisdiction. "Loan" shall mean a Tranche A Loan, Tranche B Loan, Tranche C Loan, ---- Tranche D Loan or Tranche E Loan, as applicable, and "Loans" shall mean all such ----- Loans, collectively and severally. "Loan-to-Value Ratio" shall mean: ------------------- (a) With respect to any Mortgage Loan other than an Eligible HELOC Asset or an Eligible Manufactured Housing Mortgage Loan, the ratio of the principal amount of said Mortgage Loan outstanding at the date of origination thereof divided by (1) the lesser of (i) the most recent selling price of the related Property, and (ii) the appraised value of the related Property, or (2) in the case of a Mortgage Loan which constitutes a refinancing of an existing Mortgage Loan on the related Property, the appraised value of the related Property; (b) With respect to any Mortgage Loan which is an Eligible HELOC Asset, the ratio of the face amount of the promissory note underlying said Mortgage Loan (plus, in the case of a Mortgage Loan secured by a second priority deed of trust (or mortgage), the principal amount outstanding at such date under the first Mortgage Loan affecting the related Property), divided by the lesser of: (1) the most recent selling price of the related Property, and (2) the appraised value of the related Property; and (c) With respect to any Mortgage Loan which is an Eligible Manufactured Housing Mortgage Loan, the ratio of the face amount of the promissory note underlying said Mortgage Loan, divided by the lesser of: (1) the sum of the most recent selling price of the related Property and all costs and expenses necessary to acquire, construct and permanently affix the related Manufactured Home to such Property, and (2) the projected appraised value of the related Property after the related Manufactured Home has been completed and permanently affixed to such Property, as determined and utilized by the Company in underwriting said Mortgage Loan. "Loan Documents" shall mean this Agreement, the Notes, the Security -------------- Agreement, the Pledge Agreement and each other document, instrument or agreement executed by the Company in connection herewith or therewith, as any of the same may be amended, extended or replaced from time to time. 68 "Loan Request" shall mean a request in form acceptable to the ------------ Administrative Agent for a Loan which is conveyed to the Administrative Agent by telephone or telefax from a duly authorized officer of the Company, with such request to be confirmed in writing upon the request of the Administrative Agent. "Majority Lenders" shall mean: (a) prior to the occurrence of an ---------------- Event of Default and termination of the obligation of the Lenders to fund additional Loans hereunder, the Lenders holding not less than sixty-six and two- thirds percent (66.6666667%) of the Aggregate Percentage Shares, and (b) thereafter, the Lenders holding not less than sixty-six and two-thirds percent (66.6666667%) of Loans outstanding. "Manufactured Home" shall mean a structure, transportable in one or ----------------- more sections, which is built on a permanent chassis and designed to be used as a dwelling with a permanent foundation when affixed to real property and connected to the required utilities, including, without limitation, plumbing and electrical systems. "Maturity Date" shall mean the earlier of: (a) November 4, 1998, as ------------- such date may be extended from time to time in writing by one hundred percent (100%) of the Lenders, in their sole discretion, and (b) the date the Lenders terminate their obligation to make further Loans hereunder pursuant to Paragraph 13 above. "Maximum Commitment" shall mean, with respect to any Lender, the ------------------ dollar amount agreed to in writing from time to time by the Company and such Lender and specified as such Lender's "Maximum Commitment" in the most recent Commitment Schedule and Allocation Notice delivered by the Administrative Agent to the Lenders and the Company; provided, however, that no Lender's Maximum Commitment may exceed a dollar amount which, when added to the Maximum Commitments of all the Lenders, would exceed the maximum permitted Aggregate Credit Limit. "Maximum Tranche B Commitment" shall mean for any Tranche B Lender ---------------------------- that amount agreed to in writing from time to time by the Company and such Tranche B Lender and specified as such Tranche B Lender's Maximum Tranche B Commitment in the most recent Commitment Schedule and Allocation Notice delivered by the Administrative Agent to the Lenders and the Company. "Mortgage-Backed Security" shall mean (a) any security (including, ------------------------ without limitation, a participation certificate) guaranteed by GNMA that represents an interest in a pool of mortgages, deeds of trusts or other instruments creating a Lien on Property which is improved by a completed single family residence, including but not limited to a condominium, planned unit development or townhouse, (b) a security (including a participation certificate) issued by FNMA or FHLMC that represent interests in such a pool, and (c) a privately-placed security representing undivided interests in or otherwise supported by such a pool. "Mortgage Loan" shall mean a residential real estate secured loan, ------------- including, without limitation: (a) a promissory note, any reformation thereof and related deed of trust (or mortgage) and/or security agreement; (b) all guaranties and insurance policies, including, without 69 limitation, all mortgage and title insurance policies and all fire and extended coverage insurance policies and rights of the Company to return premiums or payments with respect thereto; and (c) all right, title and interest of the Company in the Property covered by said deed of trust (or mortgage). "Multiemployer Plan" shall mean, as to the Company or any of its ERISA ------------------ Affiliates, a Plan of such Person which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA. "No-Equity Mortgage Loan" shall mean an Eligible Conforming Mortgage ----------------------- Loan, or an Eligible Non-Conforming Mortgage Loan, which in each case (a) is secured by a first priority deed of trust, (b) has a Loan-to-Value Ratio in excess of ninety-five percent (95%) and less than or equal to one hundred percent (100%), (c) is subject to a Take-Out Commitment by any Approved Investor, and (d) has not been included in the Borrowing Base for more than sixty (60) days; provided, however, that the aggregate Unit Collateral Values of all No-Equity Mortgage Loans included in the Borrowing Base at any time does not exceed ten percent (10%) of the Aggregate Credit Limit. "Notes" shall mean any of the Tranche A Notes, the Tranche B Notes, ----- the Tranche C Note, the Tranche D Notes and/or the Tranche E Notes. "Obligations" shall mean any and all debts, obligations and ----------- liabilities of the Company to the Administrative Agent, the Collateral Agent and the Lenders (whether now existing or hereafter arising, voluntary or involuntary, whether or not jointly owed with others, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether or not from time to time decreased or extinguished and later increased, created or incurred), arising out of or related to the Loan Documents. "Obligor" shall mean the Person or Persons obligated to pay the ------- Indebtedness which is the subject of a Mortgage Loan. "Operating Account" shall mean Account No. 5240204 maintained in the ----------------- Company's name alone with the Administrative Agent at its office at One First National Plaza, Chicago, Illinois 60670. "Outstanding Percentage Share" shall mean, for any Lender at any date, ---------------------------- that percentage which the dollar amount of Loans outstanding held by such Lender bears to the aggregate dollar amount of Loans outstanding held by all the Lenders. "Overnight Transaction Loan Rate" shall mean for any Tranche C Loan on ------------------------------- any day such Tranche C Loan is outstanding the rate per annum determined by the Administrative Agent for such day to be its overnight transaction loan rate plus one percent (1.00%). "Participant" shall have the meaning given such term in Paragraph ----------- 15(i) above. 70 "Paul Subordinated Debt" shall mean that Indebtedness of the Company ---------------------- described in Paragraph 5 of the schedule of Permitted Other Debt. "PBGC" shall mean the Pension Benefit Guaranty Corporation established ---- pursuant to Subtitle A of Title IV of ERISA and any successor thereto. "Permitted Investments" shall mean those investments of the Company --------------------- described on Exhibit M attached hereto. --------- "Permitted Other Debt" shall mean that Indebtedness of the Company -------------------- described as "Permitted Other Debt" on Exhibit N attached hereto. --------- "Permitted Other Secured Debt" shall mean that Indebtedness which is ---------------------------- the subject of a Lien and described as "Permitted Other Secured Debt" on Exhibit ------- N attached hereto. - - "Person" shall mean any corporation, natural person, firm, joint ------ venture, limited liability company, partnership, trust, unincorporated organization or Governmental Authority. "Plan" shall mean, as to the Company or any of its ERISA Affiliates, ---- any pension plan that is covered by Title IV of ERISA and in respect of which such Person or a Commonly Controlled Entity of such Person is an "employer" as defined in Section 3(5) of ERISA. "Pledge Agreement" shall have the meaning given such term in Paragraph ---------------- 8(b) above. "Pledged Collateral" shall mean the collateral which is the subject of ------------------ the Pledge Agreement. "Potential Default" shall mean an event which but for the lapse of ----------------- time or the giving of notice, or both, would constitute an Event of Default. "Pre-Disbursement Account" shall mean DCS Clearing Account No. 247165 ------------------------ maintained in the Administrative Agent's name with FNBC at its office at One First National Plaza, Chicago, Illinois 60670. "Pre-Tax Income" shall mean for any period the positive consolidated -------------- net income of the Company for such period, determined in accordance with the methodology described on Schedule V. ---------- "Primary Loan" shall mean a Tranche A Loan, Tranche B Loan, Tranche C ------------ Loan or Tranche D Loan, as applicable, and "Primary Loans" shall mean all such ------------- Primary Loans, collectively and severally. "Proceeds" shall mean whatever is receivable or received when -------- Collateral or proceeds are sold, collected, exchanged or otherwise disposed of, whether such disposition is voluntary or involuntary, and includes, without limitation, all rights to payment, including return premiums, with respect to any insurance relating thereto. 71 "Property" shall mean the real property, including the improvements -------- thereon, and the personal property (tangible and intangible) which are encumbered pursuant to a Mortgage Loan. "Quoted Market Value" shall mean with respect to each of the Eligible ------------------- Servicing Portfolio and the Encumbered Eligible Servicing Portfolio, at any date, the value of such Eligible Servicing Portfolio or Encumbered Eligible Servicing Portfolio, as applicable, as determined by an independent consulting firm acceptable to the Administrative Agent and set forth in a Servicing Contract Report. If, at any time, the value of such Eligible Servicing Portfolio or Encumbered Eligible Servicing Portfolio, as applicable, is expressed in terms of a range of values, the Quoted Market Value thereof shall be equal to the weighted average of the values quoted. "Regulation U" shall mean Regulation U of the Board of Governors of ------------ the Federal Reserve System (12 C.F.R. (S) 221), as the same may from time to time be amended, supplemented or superseded. "Reportable Event" shall mean a reportable event as defined in Title ---------------- IV of ERISA, except actions of general applicability by the Secretary of Labor under Section 110 of ERISA. "Requested Loans" shall have the meaning given such term in Paragraph --------------- 7(k)(l)(i) above. "Required Documents" shall have the meaning given such term in ------------------ subparagraph (q) of the definition of "Eligible Mortgage Loan". "Required Manufactured Housing Mortgage Loan Disbursement" shall mean -------------------------------------------------------- for any Eligible Manufactured Housing Mortgage Loan that amount which the Company is required to disburse relating to said Mortgage Loan prior to submitting said Mortgage Loan for inclusion in the Borrowing Base. The amount of the Required Manufactured Housing Mortgage Loan Disbursement shall be ten percent (10%) of the face amount of the promissory note underlying said Mortgage Loan. "Requirements of Law" shall mean, as to any Person, the Articles or ------------------- Certificate of Incorporation and Bylaws or other organizational or governing documents of such Person, and any law, treaty, rule or regulation, or a final and binding determination of an arbitrator or a determination of a court or other Governmental Authority, in each case applicable to or binding upon such Person or any of its property or to which such Person or any of its property is subject. "Secured Parties" shall have the meaning given such term in Paragraph --------------- 1 of the Security Agreement. "Secured Obligations" shall have the meaning given such term in ------------------- Paragraph 2 of the Pledge Agreement. 72 "Security Agreement" shall have the meaning given such term in ------------------ Paragraph 8(a) above. "Servicing Contract Report" shall mean a report in form acceptable to ------------------------- the Administrative Agent setting forth the Quoted Market Value of each of the Eligible Servicing Portfolio and the Encumbered Eligible Servicing Portfolio. "Servicing Secured Credit Agreement" shall mean that certain Amended ---------------------------------- and Restated Servicing Secured Credit Agreement dated as of August 29, 1997 by and among the Company, FNBC as "Administrative Agent" and others Lenders party thereto, as such agreement may be amended from time to time. "Settlement Account" shall mean Account No. 1919113 maintained with ------------------ the Administrative Agent at its office at One First National Plaza, Chicago, Illinois 60670. "Single Employer Plan" shall mean, as to the Company or any of its -------------------- ERISA Affiliates, any Plan of such Person which is not a Multiemployer Plan. "Statement Date" shall mean December 31, 1996. -------------- "Stock Pledge Documents" shall have the meaning given such term in ---------------------- Paragraph 8(b) above. "Subordinated Debt" shall mean all Indebtedness of the Company and its ----------------- Subsidiaries which is expressly subordinated to the Obligations in the manner and to the extent required by the Lenders pursuant to written subordination agreements satisfactory in form and substance to the Lenders. "Subsidiary" shall mean any corporation, partnership or joint venture ---------- more than fifty percent (50%) of the stock or other ownership interest of which having by the terms thereof ordinary voting power to elect the board of directors, managers or trustees of such corporation, partnership or joint venture (irrespective of whether or not at the time stock of any other class or classes of such corporation, partnership or joint venture shall have or might have voting power by reason of the happening of any contingency) shall, at the time as of which any determination is being made, be owned, either directly or through Subsidiaries. "Take-Out Commitment" with respect to any Mortgage Loan shall mean a ------------------- bona fide current, unused and unexpired forward sale whole loan commitment or forward sale Mortgage-Backed Security commitment issued by an Approved Investor of in favor of and held by the Company, and any related delivery commitments, if applicable, under which said Approved Investor agrees, prior to the expiration thereof, upon the satisfaction of certain terms and conditions therein, to provide for the purchase of such Mortgage Loan or related Mortgage-Backed Security or to purchase such Mortgage Loan or related Mortgage-Backed Security at a specified price, which commitment is not subject to any term or condition which is not customary in commitments of like nature or which, in the reasonably anticipated course of events, cannot be fully complied with prior to the expiration thereof. 73 "Total Liabilities" shall mean at any date consolidated total ----------------- liabilities of the Company and its Subsidiaries less the amount of any Subordinated Debt, determined in accordance with GAAP. "Tranche" shall mean the Loans made under the Tranche A Credit Limit, ------- the Tranche B Aggregate Credit Allocation, the Tranche C Credit Limit, the Tranche D Credit Limit or the limitations pertinent to Tranche E Loans, as applicable. "Tranche A Commitment" shall mean, for any Tranche A Lender, the -------------------- dollar amount set forth next to the name of such Lender on the most recent Commitment Schedule and Allocation Notice delivered by the Administrative Agent to the Lenders and the Company. "Tranche A Credit Limit" shall mean at any date the Aggregate Credit ---------------------- Limit minus the sum of (a) the Tranche B Aggregate Credit Allocation and (b) the Tranche C Credit Limit. "Tranche A Lender" shall mean any Lender designated as such in ---------------- Schedule II attached hereto and any Applicant Financial Institution which shall - ----------- become a Tranche A Lender hereunder. "Tranche A Loan" shall have the meaning given such term in Paragraph -------------- 1(a) above. "Tranche A Notes" shall have the meaning given such term in Paragraph --------------- 7(c) above. "Tranche A Percentage Share" shall mean at any date with respect to -------------------------- each Tranche A Lender the ratio, expressed as a percentage, which (a) such Lender's Tranche A Commitment bears to (b) the Tranche A Credit Limit. "Tranche B Aggregate Credit Allocation" shall mean at any date the sum ------------------------------------- of the Tranche B Allocations on such date; provided that in no event shall the sum of the Tranche B Allocations at any date exceed $50,000,000.00. "Tranche B Allocation" shall mean for any Tranche B Lender during any -------------------- calendar month, the lesser of: (a) that amount specified as such for such Tranche B Lender in the applicable Commitment Schedule and Allocation Notice delivered pursuant to Paragraph 2(e) above effective for such calendar month, and (b) such Tranche B Lender's Maximum Tranche B Commitment; provided that no Tranche B Lender may have a Tranche B Allocation which, when added to the Tranche B Allocations of all other Tranche B Lenders, would exceed the Tranche B Aggregate Credit Allocation. "Tranche B Borrowing Date" shall mean the first day of each Tranche B ------------------------ Interest Period during the term of this Agreement with the initial Tranche B Borrowing Date being the Effective Date. 74 "Tranche B Interest Period" shall mean the period commencing on each ------------------------- Tranche B Borrowing Date and ending one month thereafter, with Tranche B Interest Periods to be continuous and without interruption throughout the term of this Agreement; provided, however, that (a) any Tranche B Interest Period which begins on a day for which there is no numerically corresponding day in the calendar month during which such Tranche B Interest Period is to end shall end on the last day of such calendar month; (b) no Tranche B Interest Period shall extend beyond the Maturity Date; and (c) if the Effective Date is not the first day of a calendar month, the last day of the initial Tranche B Interest Period shall be that date which it would have been had the first day of such initial Tranche B Interest Period been the first day of the calendar month following the Effective Date. "Tranche B Lender" shall mean any Lender designated as such on ---------------- Schedule II attached hereto and any Applicant Financial Institution which shall - ----------- become a Tranche B Lender hereunder. "Tranche B Loan" shall have the meaning given such term in Paragraph -------------- 2(a) above. "Tranche B Notes" shall have the meaning given such term in Paragraph --------------- 7(c) above. "Tranche B Percentage Share" shall mean for any Tranche B Lender at -------------------------- any date the ratio, expressed as a percentage, which such Tranche B Lender's Tranche B Allocation bears to the Tranche B Aggregate Credit Allocation. "Tranche C Credit Limit" shall mean $20,000,000.00, as such amount may ---------------------- be increased or decreased by written agreement of FNBC and the Company. "Tranche C Lender" shall mean FNBC. ---------------- "Tranche C Loans" shall have the meaning given such term in Paragraph --------------- 3(a) above. "Tranche C Note" shall have the meaning given such term in Paragraph -------------- 7(c) above. "Tranche D Commitment" shall mean, for any Tranche D Lender, the -------------------- dollar amount set forth next to the name of such Lender on the most recent Commitment Schedule and Allocation Notice delivered by the Administrative Agent to the Lenders and the Company. "Tranche D Credit Limit" shall mean the sum of the Tranche D ---------------------- Commitments of all the Tranche D Lenders, as set forth in the most recent Commitment Schedule and Allocation Notice delivered by the Administrative Agent to the Lenders and the Company. 75 "Tranche D Lender" shall mean any Lender designated as such in ---------------- Schedule II attached hereto and any Applicant Financial Institution which shall - ----------- become a Tranche D Lender hereunder. "Tranche D Loan" shall have the meaning given such term in Paragraph -------------- 4(a) above. "Tranche D Notes" shall have the meaning given such term in Paragraph --------------- 7(c) above. "Tranche D Obligations" shall mean any and all debts, obligations and --------------------- liabilities of the Company to the Administrative Agent, the Collateral Agent and the Lenders (whether now existing or hereafter arising, voluntary or involuntary, whether or not jointly owed with others, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether or not from time to time decreased or extinguished and later increased, created or incurred), arising out of or related to the Tranche D Loans, including but not limited to principal, interest, fees, premiums and other charges due in connection therewith. "Tranche D Percentage Share" shall mean for any Tranche D Lender at -------------------------- any date the ratio, expressed as a percentage, which (a) such Lender's Tranche D Commitment bears to (b) the Tranche D Credit Limit. "Tranche E Interest Period" shall mean as to any Tranche E Loan the ------------------------- period of time from the date such Tranche E Loan is advanced until the principal amount thereof is payable in full, as agreed by the Company and the Lender which makes such Tranche E Loan; provided, however, that in no event shall any Tranche E Interest Period be shorter than seven (7) days or longer than ninety (90) days or extend beyond the Maturity Date. "Tranche E Loan" shall have the meaning given such term in Paragraph -------------- 5(a) above. "Tranche E Loan Rate" shall mean as to any Tranche E Loan such fixed ------------------- rate per annum as the Company and the Lender which agreed to advance such Tranche E Loan have agreed. "Type" for any Mortgage Loan shall mean one of the following: an ---- Eligible Conforming Mortgage Loan, an Eligible Gestation Mortgage Loan, an Eligible HELOC Asset, an Eligible Non-Agency Mortgage Loan, an Eligible Non- Conforming Mortgage Loan, an Eligible Repurchase Mortgage Loan, an Eligible Manufactured Housing Mortgage Loan, an Eligible Shipped Mortgage Loan, an Eligible Waiver Mortgage Loan or an Eligible High LTV Mortgage Loan. "Unit Collateral Value" shall mean, with respect to each Eligible --------------------- Mortgage Loan, other than an Eligible HELOC Asset, calculated as of the date such Eligible Mortgage Loan is first included in the Borrowing Base in its current category, and with respect to each Eligible HELOC Asset, as of any date, the sum of: 76 (a) If such Eligible Mortgage Loan is an Eligible Conforming Mortgage Loan (other than a No-Equity Mortgage Loan), ninety-eight percent (98%) of the least of: (1) the unpaid principal balance thereof, (2) the unpaid principal balance thereof multiplied by the Current Weighted Average Take-Out Price, and (3) the acquisition price thereof (minus any discount and rebate points and minus any servicing released premium) or origination cost thereof. (b) If such Eligible Mortgage Loan is an Eligible Shipped Mortgage Loan, ninety-eight percent (98%) of the Take-Out Commitment covering such Mortgage Loan, and if such Eligible Mortgage Loan is an Eligible Gestation Mortgage Loan, ninety-nine percent (99%) of the purchase price under the Take- Out Commitment covering such Mortgage Loan. (c) If such Eligible Mortgage Loan is an Eligible Non-Conforming Mortgage Loan (other than a No-Equity Mortgage Loan), ninety-seven percent (97%) of the least of: (1) the unpaid principal balance thereof, (2) the unpaid principal balance thereof multiplied by the Current Weighted Average Take-Out Price, and (3) the acquisition price thereof (minus any discount and rebate points and minus any servicing released premium) or origination cost thereof; (d) If such Eligible Mortgage Loan is a No-Equity Mortgage Loan, eighty percent (80%) of the unpaid principal balance thereof. (e) If such Eligible Mortgage Loan is an Eligible Non-Agency Mortgage Loan that has been pre-approved by an Approved Non-Agency Investor or under its delegated underwriting authority, ninety-seven percent (97%) of the least of: (1) the unpaid principal balance thereof, (2) the unpaid principal balance thereof multiplied by the Current Weighted Average Take-Out Price, and (3) the acquisition price thereof (minus any discount and rebate points and minus any servicing released premium) or origination cost thereof. (f) If such Eligible Mortgage Loan is an Eligible Repurchase Mortgage Loan, eighty percent (80%) of the least of: (1) the unpaid principal balance thereof, (2) the unpaid principal balance thereof multiplied by the Current Weighted Average Take-Out Price, and (3) the acquisition price thereof (minus any discount and rebate points and minus any servicing released premium) or origination cost thereof. (g) If such Eligible Mortgage Loan is an Eligible HELOC Asset with a Loan-to-Value Ratio equal to or less than ninety percent (90%), the lesser of: (1) $200,000.00, and (2) Ninety-six percent (96%) of the lesser of: (i) the outstanding principal balance of said Mortgage Loan as of a given date, and (ii) if the Take-Out Commitment for said Mortgage Loan constitutes a delivery commitment, the purchase price under such Take-Out Commitment as of such date. 77 (h) If such Eligible Mortgage Loan is an Eligible HELOC Asset with a Loan-to-Value Ratio greater than ninety percent (90%), the lesser of: (1) $200,000.00, and (2) Ninety-five percent (95%) of the lesser of: (i) the outstanding principal balance of said Mortgage Loan as of a given date, and (ii) if the Take-Out Commitment for said Mortgage Loan constitutes a delivery commitment, the purchase price under such Take-Out Commitment as of such date. (i) If such Eligible Mortgage Loan is an Eligible Manufactured Housing Mortgage Loan, (1) the outstanding principal balance of said Mortgage Loan, plus (2) the dollar amount of any Loan requested by the Company on such date the proceeds of which Loan shall be utilized to make a progress or construction payment relating to said Mortgage Loan, minus (3) the Required Manufactured Housing Mortgage Loan Disbursement relating to said Mortgage Loan. (j) If such Eligible Mortgage Loan is an Eligible High LTV Mortgage Loan, ninety percent (90%) of the lesser of (1) the unpaid principal balance of said Mortgage Loan, (2) the Current Weighted Average Take-Out Price and (3) the origination cost thereof. "VA" shall mean the Veterans Administration and any successor agency. -- "Warehouse Related MBS" shall have the meaning given such term in --------------------- Paragraph 6(b)(2) of the Security Agreement. "Weighted Average Take-Out Price" shall mean, in each case, the ------------------------------- weighted average reflected as a percentage (which percentage shall not exceed one hundred percent (100%)) of the unfilled purchase price (net of commitment fees) of all Take-Out Commitments held by the Company and applicable to each of the following types of Mortgage Loans (determined separately with respect to each type): (a) all Eligible Conforming Mortgage Loans secured by a first priority deed of trust, (b) all Eligible Non-Conforming Mortgage Loans, (c) all 78 Eligible Non-Agency Mortgage Loans, (d) all Eligible Repurchase Mortgage Loans and (e) all Eligible High LTV Mortgage Loans. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By_______________________________________ Name_____________________________________ Title____________________________________ THE FIRST NATIONAL BANK OF CHICAGO, a national bank association, as Administrative Agent and a Lender By_______________________________________ Name_____________________________________ Title____________________________________ FIRST CHICAGO NATIONAL PROCESSING CORPORATION, a Delaware corporation, as Collateral Agent By_______________________________________ Name_____________________________________ Title:___________________________________ BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ 79 GUARANTY FEDERAL BANK, F.S.B., a federal savings bank, as a Lender By ______________________________________ Name ____________________________________ Title ___________________________________ FIRST UNION NATIONAL BANK, a national banking association, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ THE BANK OF NEW YORK, a banking corporation organized under the laws of the State of New York, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ COMERICA BANK-CALIFORNIA, a California banking corporation, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ 80 LIST OF SCHEDULES AND EXHIBITS ------------------------------ Schedule I Schedule of Addresses, Etc. Schedule II Schedule of Acceptable Manufactured Housing States Schedule III Schedule of Acceptable States Schedule IV Commitment Schedule and Allocation Notice as of Effective Date Schedule V Methodology for Computation of Pre-Tax Income Exhibit A-1 Form of Tranche A Note Exhibit A-2 Form of Tranche B Note Exhibit A-3 Form of Tranche C Note Exhibit A-4 Form of Tranche D Note Exhibit A-5 Form of Tranche E Note Exhibit B Form of Security Agreement Exhibit C Form of Pledge Agreement Exhibit D Form of Officer's Certificate Exhibit E Litigation Schedule Exhibit F List of Subsidiaries Exhibit G Form of Compliance Certificate Exhibit H Form of Additional Lender Agreement Exhibit I Form of Borrowing Base Certificate Exhibit J Schedule of Required Documents 81 Exhibit K Form of Collateral Confirmation Agreement Exhibit L Schedule of Additional Required Documents Exhibit M Schedule of Permitted Investments Exhibit N Schedule of Permitted Other Debt and Permitted Other Secured Debt FIRST AMENDMENT TO AMENDED AND RESTATED MORTGAGE LOAN WAREHOUSING AGREEMENT THIS FIRST AMENDMENT TO AMENDED AND RESTATED MORTGAGE LOAN WAREHOUSING AGREEMENT (the "Amendment") is made and dated as of the 4/th/ day of November, 1997, by and among THE FIRST NATIONAL BANK OF CHICAGO, a national banking association ("FNBC"), BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, THE BANK OF NEW YORK, a banking corporation organized under the laws of the State of New York, COMERICA BANK - CALIFORNIA, a California banking corporation, FIRST UNION NATIONAL BANK, a national banking association, and GUARANTY FEDERAL BANK, a federal savings bank (all of the above individually a "Lender" and, collectively, the "Lenders"), FNBC, as administrative agent for the Lenders (in such capacity, the "Administrative Agent"), FIRST CHICAGO NATIONAL PROCESSING ASSOCIATION, a Delaware corporation, as collateral agent for the Administrative Agent and the Lenders (in such capacity, the "Collateral Agent"), and HEADLANDS MORTGAGE COMPANY, a California corporation (the "Company"). RECITALS A. Pursuant to that certain Amended and Restated Mortgage Loan Warehousing Agreement dated as of August 29, 1997 among the Administrative Agent, the Collateral Agent, the Lenders and the Company (the "Agreement"), the Lenders agreed to extend credit to the Company on the terms and subject to the conditions set forth therein. All capitalized terms not otherwise defined herein shall have the meanings given to such terms in the Agreement. B. The Company and the Lenders desire to amend certain provisions of the Agreement as more particularly described below. NOW, THEREFORE, in consideration of the foregoing Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows: AGREEMENT 1. Extension of Maturity Date. To reflect the agreement of the parties -------------------------- hereto to extend the term of the credit facility evidenced by the Agreement, effective as of the Effective Date (as defined in Paragraph 8 below), subparagraph (a) of the definition of "Maturity Date" set forth in Paragraph 16 of the Agreement is hereby amended to delete the date "November 4, 1998" set forth therein and to replace the same with the date "November 4, 1999". 2. Increase in Credit Limit. To reflect the agreement of the Lenders to ------------------------ increase the dollar amount of credit available to the Company under the Agreement, effective as of the Effective Date: 1 (a) The definition of "Aggregate Credit Limit" set forth in Paragraph 16 of the Agreement is hereby amended to delete the dollar amount "$185,000,000.00" set forth in line 4 thereof and to replace the same with the dollar amount "$215,000,000.00". (b) The current Commitment Schedule and Allocation Notice in effect immediately prior to the Effective Date shall be amended and replaced with the Commitment Schedule and Allocation Notice attached hereto as Amendment Schedule ------------------ I. - - 3. Addition of New Type of Collateral; Modification of Collateral -------------------------------------------------------------- Eligibility Requirements. To reflect the agreement of the parties hereto to - ------------------------ include a new Type of Eligible Mortgage Loan in the calculation of the Collateral Value of the Borrowing Base and to modify certain eligibility requirements applicable to Eligible Non-Conforming Mortgage Loans: (a) A new definition of "Eligible A- Mortgage Loan" is hereby added, in correct alphabetical order, to Paragraph 16 of the Agreement to read in its entirety as follows: "Eligible A- Mortgage Loan" shall mean a Mortgage Loan ------------------------- with respect to which each of the following statements is accurate and complete (and the Company by including said Mortgage Loan in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said Mortgage Loan is an Eligible Mortgage Loan; (b) The Unit Collateral Value of said Mortgage Loan, when added to the Unit Collateral Values of all other Eligible A- Mortgage Loans included in the computation of the Collateral Value of the Borrowing Base, does not exceed five percent (5%) of the Aggregate Credit Limit; (c) Said Mortgage Loan is secured by a first priority deed of trust (or mortgage) on the related Property; (d) The Obligor on said Mortgage Loan had a FICO score of not less than 575; (e) Said Mortgage Loan has not been included in the Borrowing Base for more than ninety (90) days; and (f) Said Mortgage Loan generally conforms to all underwriting and other requirements of an Approved Investor. (b) Subparagraph (v) of the definition of "Eligible Mortgage Loan" is hereby amended to add the following proviso immediately following the semi-colon and preceding the word "and" in the last line thereof: 2 "provided, however, that: (y) in the event said Mortgage Loan is an Eligible Non-Conforming Loan which otherwise complies with all requirements of an Eligible Non-Conforming Mortgage Loan, said Mortgage Loan may have a Loan-to-Value Ratio of up to eighty-five percent (85%) notwithstanding that it is not covered by a policy of private mortgage insurance as otherwise required pursuant to this subparagraph (v) so long as the Unit Collateral Value of said Mortgage Loan when added to the Unit Collateral Values of all other Eligible Non-Conforming Mortgage Loans with a Loan-to-Value Ratio in excess of eighty percent (80%) which are not covered by private mortgage insurance does not exceed five percent (5%) of the Aggregate Credit Limit, and (z) if said Mortgage Loan is an Eligible A- Mortgage Loan, the dollar amount of said Mortgage Loan in excess of seventy percent (70%) of the lesser of a. the most recent selling price of the related Property, and b. - - the appraised value of the related Property is covered by a policy of private mortgage insurance acceptable to the Approved Investor issuing the Take-Out Commitment for said Mortgage Loan;" (c) Subparagraph (c) of the definition of "Unit Collateral Value" set forth in Paragraph 16 of the Agreement is hereby amended to read in its entirety as follows: "(c) If such Eligible Mortgage Loan is an Eligible Non-Conforming Mortgage Loan (other than a No-Equity Mortgage Loan), ninety-seven percent (97%) (or if such Eligible Mortgage Loan has a Loan-to-Value Ratio in excess of eighty percent (80%) and is not covered by private mortgage insurance, ninety-six percent (96%)) of the least of: (1) the unpaid principal balance thereof, (2) the unpaid principal balance thereof multiplied by the Current Weighted Average Take-Out Price, and (3) the acquisition price thereof (minus any discount and rebate points and minus any servicing released premium) or origination cost thereof." (d) A new subparagraph (k) is added to the definition of "Unit Collateral Value" to read in its entirety as follows: "(k) If such Eligible Mortgage Loan is an Eligible A- Mortgage Loan, ninety five percent (95%) of the least of: (1) the unpaid principal balance thereof, (2) the unpaid principal balance thereof multiplied by the Current Weighted Average Take-Out Price, and (3) the origination cost thereof." (e) The definition of "Type" set forth in Paragraph 16 of the Agreement is hereby amended to insert the phrase ", an Eligible A- Mortgage Loan" immediately preceding the phrase "or an Eligible High LTV Mortgage Loan" in the last line thereof. (f) The definition of "Weighted Average Take-Out Price" set forth in Paragraph 16 of the Agreement is hereby amended to add a new subparagraph (f) to read as follows: ", and (f) all Eligible A-Mortgage Loans". (g) The form of Borrowing Base Certificate attached to the Agreement as Exhibit I is replaced by the form of Borrowing Base Certificate attached --------- hereto as Replacement Exhibit I. ----------- --------- 3 4. Addition of Approved Repo Lender. Effective as of the Effective Date, -------------------------------- the Lenders hereby approve C.S. First Boston as an additional Approved Repo Lender for all purposes of the Agreement. 5. Permitted Secured Other Debt. To reflect the agreement of the parties ---------------------------- to permit the maximum aggregate amount of Indebtedness owed under repurchase agreements and gestation repurchase credit facilities entered into by the Company from time to time to increase from $300,000,000.00 to $450,000,000.00, effective as of the Effective Date Exhibit N to the Agreement is hereby replaced --------- by Replacement Exhibit N attached hereto. --------------------- 6. Reaffirmation of Other Loan Documents. The Company hereby affirms and ------------------------------------- agrees that (a) the execution and delivery by the Company of and the performance of its obligations under this Amendment shall not in any way amend, impair, invalidate or otherwise affect any of the obligations of the Company or the rights of the Administrative Agent, the Collateral Agent or the Lenders under the Agreement, the Security Agreement or any other Loan Document, (b) the term "Obligations" as defined in Paragraph 16 of the Agreement includes, without limitation, the Obligations of the Company under the Agreement as amended by this Amendment, (c) the Security Agreement remains in full force and effect and such agreement constitutes a continuing first priority security interest in and lien upon the Collateral, and (d) for any and all purposes, any reference to the Agreement following the effective date of this Amendment shall constitute a reference to the Agreement as amended to date, including, without limitation, by this Amendment. 7. Modification of Related Documents. All reports and other forms --------------------------------- utilized in connection with the day-to-day operations of the credit facility evidenced by the Agreement shall be deemed modified consistent with the provisions of this Amendment. 8. Effective Date. This Amendment shall be effective (with such -------------- effectiveness being retroactive to the day and year first above written) on the earliest date (the "Effective Date") upon which the Administrative Agent has received (a) duly executed copies of this Amendment from each of the Lenders, the Administrative Agent, the Collateral Agent and the Company, and (b) such board resolutions, incumbency certificates and other additional documentation as the Administrative Agent may request in connection herewith. 9. Representations and Warranties. The Company hereby represents and ------------------------------ warrants to the Administrative Agent and the Lenders as follows: (a) The Company has the corporate power and authority and the legal right to execute, deliver and perform this Amendment and has taken all necessary corporate action to authorize the execution, delivery and performance of this Amendment. This Amendment has been duly executed and delivered on behalf of the Company and constitutes the legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms. The execution, delivery and performance of this Amendment will not violate any Requirement of Law or Contractual Obligation or require any consent, approval or authorization of, or registration, declaration or filing with, any Governmental Authority. 4 (b) At and as of the date of execution hereof and at and as of the effective date of this Amendment and both prior to and after giving effect hereto: (1) the representations and warranties of the Company contained in the Loan Documents are accurate and complete in all respects, and (2) there has not occurred an Event of Default or Potential Default. 10. No Other Amendment. Except as expressly amended herein, the Loan ------------------ Documents shall remain in full force and effect as currently written. 11. Counterparts. This Amendment may be executed in any number of ------------ counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By_______________________________________ Name_____________________________________ Title____________________________________ THE FIRST NATIONAL BANK OF CHICAGO, a national banking association, as Administrative Agent and a Lender By_______________________________________ Name_____________________________________ Title____________________________________ BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ 5 THE BANK OF NEW YORK, a banking corporation organized under the laws of the State of New York, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ COMERICA BANK-CALIFORNIA, a California banking corporation, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ FIRST UNION NATIONAL BANK, a national banking association, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ GUARANTY FEDERAL BANK, a federal savings bank, as a Lender By_______________________________________ Name_____________________________________ Title____________________________________ 6 FIRST CHICAGO NATIONAL PROCESSING CORPORATION, a Delaware corporation, as Collateral Agent By_______________________________________ Name_____________________________________ Title____________________________________ 7 REPLACEMENT EXHIBIT N --------------------- SCHEDULE OF PERMITTED OTHER DEBT AND (*) PERMITTED OTHER SECURED DEBT 1. Indebtedness owed under repurchase agreements and gestation repurchase credit facilities entered into by the Company from time to time with financial institutions approved by the Administrative Agent and the Majority Lenders in an aggregate amount not to exceed at any one time outstanding $450,000,000.00.* 2. Indebtedness owed under any servicing secured facility (including the Servicing Secured Credit Agreement) in an aggregate amount not to exceed at any one time outstanding $30,000,000.00.* 3. Indebtedness owed under credit facilities entered into by and between the Company and Residential Funding Corporation ("RFC") from time to time secured by Mortgage Loans that are delinquent or in foreclosure or subject to a Take-Out Commitment issued by RFC, manufactured housing loans and REO properties in an aggregate amount not to exceed at any one time outstanding $15,000,000.00.* 4. Indebtedness owed under any deposit-backed interest rate exchange agreements and/or investment arbitrage lines, entered into in the ordinary course of business.* 5. Unsecured Indebtedness of the Company to Peter Paul and/or Jessica Paul in an amount not to exceed $10,000,000.00 in the aggregate at any time outstanding and which Indebtedness is Subordinated Debt, it being agreed and understood that the required subordination shall be on terms and subject to conditions substantially similar to the terms and conditions set forth in that certain Subordination Agreement dated as of July 26, 1996 executed by Peter Paul and Jessica Paul. 6. Unsecured Indebtedness of the Company to Peter Paul in an amount not to exceed $5,000,000.00 in the aggregate at any time outstanding, the proceeds of which Indebtedness shall be used by the Company for funding short-term liquidity needs and which Indebtedness is Subordinated Debt, it being agreed and understood that the required subordination shall prohibit payments on account of such Indebtedness only if there shall either before or after such payment is made exist and Event of Default or Potential Default. 7. Indebtedness of HMSI to third party lenders in an amount not to exceed $5,000,000.00 in the aggregate at any time outstanding, the proceeds of which Indebtedness shall be used by HMSI to finance advance receivables.* 1 8. Indebtedness of HMSI secured by liens on the retained interests in securitizations of HMSI in connection with yield maintenance arrangements on securities issued through HMSI. 2 EX-10.5 13 AMENDED AND RESTATED SERVICING EXHIBIT 10.5 ------------ AMENDED AND RESTATED SERVICING SECURED CREDIT AGREEMENT THIS AMENDED AND RESTATED SERVICING SECURED CREDIT AGREEMENT (the "Agreement") is made and dated as of the 29th day of August, 1997, by and among HEADLANDS MORTGAGE COMPANY, a California corporation (the "Company"), THE FIRST NATIONAL BANK OF CHICAGO, a national banking association ("FNBC"), BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, THE BANK OF NEW YORK, a banking corporation organized under the laws of the State of New York, any other lenders from time to time party hereto, together with their respective successors and assigns (each a "Lender" and collectively the "Lenders"), and FNBC as administrative agent and collateral agent for the Lenders (in such respective capacities, the "Administrative Agent" and the "Collateral Agent"). RECITALS A. Pursuant to that certain Servicing Secured Credit Agreement dated as of October 24, 1994 by and among the Company, the Administrative Agent, the Collateral Agent and the Lenders party thereto (as amended to date, the "Existing Credit Agreement"), such Lenders agreed to extend credit to the Company on the terms and subject to the conditions set forth therein. B. The Company, the Administrative Agent, the Collateral Agent and the Lenders currently party to the Existing Credit Agreement desire to amend the Existing Credit Agreement and the documents, instruments and agreements relating thereto in certain respects and, for convenience of reference, to restate the Existing Credit Agreement in its entirety herein. NOW, THEREFORE, in consideration of the above Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto agree as follows: AGREEMENT 1. Convertible Revolving Credit Facility. ------------------------------------- 1(a) Revolving Credit Limit. On the terms and subject to the ---------------------- conditions set forth herein, the Lenders severally agree that from time to time to but not including the Conversion Date they shall advance their respective Percentage Shares of loans (the "Revolving Loans" or a "Revolving Loan") to the Company in amounts not to exceed, in the aggregate at any date outstanding, the lesser of: (1) The Revolving Loan Credit Limit; and 1 (2) The Collateral Value of the Borrowing Base. Each Revolving Loan shall be in a minimum amount of $100,000.00. Amounts borrowed hereunder and repaid prior to the Conversion Date may be reborrowed as provided herein, it being agreed and understood that the credit facility evidenced hereby is a revolving credit facility to but not including the Conversion Date. 1(b) Principal Repayment and Conversion Term Loan. Subject to -------------------------------------------- the prepayment provisions of Paragraph 3(j) below, the Company shall pay the principal amount of each Revolving Loan advanced hereunder on the Conversion Date; provided, however, that if but only if on and as of the Conversion Date there has not occurred and is not continuing an Event of Default or Potential Default and the Company shall so elect (upon not less than thirty (30) days' prior written notice to the Administrative Agent and the Lenders), the outstanding principal balance of Revolving Loans outstanding on the Conversion Date, to the extent not in excess of the Conversion Term Loan Credit Limit (as so limited, the "Term Out Amount") shall be converted to an amortizing term loan (the "Conversion Term Loan"), which shall be payable in twelve (12) installments as follows: (1) eleven (11) installments each in an amount equal to 1/12th of the Term Out Amount, the first such installment to be payable on the 90th day following the Conversion Date, each of the next ten (10) such installments to be payable quarterly on the first Business Day of each January, April, July and October, commencing on the first such date following the initial payment date, and (2) one final installment in an amount equal to the remaining principal balance outstanding on the first Business Day of October, 2000. 1(c) Interest Rates Applicable to Revolving Loans. Revolving -------------------------------------------- Loans shall be made and/or maintained, at the election of the Company made from time to time as permitted herein, at (i) the Applicable Eurodollar Rate, (ii) the Applicable Federal Funds Rate, and/or (iii) to the extent permitted pursuant to Paragraph 1(g) below, the Buy-Down Rate. 1(d) Interest Rates Applicable to Conversion Term Loan. The ------------------------------------------------- Conversion Term Loan shall be made and/or maintained, at the election of the Company made from time to time as permitted herein, at (i) the Applicable Eurodollar Rate and/or (ii) to the extent permitted pursuant to Paragraph 1(g) below, the Buy-Down Rate; provided, however, that subject to the provisions of Paragraph 2 below, the Conversion Term Loan may be maintained from time to time at the Prime Rate. 1(e) Calculation of Interest. The Company shall pay to the ----------------------- Administrative Agent for distribution to each Lender interest on Loans outstanding hereunder from the date disbursed to but not including the date of payment calculated on such Lender's Percentage Share of the principal amount of Loans outstanding from time to time hereunder during the interest calculation period, at a rate per annum equal to, at the option of and as selected by the Company from time to time (subject to the provisions of Paragraphs 2(a), 2(b) and 2(c) below): (i) with respect to each Eurodollar Loan, the Applicable Eurodollar Rate for the applicable Eurodollar Interest Period, (ii) with respect to each Federal Funds Rate Loan, a fluctuating rate per annum equal to the Applicable Federal Funds Rate during the applicable 2 computation period, and (iii) to the extent permitted pursuant to Paragraph 1(g) below, the Buy-Down Rate during the applicable computation period. 1(f) Payment of Interest. Interest accruing on Loans which are ------------------- made and/or maintained at the Applicable Federal Funds Rate and/or the Buy-Down Rate shall be payable monthly, in arrears, as provided in Paragraph 3(d) below. Interest accruing on Eurodollar Loans shall be payable at the end of the applicable Eurodollar Interest Period. The Administrative Agent, in rendering any interest billing relating to Loans, shall have no obligation to verify the amount of any Buy-Down Deposits supporting the pricing of Loans made and/or maintained at the Buy-Down Rate. 1(g) Balance Pricing and Deficiency Fees. The Company may ----------------------------------- maintain during each calendar month Buy-Down Deposits in non-interest bearing accounts with any of the Lenders in such amounts as may be established from time to time pursuant to the Buy-Down Letter between such Lender and the Company. In the event that the Company does maintain the required amounts of Buy-Down Deposits with such Lender hereunder during any monthly period, the Company shall pay to such Lender interest at the Buy-Down Rate with respect to an aggregate principal amount of Loans outstanding advanced by such Lender during such monthly period equal to the aggregate daily average balance of Buy-Down Deposits maintained with such Lender during such monthly period. In the event the Company shall fail to maintain sufficient Buy-Down Deposits with any Lender required pursuant to a Buy-Down Letter between them during any monthly period, the Company shall pay to such Lender upon demand such deficiency fees as may be established in such Buy-Down Letter. Such Lender may elect not to make demand for the payment of deficiency fees accruing in respect of Buy-Down Deposits or Loans from time to time and it is expressly agreed and understood that: (1) such deficiency fee or fees shall not be deemed to have been waived by such Lender (except as such waiver is expressly acknowledged in writing by such Lender from time to time), and (2) all deficiency fees accrued and unpaid hereunder and not so expressly waived, whether or not previously declared due and owing by such Lender, shall automatically be due and payable in full on the Conversion Date and/or the final principal payment date of the Conversion Term Loan, as applicable. Any Loans outstanding which are not matched by Buy-Down Deposits maintained with the applicable Lenders during the applicable monthly computation period pursuant to Buy-Down Letters shall accrue interest at the Applicable Federal Funds Rate and/or the Applicable Eurodollar Rate, as provided in Paragraphs 1(c) and 1(d) above. 1(h) Termination or Reduction of Revolving Loan Credit Limit. ------------------------------------------------------- The Company shall have the right, upon not less than thirty (30) Business Days' written notice to the Administrative Agent, to permanently terminate in whole or from time to time permanently reduce in part the unused portion of the Revolving Loan Credit Limit; provided, however, that any partial reduction shall be in the amount of $500,000.00 or an integral multiple thereof. The Administrative Agent shall promptly notify the Lenders in writing of such termination or reduction of the Revolving Loan Credit Limit and of each Lender's new Maximum Commitment. 3 2. Eurodollar Provisions. --------------------- 2(a) Procedures for Interest Rate Election. ------------------------------------- (1) The Company may elect from time to time to have Loans funded as Eurodollar Loans or to convert Revolving Loans outstanding as Federal Funds Rate Loans to Eurodollar Loans by giving the Administrative Agent at least three Eurodollar Business Days' prior irrevocable notice of such election. All such elections shall be made by delivery of a Loan Request by the Company to the Administrative Agent within the required time period. The Company may elect from time to time to convert Revolving Loans outstanding as Eurodollar Loans to Federal Funds Rate Loans effective upon the last day of the applicable Eurodollar Interest Period. No Loan shall be funded as a Eurodollar Loan and no Federal Funds Rate Loan shall be converted into a Eurodollar Loan if an Event of Default or Potential Default has occurred and is continuing on the day occurring three Eurodollar Business Days prior to the date of, or on the date of, any requested funding or conversion. (2) All or any part of Revolving Loans may be funded or converted and all or part of the Conversion Term Loan may be funded or converted as provided herein, provided that partial fundings or conversions shall be in a principal amount of $500,000.00 or whole multiples of $500,000.00 in excess thereof. (3) Any Eurodollar Loan may be continued as such upon the expiration of the Eurodollar Interest Period with respect thereto by the Company giving the Administrative Agent at least three Eurodollar Business Days' prior irrevocable notice of such election as set forth in a Loan Request; provided, however, that no Eurodollar Loan may be continued as such when any Event of Default or Potential Default has occurred and is continuing, but shall be automatically converted to a Federal Funds Rate Loan (in the case of Revolving Loans) or to a Prime Rate Loan (in the case of the Conversion Term Loan) on the last day of the then current Eurodollar Interest Period applicable thereto, and the Administrative Agent shall notify the Lenders and the Company promptly that such automatic conversion will occur. If the Company shall fail to give notice as provided above, the Company shall be deemed to have elected to convert any affected Eurodollar Loan to a Federal Funds Rate Loan (or a Prime Rate Loan, as applicable) on the last day of the applicable Eurodollar Interest Period. 2(b) Inability to Determine Rate. In the event that the --------------------------- Administrative Agent shall have reasonably determined (which determination shall be conclusive and binding upon the Company) that by reason of circumstances affecting the interbank market adequate and reasonable means do not exist for ascertaining the Eurodollar Rate for any Eurodollar Interest Period, the Administrative Agent shall forthwith give telex notice of such determination, confirmed in writing, to each affected Lender and to the Company. If such notice is given: (1) no Loan may be funded as a Eurodollar Loan, (2) any Federal Funds Rate Loan that was to have been converted to a Eurodollar Loan shall, subject to the provisions hereof, be continued as a Federal Funds Rate Loan and (3) any outstanding Eurodollar Loan shall be converted, on the 4 last day of the then current Eurodollar Interest Period applicable thereto, to a Federal Funds Rate Loan (in the case of Revolving Loans) or to a Prime Rate Loan (in the case of the Conversion Term Loan). Until such notice has been withdrawn by the Administrative Agent, the Company shall not have the right to convert a Federal Funds Rate Loan or a Prime Rate Loan to a Eurodollar Loan or to fund any Loan as a Eurodollar Loan or to continue a Eurodollar Loan. The Administrative Agent shall withdraw such notice in the event that the circumstances giving rise thereto no longer pertain and that adequate and reasonable means exist for ascertaining the Eurodollar Rate for the Eurodollar Interest Period requested by the Company, and following withdrawal of such notice by the Administrative Agent, the Company shall have the right to have any Loan funded as a Eurodollar Loan or convert a Federal Funds Rate Loan or a Prime Rate Loan to a Eurodollar Loan or to continue a Eurodollar Loan in accordance with the terms and conditions of this Agreement. 2(c) Illegality. Notwithstanding any other provisions herein, if ---------- any law, regulation, treaty or directive or any change therein or in the interpretation or application thereof, shall make it unlawful for any Lender to make or maintain Eurodollar Loans as contemplated by this Agreement: (1) the commitment of such Lender hereunder to make or to continue Eurodollar Loans or to convert Federal Funds Rate Loans to Eurodollar Loans shall forthwith be cancelled and (2) such Lender's Loans then outstanding as Eurodollar Loans, if any, shall be converted automatically to Federal Funds Rate Loans (in the case of Revolving Loans) or to a Prime Rate Loan (in the case of the Conversion Term Loan) at the end of their respective Eurodollar Interest Periods or within such earlier period as required by law. In the event of a conversion of any such Loan prior to the end of its applicable Eurodollar Interest Period, the Company hereby agrees promptly to pay any Lender affected thereby, upon demand, the amounts required pursuant to Paragraph 2(e) below, it being agreed and understood that such conversion shall constitute a prepayment for all purposes hereof. The provisions hereof shall survive the termination of this Agreement and payment of all other Obligations. 2(d) Funding. Each Lender shall be entitled to fund all or any ------- portion of its share of Loans in any manner it may determine in its sole discretion, including, without limitation, in the Grand Cayman inter-bank market, the London inter-bank market and within the United States, but all calculations and transactions hereunder shall be conducted as though all Lenders actually fund all Eurodollar Loans through the purchase of offshore dollar deposits in the amount of the relevant Eurodollar Loan in maturities corresponding to the applicable Eurodollar Interest Period. 2(e) Funding Indemnification. In addition to all other payment ----------------------- obligations hereunder, in the event: (1) any Eurodollar Loan is prepaid prior to the last day of the applicable Eurodollar Interest Period, whether following a voluntary prepayment, mandatory prepayment (including but not limited to application of proceeds from the sale of Collateral or in connection with an increase in availability under Paragraph 11(k) below), or otherwise, or (2) the Company shall fail to borrow a Eurodollar Loan or shall fail to continue or to make a conversion to a Eurodollar Loan after the Company has given notice thereof as required hereunder, then the Company shall immediately pay to each Lender holding the Loans prepaid or not borrowed, continued or converted, through the Administrative Agent, (x) a processing fee in the amount of 5 $150.00 and (y) an additional premium sum compensating such Lender for losses, costs and expenses incurred by such Lender in connection with such prepayment or such failure to borrow, continue or convert a Loan, including, without limitation, such as may arise out of re-employment of funds obtained by such Lender and from fees payable to terminate the deposits from which such funds were obtained, such losses, actual costs and expenses and the method of calculation thereof being set forth in reasonable detail in a statement delivered to the Company by such Lender. Under no circumstances shall any Lender have any obligation to remit monies to the Company upon prepayment of any Eurodollar Loan, even under circumstances which do not result in the necessity for the payment by the Company of any amount hereunder. The provisions hereof shall survive termination of this Agreement and payment of all other Obligations. 3. Miscellaneous Lending Provisions. -------------------------------- 3(a) Use of Proceeds. The proceeds of all Loans shall be --------------- utilized by the Company solely for its mortgage banking business and operations. 3(b) Request For Revolving Loans; Making of Revolving Loans. ------------------------------------------------------ (1) If the Company desires to borrow a Revolving Loan hereunder the Company shall: (i) in the case of a Federal Funds Rate Loan, deliver a Loan Request to the Administrative Agent no later than 9:00 a.m. (Los Angeles time) on the proposed funding date, which Loan Request shall be forwarded promptly by the Administrative Agent to the Lenders, (ii) in the case of a Eurodollar Loan, deliver a Loan Request to the Administrative Agent no later than 9:00 a.m. (Los Angeles time) not less than three Eurodollar Business Days prior to the proposed funding date, which Loan Request shall be forwarded promptly by the Administrative Agent to the Lenders, and (iii) in the case of a Buy-Down Rate Loan, deliver a Loan Request to the Administrative Agent no later than 10:00 a.m. (Los Angeles time) on the proposed funding date, which Loan Request shall be forwarded promptly by the Administrative Agent to the applicable Lender or Lenders. All Loan Requests to be forwarded by the Administrative Agent to the Lenders shall be forwarded by facsimile transmission. With respect to any Loan Request, the Company shall specify the principal amounts of the Revolving Loans requested, subject to the provisions of Paragraph 1(a) above, and in the case of any Eurodollar Loans, the respective Eurodollar Interest Periods applicable thereto. The Lenders shall make available their respective Percentage Shares of the proposed Revolving Loans by crediting the amount thereof, in immediately available same day funds, to the Pre- Disbursement Account no later than 12:30 p.m. (Los Angeles time) on the funding date, such funds to be held pending disbursement as provided in subparagraph (4) below. (2) With respect to the conversion or continuation of any Eurodollar Loan as provided in Paragraph 2(a) above, the Company shall deliver a Loan Request to the Administrative Agent no later than 9:00 a.m. (Los Angeles time) on the day occurring at least three Eurodollar Business Days prior to the date of the conversion 6 or continuation requested therein, and the Administrative Agent shall promptly notify the appropriate Lenders of the contents of such Loan Request. (3) The failure of any Lender to make any Revolving Loan (or portion thereof) to be made by it as part of any borrowing shall not relieve any other Lender of its obligation hereunder to advance its applicable portion of the principal amount thereof, but no Lender shall be responsible for the failure of any other Lender to make any such Loan. (4) Subject to the conditions set forth in Paragraph 3(b)(1) above and Paragraphs 3(n) and 5(b) below, the Administrative Agent shall disburse amounts held in the Pre-Disbursement Account to the Funding Account no later than 1:00 p.m. (Los Angeles time). Disbursements out of such account chosen by the Company shall be controlled by the Company, unless the Administrative Agent shall elect at any time and in its sole discretion to control disbursements out of such account and shall notify the Company of such election. The Company shall fully cooperate with the Administrative Agent to effectuate such change of control. Amounts held in the Pre-Disbursement Account which cannot be disbursed to the Company because the conditions set forth in Paragraph 5(b) below are not met shall constitute cash collateral for the Obligations and disbursed to the Company only at such time as such conditions are met. Such amounts shall constitute "Loans" to the Company for all purposes of the Loan Documents and shall be payable, with interest from the date first deposited in the Pre- Disbursement Account to the same extent as if such amounts had been fully disbursed. 3(c) Notes. The obligation of the Company to repay the Revolving ----- Loans and, following the Conversion Date, the Conversion Term Loan, shall be evidenced by a promissory note, which promissory note shall be issued in substitution and replacement of the "Notes" issued under the Existing Credit Agreement, payable to the order of each Lender, in the form of that attached hereto as Exhibit A (the "Notes"). The Administrative Agent shall deliver a --------- monthly statement of account to the Company setting forth the unpaid principal balance of Loans outstanding hereunder, and each Lender's interest therein, which statement shall (absent clerical error) be deemed conclusively correct and accepted by the Company unless the Company notifies the Administrative Agent to the contrary within fifteen (15) Business Days following delivery of such statement. Each Lender is hereby authorized to record the date and amount of each advance, conversion and continuation and the date and amount of each such payment or prepayment of principal of each Loan made by such Lender, the applicable Eurodollar Interest Period, if any, and the interest rate with respect thereto, on the schedules annexed to and constituting a part of its respective Note (or by any analogous method any Lender may elect consistent with its customary practices), and any such recordation shall constitute conclusive evidence of the accuracy of the information so recorded absent manifest error. The failure of any Lender to make any such notation shall not affect in any manner or to any extent the Company's obligation to pay and perform the Obligations. 3(d) Interest and Fee Billing and Payment. The Administrative ------------------------------------ Agent shall, on or before the fifth Business Day of each month for Federal Funds Rate Loans, Buy- 7 Down Rate Loans, Prime Rate Loans and fees, and three Business Days prior to the last day of the applicable Eurodollar Interest Period for Eurodollar Loans, deliver to the Company an interest and fee billing for the immediately preceding month or then-ending Eurodollar Interest Period, as the case may be, which billing shall set forth interest accrued and payable on Loans and fees payable hereunder for such period to be collected by the Administrative Agent, and the Company shall pay the full amount of such interest and fee billing no later than (x) five Business Days after receipt thereof in the case of Federal Funds Rate Loans, Buy-Down Rate Loans, Prime Rate Loans and fees, and (y) on the last day of the applicable Eurodollar Interest Period for Eurodollar Loans. Whether or not any such interest or fee billing is delivered to the Company, the Administrative Agent is hereby authorized to, and shall unless the Company is otherwise notified in advance of a different method and/or time of payment, debit the Operating Account in the amount of such interest and fees payable hereunder. Any deficiency fees payable by the Company to a Lender shall be paid pursuant to the terms of the applicable Buy-Down Letter. 3(e) Repayment of Principal of Eurodollar Loans. Subject to the ------------------------------------------ prepayment requirements of Paragraphs 3(f) and 3(o) below, and the required application of proceeds from the sale or other disposition of Collateral as provided in the Security Agreement, and the repayment provisions of Paragraph 1(b) above, the Company shall pay the principal amount of each Eurodollar Loan (unless continued or converted pursuant to Paragraph 2(a) above) on the last day of the applicable Eurodollar Interest Period relating thereto. 3(f) Borrowing Base Conformity. ------------------------- (1) In support of its obligation to repay Loans, the Company shall cause the Collateral Value of the Borrowing Base to be not less than, at any date, the aggregate principal amount of outstanding Loans. (2) The Company shall immediately prepay the applicable Loans to the Administrative Agent on behalf of the Lenders, upon telephonic demand by the Administrative Agent, on any day in the amount by which the aggregate principal amount of outstanding Loans exceeds the limitation of subparagraph (1) above. (3) If, but only if, at such time as the Company shall be required to prepay Loans under this Paragraph 3(f) there shall not have occurred and be continuing an Event of Default or Potential Default, in lieu of prepaying the Loans as required above and subject to the prior written approval of the Majority Lenders, the Company may deliver to the Collateral Agent for the benefit of the Lenders additional Assigned Servicing Rights such that the Collateral Value of the Borrowing Base, after giving effect to the inclusion of such Assigned Servicing Rights in the Borrowing Base, shall be in compliance with the requirements of subparagraph (1) above. 3(g) Nature and Place of Payments. All payments made on account ---------------------------- of the Obligations (other than amounts required to be paid to the Lenders pursuant to Paragraph 1(g) above and their respective Buy-Down Letters with the Company) shall be made to the Administrative Agent for prompt distribution to the Lenders. All payments made on account of the Obligations shall be made without setoff or counterclaim in lawful money of the 8 United States of America in immediately available same day funds, free and clear of and without deduction for any taxes, fees or other charges of any nature whatsoever imposed by any taxing authority and must be received by the Administrative Agent by 10:00 a.m. (Los Angeles time) on the date of payment, it being expressly agreed and understood that if a payment is received after 10:00 a.m. (Los Angeles time) by the Administrative Agent, such payment will be considered to have been made on the next succeeding Business Day and interest thereon shall be payable at the then applicable rate during such extension. All payments on account of the Obligations shall be made to the Administrative Agent through its office located at One First National Plaza, Chicago, Illinois 60670. If any payment required to be made by the Company hereunder becomes due and payable on a day other than a Business Day, the due date thereof shall be extended to the next succeeding Business Day and interest thereon shall be payable at the then applicable rate during such extension. 3(h) Post-Maturity Interest. Any Obligations not paid when due ---------------------- (whether at stated maturity, upon acceleration or otherwise) shall bear interest from the date due until paid in full at a per annum rate equal to three percent (3%) above the Corporate Base Rate. 3(i) Computations. All computations of interest and fees payable ------------ hereunder shall be based upon a year of 360 days for the actual number of days elapsed. 3(j) Prepayments. ----------- (1) The Company may prepay Loans hereunder (other than Eurodollar Loans) in whole or in part at any time; provided, however, that any such voluntary prepayment shall be in the amount of $50,000.00 or an integral multiple of $50,000.00 in excess thereof. (2) Loans hereunder are subject to mandatory prepayment pursuant to Paragraphs 3(f) above and 3(o) below, and in addition, by application of proceeds of the sale or other disposition of Collateral as provided in the Security Agreement. (3) Principal amounts prepaid on the Conversion Term Loan shall be applied to installments on the Conversion Term Loan in inverse order of maturity. The Company shall pay in connection with any prepayment hereunder all interest accrued but unpaid on Loans to which such prepayment is applied pursuant to Paragraph 3(k) below concurrently with payment to the Administrative Agent of any principal amounts and, in addition, any amounts payable on account thereof pursuant to Paragraph 2(e) above. 3(k) Allocation of Payments Received. ------------------------------- (1) Prior to the occurrence of an Event of Default and acceleration of any Obligations, principal amounts received by the Administrative Agent shall be allocated among the Lenders on account of the Obligations as the Company may 9 direct in writing, subject only to the requirement that such allocation shall not result in a non-pro rata distribution among the Lenders. (2) Following the occurrence of an Event of Default and acceleration of any Obligations: (i) All amounts received by the Administrative Agent on account of the Obligations (other than amounts received from the sale or other disposition of the Pledged Collateral) shall be allocated by the Administrative Agent as follows: a. First, to the payment of costs and expenses incurred by the Administrative Agent and Collateral Agent in the performance of their duties and enforcement of their rights under the Loan Documents, including, without limitation, all costs and expenses of collection, reasonable attorneys' fees, court costs and foreclosure expenses; b. Then, to the Lenders, pro rata in accordance with their respective Percentage Shares until the Obligations are paid in full; and c. Then, to such Persons as may be legally entitled thereto. (ii) All amounts received by the Administrative Agent upon the sale or other disposition of the Pledged Collateral shall be allocated by the Administrative Agent as follows: a. First, to the payment of expenses incurred by the Administrative Agent and the Collateral Agent in the performance of their duties and enforcement of their rights under the Pledge Agreement and the other Stock Pledge Documents; b. Then, to the Lenders and the "Lenders" under (and as the term "Lenders" is defined in) the Warehousing Agreement, pro rata in accordance with their respective Combined Percentage Shares, until the Secured Obligations are paid in full; and c. Then, to such Persons as may be legally entitled thereto. 3(l) Fees. The Company shall pay the following fees: ---- 10 (1) To the Administrative Agent for the account of each Lender, quarterly in advance, a non-refundable commitment fee equal to the product of (i) seven-twentieths of one percent (0.35%) per annum times (ii) such Lender's Maximum Commitment on the Effective Date and on the first Business Day of each calendar quarter thereafter, said fee to be payable (but only to the extent not previously paid under the Existing Credit Agreement) on the Effective Date for the period from such date to but not including January 1, 1998 and on the first Business Day of each January, April , July and October thereafter for the applicable calendar quarter (or portion thereof). (2) To the Administrative Agent for the account of each Lender, a non-refundable commitment fee equal to the product of (i) one- quarter of one percent (0.25%) times (ii) such Lender's Percentage Share of the Conversion Term Loan on the Conversion Date, said fee to be payable on the Conversion Date. (3) To the Administrative Agent for the account of each Lender which provides its written consent to an amendment, waiver or other modification of the Loan Documents on or before the date such amendment, waiver or other modification becomes effective as a result of the written approval thereof by the requisite number of Lenders required by the Loan Documents, a processing fee of $1,500.00, said fee to be payable promptly following such effective date; provided, however, that such fee shall not apply to the first two such amendments, waivers or other modifications hereunder during any continuous one year period (calculated from the date of this Agreement). (4) To the Administrative Agent and the Collateral Agent, such fees in such amounts and payable at such times as the Company and the Administrative Agent and the Company and the Collateral Agent, as applicable, may from time to time agree in writing. 3(m) Requirements of Law; Increased Costs. In the event that any ------------------------------------ applicable law, order, regulation, treaty or directive issued by any central bank or other Governmental Authority, or in the governmental or judicial interpretation or application thereof, or compliance by any Lender with any request or directive (whether or not having the force of law) issued subsequent to the date hereof by any central bank or other Governmental Authority: (1) Does or shall subject any Lender to any tax of any kind whatsoever with respect to this Agreement or any Loans made hereunder, or change the basis of taxation of payments to such Lender of principal, fee, interest or any other amount payable hereunder (except for change in the rate of tax on the overall net income of such Lender imposed by the jurisdiction in which such Lender maintains its principal office); (2) Does or shall impose, modify or hold applicable any reserve, capital requirement, special deposit, compulsory loan or similar requirements against assets held by, or deposits or other liabilities in or for the account of, advances or loans by, or other credit extended by, or any other acquisition of funds by, any office of such Lender which are not otherwise included in the determination of the Applicable 11 Eurodollar Rate, the Federal Funds Funding Rate, the Prime Rate or the Buy- Down Rate; or (3) Does or shall impose on such Lender any other condition; and the result of any of the foregoing is to increase the cost to such Lender of making, renewing or maintaining any Loan or to reduce any amount receivable in respect thereof or to reduce the rate of return on the capital of such Lender or any Person controlling such Lender, then, in any such case, the Company shall promptly pay to the Administrative Agent for remittance to such Lender, upon its written demand made through the Administrative Agent, any additional amounts necessary to compensate such Lender for such additional cost or reduced amounts receivable or rate of return as reasonably determined by such Lender with respect to this Agreement or Loans made hereunder. If a Lender becomes entitled to claim any additional amounts pursuant to this Paragraph 3(m), it shall promptly notify the Company through the Administrative Agent of the event by reason of which it has become so entitled. In conjunction with such notification, such Lender shall provide the Company with a certificate specifying any additional amounts payable pursuant to the foregoing sentence, which certificate shall set forth the calculation of such amounts in sufficient detail and according to reasonable and customary computation methods. The provisions hereof shall survive the termination of this Agreement and payment of all other Obligations. 3(n) Assumption of Funding. The Administrative Agent may (but --------------------- shall not be obligated to) assume that each Lender has made its Percentage Share of Revolving Loans available on the funding date therefor and may, in reliance on such assumption, make available to the Company on such date a corresponding amount. If and to the extent any Lender shall not have made such amount available, such Lender and the Company jointly and severally agree to repay to the Administrative Agent forthwith on demand such amount together with interest thereon for each date from the date such amount is funded by the Administrative Agent until the date such amount is repaid to the Administrative Agent at the Federal Funds Funding Rate. If such Lender shall repay to the Administrative Agent such amount, such amount shall constitute such Lender's Percentage Share of such Loan for all purposes of the Loan Documents. 3(o) Mark-to-Market Requirement. At any time on the Business Day -------------------------- following telephonic request therefor by the Administrative Agent at the request of any Lender from time to time, the Company will provide to each Lender a Borrowing Base Certificate setting forth the Fair Market Value of the Borrowing Base as of the end of the preceding Business Day and the aggregate dollar amount of Loans outstanding on such date. In the event the aggregate dollar amount of Loans outstanding exceeds the Fair Market Value of the Borrowing Base, the Company shall immediately pay to the Administrative Agent for distribution to the Lenders as provided in Paragraph 3(k)(2) above the full amount of such excess. 12 4. Reaffirmation of Security Agreement; Pledge Agreement; Additional ----------------------------------------------------------------- Documents. - --------- 4(a) Security Agreement. As collateral security for the ------------------ Obligations of the Company under (and as the term "Obligations" is defined in) the Existing Credit Agreement, the Company executed and delivered to the Collateral Agent that certain Security and Collateral Agency Agreement dated as of October 24, 1994 (as amended from time to time, the "Existing Security Agreement"). The Company hereby confirms that the first priority, perfected security interest of the Collateral Agent for the benefit of the Lenders participating in the Existing Credit Agreement shall continue in full force and effect with respect to all Obligations hereunder. On or before the Effective Date, the Existing Security Agreement shall be amended and, for convenience of reference, restated in its entirety with a replacement security agreement in the form of that attached hereto as Exhibit B (as amended, extended or replaced from --------- time to time, the "Security Agreement"), which Security Agreement shall continue the perfection and priority of the security interest of the Collateral Agent for the benefit of the Lenders in the Collateral thereunder. In addition, there shall be delivered to the Collateral Agent such acknowledgment agreements, or reaffirmations of existing acknowledgment agreements, of investors under servicing contracts included in the Assigned Servicing Rights as the Collateral Agent may request (the "Required Investor Consents"). 4(b) Pledge Agreement. As additional collateral security for the ---------------- Obligations and the Obligations of the Company under (and as the term "Obligations" is defined in) the Warehousing Agreement, the Company shall execute and deliver to the Collateral Agent: (1) a pledge agreement in the form of that attached hereto as Exhibit C (as amended, extended or replaced from time --------- to time, the "Pledge Agreement") pursuant to which the Company shall assign, transfer and pledge to the Collateral Agent for the benefit of the Lenders a first priority security interest in and lien upon all now owned and hereafter issued or acquired stock of all now existing and hereafter formed or acquired Subsidiaries of the Company, including, without limitation, all outstanding capital stock of HMSI, (2) stock certificates evidencing all outstanding capital stock of Subsidiaries of the Company existing on the Effective Date and undated blank stock transfer powers therefor, and (3) such UCC-1 financing statements as the Administrative Agent shall require (collectively, the "Stock Pledge Documents"). 4(c) Further Documents. The Company agrees to execute and ----------------- deliver or to cause to be executed and delivered to the Administrative Agent on behalf of the Lenders from time to time such confirmatory or supplementary security agreements, financing statements, acknowledgments, consents and notices to third parties and other documents, instruments or agreements as the Administrative Agent on behalf of the Lenders may reasonably request, which are in the Administrative Agent's reasonable judgment necessary or desirable to obtain for the Lenders the benefit of the Loan Documents and the Collateral and the Pledged Collateral. 13 5. Conditions to Making of Loans. ----------------------------- 5(a) First Loan. As conditions precedent to the effectiveness of ---------- this Agreement and the other Loan Documents and to each Lender's obligation to make the first Loan hereunder: (1) The Company shall have delivered or shall have had delivered to the Administrative Agent, in form and substance satisfactory to the Lenders and their counsel, each of the following (with sufficient copies for each of the Lenders): (i) A duly executed copy of this Agreement; (ii) Duly executed copies of the Notes; (iii) A duly executed copy of the Security Agreement; (iv) Copies of the Required Investor Consents duly executed by the Company; (v) A duly executed copy of the Pledge Agreement and the other Stock Pledge Documents; (vi) Duly executed copies of all financing statements and other documents, instruments and agreements, properly executed, deemed necessary or appropriate by the Administrative Agent, in its reasonable discretion, to obtain and maintain in favor of the Collateral Agent for the benefit of the Lenders a perfected security interest in and lien upon the Collateral and the Pledged Collateral; (vii) Such credit applications, financial statements, authorizations and information concerning the Company and its business, operation and condition (financial and otherwise) as any Lender may reasonably request; (viii) Certified copies of resolutions of the Board of Directors of the Company approving the execution and delivery of the Loan Documents, the performance of the Obligations and the consummation of the transactions contemplated thereby; (ix) A certificate of the Secretary or an Assistant Secretary of the Company certifying the names and true signatures of the officers of the Company authorized to execute and deliver the Loan Documents; (x) An opinion of counsel for the Company in form and substance satisfactory to the Administrative Agent and the Lenders; (xi) A certificate of an executive officer of the Company in the form of that attached hereto as Exhibit D dated as of --------- the date of this Agreement; 14 (xii) Evidence satisfactory to the Administrative Agent that the Operating Account has been opened; and (xiii) A Borrowing Base Certificate, certified by the chief financial officer, treasurer or controller of the Company demonstrating that the Company is in compliance with the requirements of Paragraph 3(f) above (and assuming that all "Loans" outstanding under the Existing Credit Agreement are Loans outstanding hereunder, it being agreed and understood that on the Effective Date such "Loans' and all other "Obligations" under (and as defined in) the Existing Credit Agreement shall automatically be deemed to be Loans and Obligations hereunder). (2) All acts and conditions (including, without limitation, the obtaining of any necessary regulatory approvals and the making of any required filings, recordings or registrations) required to be done and performed and to have happened precedent to the execution, delivery and performance of the Loan Documents and to constitute the same legal, valid and binding obligations, enforceable in accordance with their respective terms, shall have been done and performed and shall have happened in due and strict compliance with all applicable laws. (3) All documentation, including without limitation, documentation for corporate and legal proceedings in connection with the transactions contemplated by the Loan Documents, shall be reasonably satisfactory in form and substance to the Administrative Agent and its counsel. (4) All fees required to be paid pursuant to Paragraph 3(l) above on or before the Effective Date shall have been paid prior to (or will be paid concurrently with) the making of the initial Loans hereunder. 5(b) All Loans. As conditions precedent to each Lender's --------- obligation to make any Loan hereunder, including the initial Loans and including the conversion of any Loan to another type of Loan or the continuation of any Eurodollar Loan after the end of its Eurodollar Interest Period, at and as of the date of the funding, conversion or continuation thereof: (1) There shall have been delivered to the Administrative Agent a Loan Request therefor; (2) The representations and warranties of the Company contained in the Loan Documents shall be accurate and complete in all respects as if made on and as of the date of such funding, conversion or continuance; (3) There shall not have occurred an Event of Default or Potential Default; and (4) Following the funding of the requested Loan: (i) the aggregate principal amount of Revolving Loans outstanding advanced by any Lender will 15 not exceed its respective Maximum Commitment, (ii) the aggregate principal amount of Revolving Loans outstanding advanced by all Lenders will not exceed the Revolving Loan Credit Limit, and (iii) the aggregate principal amount of Loans outstanding will not exceed the applicable limitations of Paragraphs 1(a) and 1(b) above. By delivering a Loan Request to the Administrative Agent hereunder, the Company shall be deemed to have represented and warranted the accuracy and completeness of the statements set forth in subparagraphs (b)(2) through (b)(4) above. 6. Representations and Warranties of the Company. --------------------------------------------- As an inducement to the Agent and each Lender to enter into this Agreement and to make Loans as provided herein, the Company represents and warrants to the Agent and each Lender that: 6(a) Financial Condition. The financial statements, dated the ------------------- Statement Date and the Interim Date, copies of which have heretofore been furnished to each Lender, are complete and correct and present fairly in accordance with GAAP, the financial condition of the Company and its consolidated Subsidiaries, at such dates and the consolidated results of their operations and changes in financial position for the fiscal periods then ended. 6(b) No Change. Since each of the Statement Date and the --------- Interim Date, there has been no material adverse change in the business, operations, assets or financial or other condition of the Company or the Company and its consolidated Subsidiaries taken as a whole. 6(c) Corporate Existence; Compliance with Law. The Company and ---------------------------------------- each of its Subsidiaries: (1) is duly organized, validly existing and in good standing as a corporation under the laws of the State of California and is qualified to do business in each jurisdiction where its ownership of property or conduct of business requires such qualification and where failure to qualify could have a material adverse effect on the Company or its property and/or business or on the ability of the Company to pay or perform the Obligations, (2) has the corporate power and authority and the legal right to own and operate its property and to conduct business in the manner in which it does and proposes so to do, and (3) is in compliance with all Requirements of Law and Contractual Obligations, the failure to comply with which could have a material adverse effect on the business, operations, assets or financial or other condition of the Company or the Company and its consolidated Subsidiaries taken as a whole or on the Collateral or the Fair Market Value thereof. 6(d) Corporate Power; Authorization; Enforceable Obligations. ------------------------------------------------------- The Company has the corporate power and authority and the legal right to execute, deliver and perform the Loan Documents and borrow thereunder, and has taken all necessary corporate action to authorize the execution, delivery and performance of the Loan Documents and borrowing thereunder. The Loan Documents have been duly executed and delivered on behalf of the Company and constitute legal, valid and binding obligations of the Company enforceable against the Company in accordance with their respective terms, subject to the effect of applicable 16 bankruptcy and other similar laws affecting the rights of creditors generally and the effect of equitable principles whether applied in an action at law or a suit in equity. 6(e) No Legal Bar. The execution, delivery and performance of ------------ the Loan Documents, the borrowing thereunder and the use of the proceeds thereof, will not violate any Requirement of Law or any Contractual Obligation of the Company or any of its Subsidiaries or create or result in the creation of any Lien (except the Liens created by the Security Agreement and the Pledge Agreement) on any assets of the Company or any of its Subsidiaries. 6(f) No Material Litigation. Except as disclosed on Exhibit E ---------------------- --------- attached hereto, no litigation, investigation or proceeding of or before any arbitrator or Governmental Authority or any other Person is pending or, to the knowledge of the Company, threatened by or against the Company or any of its Subsidiaries or against any of such Persons' properties or revenues which (1) is likely to be adversely determined and which, if adversely determined, is likely to have a material adverse effect on the business, operations, property or financial or other condition of the Company or any of its Subsidiaries or (2) questions the validity or enforceability of any of the Loan Documents. 6(g) Taxes. The Company and each of its Subsidiaries have filed ----- or caused to be filed all tax returns that are required to be filed and have paid all taxes shown to be due and payable on said returns or on any assessments made against them or any of their property other than taxes which are being contested in good faith by appropriate proceedings and as to which the Company or applicable Subsidiary has established adequate reserves in conformity with GAAP. 6(h) Investment Company Act. The Company is not an "investment ---------------------- company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended. 6(i) Subsidiaries. Attached hereto as Exhibit F is an accurate ------------ --------- and complete list of all presently existing Subsidiaries of the Company, their respective jurisdictions of incorporation and the percentage of their capital stock owned by the Company or other Subsidiaries of the Company. All of the issued and outstanding shares of capital stock of such Subsidiaries have been duly authorized and issued and are fully paid and non-assessable. 6(j) Federal Reserve Board Regulations. Neither the Company nor --------------------------------- any of its Subsidiaries is engaged or will engage, principally or as one of its important activities, in the business of extending credit for the purpose of "purchasing" or "carrying" any "margin stock" within the respective meanings of such terms under Regulation U. No part of the proceeds of any Loan made hereunder will be used for "purchasing" or "carrying" "margin stock" as so defined or for any purpose which violates, or which would be inconsistent with, the provisions of the Regulations of the Board of Governors of the Federal Reserve System. 6(k) ERISA. The Company and each of its ERISA Affiliates are in ----- compliance in all respects with the requirements of ERISA and no Reportable Event has occurred 17 under any Plan maintained by the Company or any of its ERISA Affiliates which is likely to result in the termination of such Plan for purposes of Title IV of ERISA. 6(l) Assets. The Company and each of its Subsidiaries has good ------ and marketable title to all property and assets reflected in the financial statements referred to in Paragraph 6(a) above, including without limitation, the Collateral, except property and assets sold or otherwise disposed of in the ordinary course of business subsequent to the respective dates thereof. Neither the Company nor any of its Subsidiaries has outstanding Liens on any of its properties or assets, including, without limitation, the Collateral and the Pledged Collateral, nor are there any security agreements to which the Company or any of its Subsidiaries is a party, or title retention agreements, whether in the form of leases or otherwise, of any personal property except as reflected in the financial statements referred to in Paragraph 6(a) above or as permitted under Paragraph 8(a) below. 6(m) Securities Acts. The Company has not issued any --------------- unregistered securities in violation of the registration requirements of Section 5 of the Securities Act of 1933, as amended, or any other law, and is not violating any rule, regulation or requirement under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended. The Company is not required to qualify an indenture under the Trust Indenture Act of 1939, as amended, in connection with its execution and delivery of the Notes. 6(n) Consents, etc. No consent, approval or authorization of, ------------- or registration, declaration or filing with, any Governmental Authority or any other Person is required on the part of the Company in connection with the execution and delivery of the Loan Documents (other than filings to perfect the Liens granted pursuant to the Security Agreement) or the performance of or compliance with the terms, provisions and conditions hereof or thereof or any borrowing hereunder or to assure the validity and enforceability of any of the Loan Documents. 6(o) Hedging Program. The Company's Hedging Program --------------- represents a reasonable means for the Company to hedge certain interest rate risks associated with the mortgage banking business, and is a customary and standard Hedging Program comparable to that of other mortgage banking companies. The Company shall not alter or modify its Hedging Program without the consent of the Majority Lenders; provided, however, that consent shall be deemed given to any new Hedging Program proposed in writing by the Company to the Lenders if the Company is not notified of the objection to such new Hedging Program by Lenders holding at least 33.3333% of the Aggregate Percentage Shares within five (5) Business Days of receipt of notice thereof from the Company. 7. Affirmative Covenants. The Company hereby covenants and agrees --------------------- with the Administrative Agent and each Lender that, as long as any Obligations remain unpaid or any Lender has any obligation to make Loans hereunder, the Company shall: 7(a) Financial Statements. Furnish or cause to be furnished to -------------------- the Administrative Agent and each Lender directly: 18 (1) Within ninety-one (91) days after the last day of each fiscal year of the Company, consolidated and consolidating statements of income and cash flows for such year and balance sheets as of the end of such year of the Company and its Subsidiaries presented fairly in accordance with GAAP and accompanied by an unqualified report of a firm of independent certified public accountants acceptable to the Administrative Agent and including therewith a copy of any management letter from such certified public accountants; and (2) Within thirty (30) days after the last day of each calendar month, consolidated and consolidating statements of income and cash flows for such month and balance sheets as of the end of such month of the Company and its Subsidiaries, accompanied in each case by a certificate of the chief financial officer, treasurer or controller of the Company in the form of that attached hereto as Exhibit G, stating that such financial --------- statements are prepared fairly in accordance with GAAP and demonstrating in detail satisfactory to the Administrative Agent the Company's compliance with the financial covenants set forth in Paragraphs 8(f), 8(j), 8(k), 8(l), 8(m), 8(n) and 8(o) below as of and at the end of such month, and indicating whether the Company has been audited by any of FNMA or FHLMC (or GNMA if the Company becomes an approved GNMA issuer). 7(b) Certificates; Reports; Other Information. Furnish or cause ---------------------------------------- to be furnished to the Collateral Agent, the Administrative Agent and each of the Lenders directly: (1) (i) No later than thirty (30) days after the last day of each calendar month (setting forth information as of the last day of the immediately preceding month), and at such other times as the Administrative Agent or Majority Lenders may reasonably request, a. a Borrowing Base -- Certificate (which shall be in addition to the Borrowing Base Certificates delivered pursuant to Paragraph 3(o) above), and b. a pipeline report, -- commitment position report, servicing delinquency report, use of proceeds report and production report; all of the foregoing to be in form and substance satisfactory to the Administrative Agent and certified as accurate and complete by a financial officer of the Company; (2) Within five (5) Business Days of submission thereof by the Company, copies of all documents submitted in connection with any audits by any of FNMA or FHLMC (or GNMA if the Company becomes an approved GNMA issuer), and, within ten (10) Business Days of receipt thereof by the Company, copies of all compliance and audit reports received from any of FNMA or FHLMC (or GNMA if the Company becomes an approved GNMA issuer), and, within two (2) Business Days of receipt thereof by the Company, copies of all notices received from FNMA or FHLMC (or GNMA if the Company becomes an approved GNMA issuer), of any change in agency status or notices of any withdrawal of approval of the Company as an issuer of Mortgage-Backed Securities or a servicer of Mortgage Loans; 19 (3) No later than the last Business Day of the first month following the end of each calendar quarter, and at such other times as the Administrative Agent may reasonably request, a Servicing Contract Report demonstrating to the satisfaction of the Administrative Agent that: (i) the Assigned Servicing Rights which are included in the Borrowing Base have a Collateral Value of not less than the aggregate amount of Loans outstanding; and (ii) the Mortgage Loans which are included in the Eligible Servicing Portfolio have an outstanding principal balance of not less than the amount required by Paragraph 8(l) below; (4) Prior to the consummation thereof, notice of any bulk sale of servicing rights owned by the Company with an outstanding principal balance in excess of $50,000,000.00; (5) Promptly, such additional financial and other information, including, without limitation, financial statements of the Company and information regarding the Collateral, as any Lender, through the Administrative Agent, may from time to time reasonably request, including, without limitation, such information as is necessary for any Lender to assign or participate out any of its interests in the Loans hereunder or to enable other financial institutions to become signatories hereto; and (6) Promptly, and on a best efforts basis only, such additional financial and other information regarding any Affiliate of the Company, any Approved Investor (other than FNMA or FHLMC) or any Approved Repo Lender as any Lender, through the Administrative Agent, may from time to time reasonably request. 7(c) Payment of Indebtedness. And shall cause each of its ----------------------- Subsidiaries to, pay, discharge or otherwise satisfy at or before maturity or before it becomes delinquent, defaulted or accelerated, as the case may be, all its Indebtedness (including taxes), except Indebtedness being contested in good faith by appropriate proceedings and for which provision is made to the satisfaction of the Administrative Agent for the payment thereof in the event the Company is found to be obligated to pay such Indebtedness and which Indebtedness is thereupon promptly paid by the Company. 7(d) Maintenance of Existence and Properties. And shall cause --------------------------------------- each of its Subsidiaries to, maintain its corporate existence and obtain and maintain all rights, privileges, licenses, approvals, franchises, properties and assets necessary or desirable in the normal conduct of its business, including but not limited to all approvals with respect to FNMA, FHLMC, FHA and VA, as applicable, and comply with all Contractual Obligations and Requirements of Law, the failure to comply with which could have a material adverse effect on the business, operations, property or financial or other condition of the Company or any of its Subsidiaries or on the Collateral. The Company will at all times be a FNMA and FHLMC approved Seller/Servicer. 20 7(e) Inspection of Property; Books and Records; Audits. And ------------------------------------------------- shall cause each of its Subsidiaries to: (1) Keep proper books of record and account in which full, true and correct entries in conformity with GAAP and all Requirements of Law shall be made of all dealings and transactions in relation to its business and activities; and (2) Permit representatives of the Administrative Agent or any Lender (at no cost or expense to the Company or any Subsidiary unless there shall have occurred and be continuing an Event of Default), upon the giving of reasonable prior written notice to: (i) visit and inspect any of its properties and examine and make abstracts from any of its books and records at any reasonable time and as often as may reasonably be desired by the Administrative Agent or any Lender, (ii) discuss the business, operations, properties and financial and other condition of the Company and any of its Subsidiaries with officers and employees of such Persons, and with their independent certified public accountants and (iii) conduct periodic operational audits of the Company's and its Subsidiaries' business and/or operations. 7(f) Notices. Promptly give written notice to each Lender of: ------- (1) The occurrence of any Potential Default or Event of Default and the proposed method of cure thereof; (2) Any litigation or proceeding affecting the Company or any of its Subsidiaries or the Collateral which (i) could have a material adverse effect on the Collateral or the business, operations, property, or financial or other condition of the Company or any of its Subsidiaries or (ii) questions the validity or enforceability of the Loan Documents; (3) A material adverse change in the business, operations, property or financial or other condition of the Company or any of its Subsidiaries; (4) Any changes in the following senior management positions of the Company: chief executive officer, manager of operations, manager of production, manager of secondary marketing, chief financial officer, and manager of servicing; and (5) Any loss of delegated underwriting status with any Approved Investor. 7(g) Expenses. Pay all reasonable out-of-pocket costs and -------- expenses (including fees and disbursements of counsel): (1) of the Administrative Agent and the Collateral Agent incident to the preparation, negotiation and administration of the Loan Documents, any amendments or waivers thereto, and the protection of the rights of the Lenders, the Administrative Agent and the Collateral Agent under the Loan Documents, and (2) of the Administrative Agent, the Collateral Agent and each of the Lenders incident to the enforcement of payment of the Obligations, whether by judicial proceedings or otherwise, including, without 21 limitation, in connection with bankruptcy, insolvency, liquidation, reorganization, moratorium or other similar proceedings involving the Company or a "workout" of the Obligations. Notwithstanding any provisions herein to the contrary, the obligations of the Company under this Paragraph 7(g) shall be effective and enforceable whether or not any Loan is advanced by any Lender hereunder and shall survive payment of all other Obligations. 7(h) Loan Documents. Comply with and observe all terms and -------------- conditions of the Loan Documents. 7(i) Insurance. And shall cause each of its Subsidiaries to, --------- obtain and maintain insurance with responsible companies in such amounts and against such risks as are usually carried by corporations engaged in similar businesses similarly situated, including, without limitation, errors and omissions coverage and fidelity coverage in form and substance acceptable under FNMA or FHLMC guidelines, and furnish the Administrative Agent on request full information as to all such insurance. 7(j) Tax Refund. Contribute any tax refund received by the ---------- Company in each fiscal year towards the capital of the Company. 8. Negative Covenants. The Company hereby covenants and agrees with ------------------ the Administrative Agent and each Lender that, as long as any Obligations remain unpaid or any Lender has any obligation to make Loans hereunder, the Company shall not at any time, directly or indirectly: 8(a) Liens. And shall not permit any of its Subsidiaries to, ----- create, incur, assume or suffer to exist any Lien upon the Collateral or the Pledged Collateral except as contemplated by the Security Agreement and the Pledge Agreement, respectively, or create, incur, assume or suffer to exist any Lien upon any of its other property and assets (including servicing rights) except: (1) Liens or charges for current taxes, assessments or other governmental charges which are not delinquent or which remain payable without penalty, or the validity of which are contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof, provided that the Company or such Subsidiary shall have set aside on its books and shall maintain adequate reserves for the payment of same in conformity with GAAP; (2) Liens, deposits or pledges made to secure statutory obligations, surety or appeal bonds, or bonds for the release of attachments or for stay of execution, or to secure the performance of bids, tenders, contracts (other than for the payment of borrowed money) or leases or for purposes of like general nature in the ordinary course of the Company's or such Subsidiary's business; (3) Purchase money security interests for property (except Mortgage Loans) hereafter acquired, conditional sale agreements, or other title retention agreements, with respect to property hereafter acquired; provided, however, that no such 22 security interest or agreement shall affect any servicing rights or extend to any property other than the property acquired; (4) Liens securing the "Obligations" under (and as that term is defined in) the Warehousing Agreement; and (5) Liens securing Permitted Other Secured Debt. 8(b) Indebtedness. And shall not permit any of its Subsidiaries ------------ to, create, incur, assume or suffer to exist, or otherwise become or be liable in respect of, any Indebtedness except: (1) The Obligations and the "Obligations" under (and as defined in) the Warehousing Agreement; (2) Indebtedness reflected in the financial statements referred to in Paragraph 6(a) above; (3) Trade debt incurred in the ordinary course of business, paid within forty-five (45) days after the same has become due and payable or which is being contested in good faith, provided provision is made to the satisfaction of the Administrative Agent for the eventual payment thereof in the event it is found that such contested trade debt is payable by the Company; (4) Indebtedness secured by Liens permitted under Paragraph 8(a) above; and (5) Permitted Other Debt. 8(c) Mandatory Commitments. Hold Take-Out Commitments and Hedge --------------------- Contracts in less than an aggregate amount necessary to provide for the sale and/or coverage of one hundred percent (100%) of all closed Mortgage Loans owned by the Company and held for sale. 8(d) Consolidation and Merger. And shall not permit any of its ------------------------ Subsidiaries to: (1) Liquidate or dissolve or enter into any consolidation or merger except, so long as both before and after the consummation thereof there shall not exist an Event of Default or Potential Default: (i) consolidations or mergers of a Subsidiary into the Company, with the Company being the surviving corporation, and (ii) the merger of Headlands Mortgage LLC into HMSI, with HMSI being the surviving corporation; or (2) Enter into any partnership, joint venture, syndicate or other combination which involves a material amount of the assets of, or could have a material 23 effect on the business, operation, property or financial or other condition of, the Company or such Subsidiary. 8(e) Acquisitions. And shall not permit any of its Subsidiaries ------------ to, purchase or acquire or incur liability for the purchase or acquisition of any or all of the assets or business of any Person, other than in the normal course of business for mortgage banking companies (it being expressly agreed and understood that the acquisition of servicing is a normal course of business activity). 8(f) Payment of Dividends. (1) Declare or pay any dividends -------------------- upon any shares of the Company's stock now or hereafter outstanding, except dividends payable in the capital stock of the Company, or (2) make any distribution of assets to its stockholders as such, whether in cash, property or securities, or (3) set aside any of its property for the purpose of doing any of the foregoing; provided, however, that the Company may pay dividends (i) if the Company maintains its status as a Subchapter S Corporation under the Code, for the purpose of payment of shareholder level taxes then due and payable in amounts no greater than necessary to allow each of its shareholders to pay his, her or its actual tax liabilities attributable to the inclusion of income of the Company in such shareholder's taxable income as set forth in his, her or its annual tax returns, and provided that the Company shall on a timely basis supply on request of the Administrative Agent or any Lender evidence demonstrating that (x) the amount of any such dividend does not exceed such actual tax liabilities and (y) the proceeds of any such dividend will be applied exclusively to the payment of such actual tax liabilities, and (ii) during any fiscal year of the Company, additional dividends and distributions in an aggregate amount not to exceed twenty percent (20%) of Pre-Tax Income of the Company for such fiscal year (calculated on a quarterly basis); and provided further, that no dividend payment otherwise permitted pursuant to subparagraph (i) or (ii) above shall be made if, immediately before or after giving effect to any such dividend payment, any Event of Default or Potential Default exists or would exist. 8(g) Purchase or Retirement of Stock. Acquire, purchase, redeem ------------------------------- or retire any shares of its capital stock now or hereafter outstanding. 8(h) Investments; Advances. And shall not permit any of its --------------------- Subsidiaries to, make or commit to make any advance, loan or extension of credit (other than Mortgage Loans made in the ordinary course of the Company's business) or capital contribution to, or purchase any stocks, bonds, notes, debentures or other securities of, or make any other investment in, any Person; provided, however, that the Company and its Subsidiaries may make or maintain Permitted Investments. 8(i) Sale of Assets. And shall not permit any of its -------------- Subsidiaries to, sell, lease, assign, transfer or otherwise dispose of any of its assets which are material (individually or in the aggregate) (other than obsolete or worn out property), whether now owned or hereafter acquired, other than in the ordinary course of business as presently conducted and at fair market value (it being expressly agreed and understood that the sale or other disposition of Mortgage- 24 Backed Securities and Mortgage Loans with or without servicing released and of mortgage servicing rights is in the ordinary course of business). 8(j) Liabilities to Net Worth Ratio. Permit its consolidated ------------------------------ ratio at any date of (1) Total Liabilities to Effective Net Worth to be more than 20.0:1.0, or (2) Total Liabilities to Adjusted Tangible Net Worth to be more than 8.0:1.0. 8(k) Minimum Net Worth. Permit at any date its consolidated: ----------------- (1) Effective Net Worth be less than $12,000,000.00; or (2) Adjusted Tangible Net Worth to be less than $46,100,000.00. 8(l) Servicing Portfolio. Permit: ------------------- (1) The aggregate outstanding principal balance of the Company's Eligible Servicing Portfolio, minus the aggregate outstanding principal balance of the Company's Encumbered Eligible Servicing Portfolio, to be less than $1,000,000,000.00, or (2) The aggregate outstanding principal amount of Mortgage Loans which the Company services for, and has a direct obligation to repurchase from, the applicable investor pursuant to a recourse arrangement to exceed $10,000,000.00. 8(m) Current Ratio. Permit its consolidated Current Ratio at ------------- any date to be less than 1.03:1.0. 8(n) Maximum Total Liabilities. Permit its consolidated Total ------------------------- Liabilities at any date to exceed the sum of: (1) one hundred percent (100%) of Cash and/or cash equivalents (excluding restricted cash), plus (2) ninety-eight percent (98%) of the outstanding principal balance of all "Eligible Mortgage Loans" other than "Eligible HELOC Assets" (as those terms are defined in the Warehousing Agreement), plus (3) ninety-five percent (95%) of the outstanding principal balance of all "Eligible HELOC Assets," plus (4) eighty percent (80%) of: (i) the outstanding principal balance of all Mortgage Loans excluded from the definition of "Eligible Mortgage Loan" under the Warehousing Agreement, and (ii) REO net of reserves, plus (5) eighty percent (80%) of its current advances and receivables, plus (6) the lesser of: (i) seventy percent (70%) multiplied by the Quoted Market Value of the Eligible Servicing Portfolio, and (ii) one percent (1%) of the outstanding principal balance of the Eligible Servicing Portfolio, plus (7) seventy percent (70%) of all REMIC-related Mortgage-Backed Securities held for sale and marked to market quarterly (as shown on the Company's financial statements), plus (8) fifty percent (50%) of the sum of: (i) all other securities held for investment (net of reserves), and (ii) excess servicing (as shown on the Company's financial statements). 8(o) Debt Service Cash Flow Coverage Ratio. Permit its ------------------------------------- consolidated Debt Service Cash Flow Coverage Ratio at any date after the Conversion Date to be less than 1.3:1.0. 25 8(p) Limitation on Other Business. And shall not permit any of ---------------------------- its Subsidiaries to, engage in any business other than mortgage banking and activities directly related thereto, or engage in the business of developing any real property. 9. Events of Default. Upon the occurrence of any of the following ----------------- events (an "Event of Default"): 9(a) The Company shall fail to pay any Obligation (including but not limited to any prepayment required pursuant to Paragraph 3(f) above) on the date when due; or 9(b) Any representation or warranty made or deemed made by the Company in any Loan Document or in connection with any Loan Document shall be inaccurate or incomplete in any respect on or as of the date made or deemed made; or 9(c) The Company shall fail to maintain its corporate existence or shall default in the observance or performance of any covenant or agreement contained in Paragraph 8 above or in the Security Agreement or the Pledge Agreement; or 9(d) The Company shall fail to observe or perform any other term or provision contained in the Loan Documents and such failure shall continue for thirty (30) days after the earlier to occur of (i) receipt by the Company of written notice of such failure, and (ii) the date the Company obtains knowledge of such failure; or 9(e) The Company or any of its Subsidiaries shall default in any payment of principal of or interest on any Indebtedness (other than the Obligations), or any other event shall occur, the effect of which other event is to permit such Indebtedness to be declared or otherwise to become due prior to its stated maturity; or 9(f) (1) The Company or any of its Subsidiaries shall commence any case, proceeding or other action (i) under any existing or future law of any jurisdiction, domestic or foreign, relating to bankruptcy, insolvency, reorganization or relief of debtors, seeking to have an order for relief entered with respect to it, or seeking to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, winding-up, liquidation, dissolution, composition or other relief with respect to it or its debts, or (ii) seeking appointment of a receiver, trustee, custodian or other similar official for it or for all or any substantial part of its assets, or the Company or any of its Subsidiaries shall make a general assignment for the benefit of its creditors; or (2) there shall be commenced against the Company or any of its Subsidiaries any case, proceeding or other action of a nature referred to in clause (1) above which (i) results in the entry of an order for relief or any such adjudication or appointment, or (ii) remains undismissed, undischarged or unbonded for a period of sixty (60) days; or (3) there shall be commenced against the Company or any of its Subsidiaries any case, proceeding or other action seeking issuance of a warrant of attachment, execution, distraint or similar process against all or substantially all of its assets which results in the entry of an order for any such relief which shall not have been vacated, discharged, stayed, satisfied or bonded pending appeal within sixty (60) days from the entry thereof; or (4) the Company or any of its Subsidiaries shall take any action in furtherance of, or indicating its consent to, approval of, or acquiescence in (other than in 26 connection with a final settlement), any of the acts set forth in clause (1), (2) or (3) above; or (5) the Company or any of its Subsidiaries shall generally not, or shall be unable to, or shall admit in writing its inability to, pay its debts as they become due; or 9(g) (1) Any Person shall engage in any "prohibited transaction" (as defined in Section 406 of ERISA or Section 4975 of the Code) involving any Plan, (2) any "accumulated funding deficiency" (as defined in Section 302 of ERISA), whether or nor waived, shall exist with respect to any Plan, (3) a Reportable Event shall occur with respect to, or proceedings shall commence to have a trustee appointed (or a trustee shall be appointed) to administer, or to terminate, any Single Employer Plan, which Reportable Event or institution of proceedings is, in the reasonable opinion of the Administrative Agent, likely to result in the termination of such Plan for purposes of Title IV of ERISA, and, in the case of a Reportable Event, the continuance of such Reportable Event unremedied for ten days after notice of such Reportable Event pursuant to Section 4043(a), (c) or (d) of ERISA is given or the continuance of such proceedings for ten days after commencement thereof, as the case may be, (4) any Single Employer Plan shall terminate for purposes of Title IV of ERISA, (5) any withdrawal liability to a Multiemployer Plan shall be incurred by the Company or any of its ERISA Affiliates or (6) any other event or condition shall occur or exist; and in each case in clauses (1) through (6) above, such event or condition, together with all other such events or conditions, if any, is likely to subject the Company or any of its ERISA Affiliates to any tax, penalty or other liabilities in the aggregate material in relation to the business, operations, property or financial or other condition of the Company or any of its ERISA Affiliates; or 9(h) One or more judgments or decrees in an aggregate amount in excess of $50,000.00 shall be entered against the Company or any of its Subsidiaries and all such judgments or decrees shall not have been vacated, discharged, stayed, satisfied or bonded pending appeal within sixty (60) days from the entry thereof; or 9(i) Peter Paul and Dennis Hart shall collectively cease to own at least fifty-one percent (51%) of the outstanding shares of capital stock of the Company; or 9(j) There shall occur a material adverse change in the business, operations, assets or financial or other conditions of the Company or the Company and its Subsidiaries taken as a whole from the condition thereof at the Effective Date; or 9(k) Any Person who is the holder of Subordinated Debt shall fail to perform such Person's obligations under or shall cease to comply with the terms of the subordination agreement covering such Subordinated Debt, or such Person shall attempt to terminate, rescind or revoke any such subordination agreement; THEN, automatically upon the occurrence of an Event of Default under Paragraph 9(f) above, and in all other cases, at the option of the Majority Lenders, the obligation of the Lenders to make Loans hereunder shall terminate and/or the principal balance of outstanding Loans and interest accrued but unpaid thereon and all other Obligations shall become immediately due and payable, without demand upon or presentment to the Company, which are expressly waived by the Company. 27 10. The Agents. ---------- 10(a) Appointment. Each Lender hereby irrevocably designates and ----------- appoints the Administrative Agent and the Collateral Agent (jointly and severally, the "Agents" or, individually, an "Agent") as the agent of such Lender under the Loan Documents and each Lender hereby irrevocably authorizes each Agent to take such action on its behalf under the provisions of the Loan Documents and to exercise such powers and perform such duties as are expressly delegated to such Agent by the terms of the Loan Documents, together with such other powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary elsewhere in the Loan Documents, no Agent shall have any duties or responsibilities except those expressly set forth in the Loan Documents or any fiduciary relationship with any Lender, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into the Loan Documents or otherwise exist against any Agent. The Company shall pay to each Agent such fees as each Agent and the Company may from time to time agree in writing. 10(b) Delegation of Duties. Each Agent may execute any of its -------------------- duties under the Loan Documents by or through agents or attorneys-in-fact and shall be entitled to advice of counsel concerning all matters pertaining to such duties. No Agent shall be responsible for the negligence or misconduct of any agents or attorneys-in-fact selected by it with reasonable care. 10(c) Exculpatory Provisions. No Agent nor any of its officers, ---------------------- directors, employees, agents, attorneys-in-fact or affiliates shall be (1) liable for any action lawfully taken or omitted to be taken by it or such Person under or in connection with the Loan Documents (except for its or such Person's own gross negligence or willful misconduct), or (2) responsible in any manner to any of the Lenders for any recitals, statements, representations or warranties made by the Company or any officer thereof contained in the Loan Documents or in any certificate, report, statement or other document referred to or provided for in, or received by any Agent under or in connection with, the Loan Documents or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of the Loan Documents or for any failure of the Company to perform its obligations thereunder. No Agent shall be under any obligation to any Lender to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, the Loan Documents or to inspect the properties, books or records of the Company. 10(d) Reliance. Each Agent shall be entitled to rely, and shall -------- be fully protected in relying, upon any note, writing, resolution, notice, consent, certification, affidavit, letter, cablegram, telegram, telecopy, telex or teletype message, statement, order or other document or telephone call or conversation reasonably believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons and upon advice and statements of legal counsel (including, without limitation, counsel to the Company), independent accountants and other experts selected by such Agent. Each Agent may deem and treat the payee of any Note as the owner thereof for all purposes until notified of an assignment pursuant to Paragraph 11(h) below. As to the Lenders: (1) each Agent shall be fully justified in failing or refusing to take any action under the Loan Documents unless it shall first receive such advice or 28 concurrence of the Majority Lenders or all of the Lenders, as appropriate, or it shall first be indemnified to its satisfaction by the Lenders ratably in accordance with their respective Percentage Shares against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any action (except for liabilities and expenses resulting from such Agent's gross negligence or willful misconduct), and (2) each Agent shall in all cases be fully protected in acting, or in refraining from acting, under the Loan Documents in accordance with a request of the Majority Lenders or all of the Lenders, as appropriate, and such request and any action taken or failure to act pursuant thereto shall be binding upon all the Lenders. 10(e) Notice of Default. No Agent shall be deemed to have ----------------- knowledge or notice of the occurrence of any Potential Default or Event of Default unless such Agent has received notice from a Lender or the Company referring to the Loan Documents, describing such Potential Default or Event of Default and stating that such notice is a "notice of default." In the event that any Agent receives such a notice, such Agent shall give notice thereof to the Lenders and the other Agent. Each Agent shall take such action with respect to such Potential Default or Event of Default as shall be reasonably directed by the Majority Lenders or all Lenders, as applicable; provided that, unless and until an Agent shall have received such directions, such Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Potential Default or Event of Default as it shall deem advisable in the best interest of the Lenders. 10(f) Independent Decisions. Each Lender expressly acknowledges --------------------- that neither of the Agents nor any of their respective officers, directors, employees, agents, attorneys-in-fact or Affiliates has made any representations or warranties to it and that no act by any Agent hereafter taken, including any review of the affairs of the Company, shall be deemed to constitute any representation or warranty by either Agent to any Lender. Each Lender represents to the Agents that it has, independently and without reliance upon either of the Agents or any other Lender, and based on such documents and information as it has deemed appropriate, made its own appraisal of and investigation into the business, operations, property, financial and other condition and creditworthiness of the Company and made its own decision to make its Loans hereunder and enter into this Agreement. Each Lender also represents that it will, independently and without reliance upon either Agent 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 analysis, appraisals and decisions in taking or not taking action under this Agreement, and to make such investigation as it deems necessary to inform itself as to the business, operations, property, financial and other condition and creditworthiness of the Company. Except for notices, reports and other documents expressly required to be furnished to the Lenders by an Agent under the Loan Documents, neither Agent shall have any duty or responsibility to provide any Lender with any credit or other information concerning the business, operations, property, financial and other condition or creditworthiness of the Company which may come into the possession of such Agent or any of its officers, directors, employees, agents, attorneys-in-fact or Affiliates. 10(g) Indemnification. The Lenders agree to indemnify each Agent --------------- in its capacity as such (to the extent not reimbursed by the Company and without limiting the 29 obligation of the Company to do so), ratably according to the respective amounts of their Percentage Shares, from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements (including, without limitation, attorneys fees) of any kind whatsoever which may at any time (including without limitation at any time following the payment of the Obligations) be imposed on, incurred by or asserted against such Agent in any way relating to or arising out of the Loan Documents or any documents contemplated by or referred to therein or the transactions contemplated thereby or any action taken or omitted by such Agent under or in connection with any of the foregoing; provided that no Lender shall be liable for the payment of any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from any Agent's gross negligence or willful misconduct. The provisions hereof shall survive the termination of this Agreement and the payment of the Obligations. 10(h) Agents in Their Individual Capacities. Each Agent and its ------------------------------------- Affiliates may make loans to, accept deposits from and generally engage in any kind of business with the Company as though such Agent were not an Agent hereunder. With respect to Loans made or renewed by them and any Note issued to them, the Agents shall have the same rights and powers under the Loan Documents as any Lender and may exercise the same as though they were not Agents hereunder and the terms "Lender" and "Lenders" shall include the Agents in their respective individual capacities if applicable. 10(i) Successor Agents. Either Agent may resign as an Agent under ---------------- the Loan Documents upon ninety (90) days' notice to the Lenders, the Company and the other Agent, and the Administrative Agent agrees that it will so resign in the event it ceases to hold any share of the Obligations. In addition, the Majority Lenders may, for cause, effective upon not less than ninety (90) days' notice to the Lenders, each Agent and the Company, remove and discharge either Agent from the performance of such Agent's duties under this Agreement and/or the Security Agreement. If any Agent shall resign or be removed, then within said ninety-day notice period the Majority Lenders shall appoint from among the Lenders a successor agent or if the Majority Lenders are unable to agree on the appointment of a successor agent, the applicable Agent shall appoint a successor agent for the Lenders (which successor agent, assuming that there does not exist a Potential Default or Event of Default, shall be reasonably acceptable to the Company), whereupon such successor agent shall succeed to the rights, powers and duties of the applicable Agent and the term "Administrative Agent" or "Collateral Agent" shall mean such successor agent, as applicable, effective upon its appointment, and the former Agent's rights, powers and duties as Agent shall be terminated, without any other or further act or deed on the part of such former Agent or any of the parties to this Agreement or any of the other Loan Documents or successors thereto. After any Agent's resignation or removal hereunder, the provisions of this Paragraph 10 shall inure to its benefit as to any actions taken or omitted to be taken by it while it was an Agent under the Loan Documents. 11. Miscellaneous Provisions. ------------------------ 11(a) No Assignment. The Company may not assign its rights or ------------- obligations under this Agreement and/or the other Loan Documents without the prior written 30 consent of one hundred percent (100%) of the Administrative Agent and the Lenders. Subject to the foregoing, all provisions contained in this Agreement or any document or agreement referred to herein or relating hereto shall inure to the benefit of each Lender, its successors and assigns, and shall be binding upon the Company, its successors and assigns. 11(b) Amendment. This Agreement and the other Loan Documents --------- may not be amended or terms or provisions hereof or thereof waived unless such amendment or waiver is in writing and signed by the Majority Lenders, the Administrative Agent and the Company; provided, however, that without the prior written consent of one hundred percent (100%) of the Lenders, the Administrative Agent and the Company, no amendment or waiver shall: (1) waive or amend any term or provision of Paragraph 8(f), 8(j), 8(k), 8(l), 8(m), 8(n) or 8(o) above, (2) reduce the principal of, or rate of interest on, the Loans or fees, (3) except as expressly contemplated by Paragraphs 11(h) and 11(k) below, modify the Revolving Loan Credit Limit, the Conversion Term Loan Credit Limit or the Maximum Commitment of any Lender, (4) modify the definition of "Majority Lenders", (5) extend or waive any scheduled payment date for any principal, interest or fees, or the Conversion Date, (6) amend this Paragraph 11(b), or (7) amend any provision of the Loan Documents which by its terms requires the consent or approval of one hundred percent (100%) of the Lenders; provided, further, that without the prior written consent of one hundred percent (100%) of the Lenders, the Administrative Agent, the Collateral Agent and the Company, no amendment or waiver shall amend or waive the definition of "Collateral Value of the Borrowing Base." It is expressly agreed and understood that the failure by the required Lenders to elect to accelerate amounts outstanding hereunder and/or to terminate the obligation of the Lenders to make Loans hereunder shall not constitute an amendment or waiver of any term or provision of this Agreement. 11(c) Cumulative Rights; No Waiver. The rights, powers and ---------------------------- remedies of the Lenders under the Loan Documents are cumulative and in addition to all rights, powers and remedies provided under any and all agreements among the Company and the Lenders relating hereto, at law, in equity or otherwise. Any delay or failure by the Administrative Agent, the Collateral Agent or the Lenders to exercise any right, power or remedy shall not constitute a waiver thereof and no single or partial exercise by the Administrative Agent, the Collateral Agent or the Lenders of any right, power or remedy shall preclude any other or further exercise thereof or any exercise of any other rights, powers or remedies. 11(d) Entire Agreement. The Loan Documents and the documents ---------------- and agreements referred to therein embody the entire agreement and understanding between the parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof and thereof. 11(e) Survival. All representations, warranties, covenants -------- and agreements herein contained on the part of the Company shall survive the termination of this Agreement and shall be effective until the Obligations are paid and performed in full or longer as expressly provided herein. 31 11(f) Notices. All notices given by any party to the others ------- shall be in writing unless otherwise provided for herein, delivered personally or by depositing the same for delivery on the following Business Day, charges prepaid, addressed to such party at the address set forth on Schedule I hereto, ---------- or by telefacsimile (and except for Loan Requests, to be confirmed by mailed copy). Any party may change the address to which notices are to be sent by notice of such change to each other party given as provided herein. Such notices shall be effective on the date received or, if deposited for overnight delivery, on the Business Day following the date mailed. 11(g) Governing Law. This Agreement shall be governed by and ------------- construed in accordance with the laws of the State of California. 11(h) Assignment; Addition of New Lender. ---------------------------------- (1) The Company or any Lender may at any time propose that one or more commercial banks each of which is organized under the laws of the United States or any State thereof or organized under the laws of any other country, or a political subdivision thereof (provided that such foreign bank is acting through a branch or agency located in the United States, or is organized under the laws of a country that is a member of the Organization for Economic Cooperation and Development or a political subdivision of such country), is regularly engaged in the business of mortgage warehouse lending, has capital and surplus of at least $300,000,000.00, and is acceptable to the existing Lenders (each, an "Applicant Financial Institution") become an additional Lender hereunder. At such time, the Company or such Lender, as applicable, shall notify the other parties hereto, including the Administrative Agent, of such Applicant Financial Institution's proposed Maximum Commitment (which must be not less than $2,000,000.00). The addition of any Applicant Financial Institution shall be subject to: (i) The prior written consent of the Administrative Agent (and if such Applicant Financial Institution is proposed for inclusion as a Lender hereunder by a Lender, the prior written consent of the Company), which consents shall not be unreasonably withheld or delayed and which, if given, shall be given in writing by the Administrative Agent (and, if applicable, the Company) to the other Lenders no later than the tenth day following receipt by the Administrative Agent (and, if applicable, the Company) of a written request for the inclusion of such Applicant Financial Institution as a Lender hereunder; (ii) If such Applicant Financial Institution will be acquiring a portion of an existing Lender's Maximum Commitment by way of an assignment from such existing Lender, such existing Lender holding a Maximum Commitment of not less than $2,000,000.00 following the consummation of the contemplated assignment; and (iii) Delivery of each of the items and the occurrence of each of the events described in subparagraph (2) below. 32 (2) Assuming delivery of any consents required pursuant to subparagraph (1)(i) above, the Administrative Agent and the Company shall mutually agree on the Adjustment Date on which such Applicant Financial Institution shall become a party hereto and a Lender hereunder. On such Adjustment Date: (i) The Company shall deliver to the Administrative Agent and each of the Lenders a schedule to be effective from such Adjustment Date, with such schedule to reflect the Lenders' respective Maximum Commitments and Percentage Shares. (ii) Such Applicant Financial Institution shall pay to the Administrative Agent, no later than 12:00 noon (Los Angeles time), an amount equal to such Applicant Financial Institution's Percentage Share of Loans outstanding to be funded on such Adjustment Date, as applicable. The Administrative Agent shall thereupon remit to the Lenders their respective shares of such funds, as applicable. Following such Adjustment Date, fees and interest accrued on Loans to but not including such Adjustment Date shall be payable to the Lenders in accordance with their respective Percentage Shares prior to such Adjustment Date before giving effect to the readjustment thereof pursuant to the schedule provided by the Company on such Adjustment Date. (iii) The Administrative Agent, the Company and such Applicant Financial Institution shall execute and deliver an agreement in the form of that attached hereto as Exhibit H (an --------- "Additional Lender Agreement"), which agreement shall constitute an amendment to this Agreement to the extent necessary to reflect the inclusion of such Applicant Financial Institution as a Lender hereunder. In addition, if in connection with the inclusion of such Applicant Financial Institution as a Lender hereunder, the Revolving Loan Credit Limit will be increased, the parties hereto will execute any additional amendments to the Loan Documents as the Administrative Agent reasonably requests to reflect such increase. (iv) The Company shall execute and deliver a new Note to such Applicant Financial Institution. (v) Subject to the requirements described above, such Applicant Financial Institution shall become a party hereto and a Lender hereunder and shall be entitled to all rights, benefits and privileges accorded a Lender hereunder and under the other Loan Documents and shall be subject to all obligations of a Lender hereunder and under the other Loan Documents. (vi) The Applicant Financial Institution shall pay to the Administrative Agent a registration fee of $2,500.00 (said fee covering the admission of the Applicant Financial Institution into this Agreement). 11(i) Sub-Participations by Lenders. Any Lender may at any ----------------------------- time sell to one or more Persons (each of such Persons being herein called a "Participant") participating 33 interests in any of the Obligations held by such Lender and its commitments hereunder; provided, however, that: (1) No participation contemplated by this Paragraph 11(i) shall relieve such Lender from its obligations hereunder or under any other Loan Document; (2) Such Lender shall remain solely responsible for the performance of such obligations and such Lender shall grant no voting rights to any Participant other than as to matters which require the approval of one hundred percent (100%) of the Lenders pursuant to Paragraph 11(b) above; and (3) The Company, the Administrative Agent, the Collateral 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 the Loan Documents; provided, however, that the Company acknowledges and agrees that each Participant shall be considered a Lender for purposes of Paragraphs 2(c), 2(d), 2(e) and 3(m) above. 11(j) Federal Reserve Bank. Notwithstanding the provisions of -------------------- Paragraphs 11(h) and 11(i) above, any Lender may at any time pledge or assign all or any portion of such Lender's rights under this Agreement and the other Loan Documents to a Federal Reserve Bank. 11(k) Increases in Availability. ------------------------- (1) From time to time the Company and any Lender (an "Increasing Lender") may agree, with the prior written consent of the Administrative Agent, which consent shall not be unreasonably withheld or delayed, to permanently or temporarily increase such Increasing Lender's Maximum Commitment, the dollar amount of any such increase being subject to the limitations specified in the defined term "Revolving Loan Credit Limit". Any such increase shall be in the minimum dollar amount of, with respect to such Lender's Maximum Commitment, $1,000,000.00 and integral multiples of $1,000,000.00 in excess thereof. The Company, the Administrative Agent and the Increasing Lender shall agree upon the Adjustment Date for such increase and if such increase is a temporary rather than permanent increase, the date on which said increase shall terminate (the "Temporary Increase Termination Date"). (2) On the Adjustment Date for any increase in availability provided by an Increasing Lender and as a condition precedent thereto, the Company shall pay to the Administrative Agent for the benefit of such Increasing Lender the full amount of any fees due in respect of such increase, which fees shall be pro rated based upon the actual days from such Adjustment Date to the Conversion Date or the Temporary Increase Termination Date, as the case may be, and shall deliver to the Administrative Agent and each Lender a schedule specifying the Maximum Commitment and Percentage Share for each of the Lenders from such Adjustment Date. Any reallocation of Loans outstanding on such Adjustment Date necessitated by an increase in an Increasing Lender's Maximum Commitment shall be effected on and as of such 34 Adjustment Date by the purchase and sale among the Lenders of the Obligations outstanding on such date. (3) If said increase was a temporary rather than permanent increase, on the Temporary Increase Termination Date the aggregate amount of such Increasing Lender's Percentage Share of Loans outstanding in excess of its respective Maximum Commitment shall, if but only if at such Temporary Increase Termination Date there does not exist an Event of Default, be payable in full. If at such Temporary Increase Termination Date there exists an Event of Default, the temporary increase of the Increasing Lender shall continue in effect and, unless otherwise agreed by one hundred percent (100%) of the Lenders, shall be treated thereafter as a permanent increase in said Increasing Lender's Maximum Commitment. 11(l) Counterparts. This Agreement and the other Loan ------------ Documents may be executed in any number of counterparts, all of which together shall constitute one agreement. 11(m) Setoff; Sharing of Payments. Except as expressly --------------------------- provided in Paragraph 3(k) above, if any Lender shall receive and retain any payment, whether by setoff, application of deposit balance or security, or otherwise, in respect of the Obligations in excess of such Lender's Percentage Share thereof, then such Lender shall purchase from the other Lenders for cash and at face value and without recourse, such participation in the Obligations held by them as shall be necessary to cause such excess payment to be shared ratably as aforesaid with each of them; provided, that if such excess payment or part thereof is thereafter recovered from such purchasing Lender, the related purchases from the other Lenders shall be rescinded ratably and the purchase price restored as to the portion of such excess payment so recovered, but without interest. Each Lender agrees to exercise any and all rights of setoff, counterclaim or bankers' lien first fully against the Obligations held by such Lender, and only then to any other Indebtedness of the Company to such Lender; provided, however, that to the extent any Lender has a right of set-off, counterclaim or bankers' lien which arises specifically out of a relationship of such Lender with the Company which is not related to the Obligation (including the relationship under the Warehousing Agreement), such rights may be exercised first against any Indebtedness owing to such Lender arising out of such relationship and then against the Obligations held by such Lender. 11(n) Indemnification by the Company. ------------------------------ (1) In addition to the payment of expenses pursuant to Paragraph 7(g) above, whether or not the transactions contemplated hereby shall be consummated, the Company agrees to pay, and indemnify and hold harmless the Administrative Agent, the Collateral Agent and each Lender and any holder of any of the Obligations, and the shareholders, officers, directors, employees and agents of the Administrative Agent, the Collateral Agent, the Lenders and such holders (individually, an "Indemnitee" and collectively, the "Indemnitees") from and against, any and all other liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature whatsoever (including, without 35 limitation, the reasonable fees and disbursements of counsel for any Indemnitee in connection with any investigative, administrative or judicial proceeding, whether or not such Indemnitee shall be designated a party thereto), which may be imposed on, incurred by, or asserted against such Indemnitee, in any manner relating to or arising out of (i) the use or intended use of the proceeds of Loans hereunder, or (ii) any of the Loan Documents or the transactions contemplated by the Loan Documents, (iii) any funding or proposed funding, or arrangements to obtain funding, made available or proposed to have been made available, to the Company, or (iv) any action taken or omitted to be taken by any such Indemnitee pursuant to the Loan Documents (collectively, the "Losses"); provided, however, that the Company shall not be liable for any Losses resulting directly from the gross negligence or willful misconduct of the applicable Indemnitee. Attorneys' fees and disbursements incurred in enforcing, or on appeal from, a judgment pursuant hereto shall be recoverable separately from and in addition to any other amount included in such judgment, and this subparagraph is intended to be severable from the other provisions of this Agreement and to survive and not be merged into such judgment. (2) In the event that any Indemnitee asserts any Losses against the Company, such Indemnitee shall submit a proof of claim to the Company, and the Company shall promptly pay the full amount of such Losses in immediately available funds, or if such Losses have not yet been paid by such Indemnitee, such Indemnitee and the Company shall follow the procedures set forth in the next succeeding sentences of this subparagraph (2). If there is asserted any claim, liability or obligation that in the judgment of an Indemnitee may give rise to any Losses or if such Indemnitee determines the existence of the foregoing, whether or not the same shall have been asserted, such Indemnitee shall give the Company notice within thirty (30) Business Days in each case, of the assertion of any such claim, liability or obligation, or of receipt of notice of the filing or of any lawsuit based upon such assertion, or, with respect to a claim not yet asserted against such Indemnitee, of the determination by an executive officer of such Indemnitee of the existence of the same, and shall give Company a reasonable opportunity of assuming the defense of such claim, liability or obligation, using counsel acceptable to such Indemnitee; provided, however, that such Indemnitee shall have the right to participate in such defense, and to retain separate counsel. Failure by any Indemnitee to give timely notice pursuant to this subparagraph shall not relieve the Company of its obligations hereunder, except to the extent that the Company is actually prejudiced by such failure to give timely notice. No settlement or adjustment shall be made without the applicable Indemnitee's prior written consent, which consent will not be unreasonably withheld. If the Company fails to contest in good faith any such claim, liability or obligation, the applicable Indemnitee shall have the right to defend, settle or pay the same and pursue its remedies against the Company hereunder. Each Indemnitee shall cooperate with the Company in any such defense which the Company elects to assume in the event the Company makes such request to such Indemnitee and such request is reasonable, provided the Company will hold such Indemnitee harmless from all its out-of-pocket expenses, including attorneys' fees, incurred in connection with such cooperation. 36 (3) The provisions of this Paragraph 11(n) shall survive the termination of this Agreement and payment of all other Obligations. Attorneys' fees and disbursements incurred in enforcing, or on appeal from, a judgment pursuant hereto shall be recoverable separately from and in addition to any other amount included in such judgment, and this Paragraph 11(n) is intended to be severable from the other provisions of this Agreement and to survive and not be merged into such judgment. 11(o) Confidentiality. Each of the Administrative Agent and --------------- each Lender agrees to take normal and reasonable precautions and exercise due care to maintain the confidentiality of all non-public information provided to it by the Company (or by the Administrative Agent on the Company's behalf) in connection with the Loan Documents. The Administrative Agent or any Lender may disclose such information: (1) at the request of any Governmental Authority or in connection with an examination of the Administrative Agent or such Lender by any such Governmental Authority, (2) pursuant to subpoena or other court process, (3) when required to do so in accordance with the provisions of any Requirements of Law, (4) to the Administrative Agent's or such Lender's internal or independent auditors, counsel and other professional advisors, (5) if such information has become public other than through disclosure by the Administrative Agent or any Lender, (6) in connection with any litigation involving the Administrative Agent or any Lender, and (7) to any Affiliate of the Administrative Agent or such Lender. Notwithstanding the foregoing, the Company authorizes the Administrative Agent and each Lender to disclose to any Applicant Financial Institution or prospective or actual Participant such financial and other information in its possession (x) which has been delivered to the Administrative Agent and/or the Lenders pursuant to the Loan Documents or which has been delivered to any such Person by the Company prior to entering into the Loan Documents or (y) which is reasonably necessary to effectuate the purposes of this Agreement. 12. Definitions. For purposes of the Loan Documents, the terms set ----------- forth below shall have the following meanings: "Acceptable State" shall mean any state listed on a schedule of ---------------- "Acceptable States" mutually agreed by the Company and the Administrative Agent, with the consent of the "Majority Lenders" under the Warehousing Agreement, from time to time. "Additional Lender Agreement" shall have the meaning given such term --------------------------- in Paragraph 11(h)(2)(iii) above. "Adjusted Tangible Net Worth" shall mean, at any date: --------------------------- (a) Effective Net Worth; plus (b) The lesser of (i) one percent (1.00%) of the Eligible Servicing Portfolio and (ii) the Quoted Market Value of the Eligible Servicing Portfolio; minus (c) All assets which would be classified as intangible assets under GAAP, including, without limitation, purchased and capitalized value of servicing rights, 37 goodwill (whether representing the excess cost over book value of assets acquired or otherwise), patents, trademarks, service marks, trade names, copyrights, franchises and deferred charges (including, without limitation, unamortized debt discount and expense, organization costs and research and product development costs). "Adjustment Date" shall mean, with respect to the assignment of --------------- Obligations by any Lender, or the addition of an Applicant Financial Institution as a Lender hereunder pursuant to Paragraph 11(h) above, or the increase in availability by an Increasing Lender pursuant to Paragraph 11(k) above, the effective date thereof. "Administrative Agent" shall have the meaning given such term in the -------------------- introductory paragraph hereof. "Affiliate" shall mean, as to any Person, any other Person directly or --------- indirectly controlling, controlled by or under direct or indirect common control with, such Person. "Control" as used herein means the power to direct the management and policies of such Person. "Agent" shall have the meaning given such term in Paragraph 10(a) ----- above. "Agreement" shall mean this Agreement, as the same may be amended, --------- extended or replaced from time to time. "Applicable Eurodollar Rate" shall mean, with respect to any -------------------------- Eurodollar Loan for the Eurodollar Interest Period applicable to such Eurodollar Loan, the rate per annum (rounded upward, if necessary, to the next higher 1/16 of one percent (.06250%)) calculated in accordance with the following formula: ER +ES ----- Eurodollar Rate = 1 - ERP where ER = Eurodollar Rate ERP = Eurodollar Reserve Percentage ES = Eurodollar Spread "Applicable Federal Funds Rate" shall mean the Federal Funds Funding ----------------------------- Rate plus the Federal Funds Pricing Spread. "Applicant Financial Institution" shall have the meaning given such ------------------------------- term in Paragraph 11(h)(1) above. "Approved Investor" shall mean FNMA, FHLMC, GNMA or any other Person ----------------- pre-approved in writing (which pre-approval may be limited in dollar amount, by type and otherwise) pursuant to the Warehousing Agreement. 38 "Approved Private Investor" shall mean a bankruptcy-remote entity ------------------------- formed by or on behalf of the Company to acquire Mortgage Loans from the Company in connection with the securitization thereof, which entity is set forth in Exhibit L hereto or has been pre-approved in writing by one hundred percent (100%) of the Lenders and any bank or trust company acting as trustee in any such securitization. "Approved Repo Lender" shall mean any Approved Investor or any other -------------------- Person pre-approved in writing pursuant to the Warehousing Agreement. "Assigned Servicing Contract" shall mean a servicing contract between --------------------------- FNMA and the Company, FHLMC and the Company or an Approved Private Investor and the Company (including in each case all manuals, guides, laws, rules and regulations incorporated by reference or otherwise governing the terms of the relationship thereunder between the Company and FNMA, the Company and FHLMC or the Company and such Approved Private Investor, as applicable), as to which each of the following is accurate and complete (and the Company by including such servicing contract as part of the Encumbered Eligible Servicing Portfolio in any computation of the Collateral Value of the Borrowing Base shall be deemed to so represent and warrant to the Administrative Agent, the Collateral Agent and the Lenders at and as of the date of such computation): (a) Said servicing contract provides for the servicing by the Company of Mortgage Loans owned by FNMA, FHLMC or an Approved Private Investor, as applicable, and/or the servicing by the Company of Mortgage Loans in pools underlying Mortgage-Backed Securities (including, without limitation, participation certificates) issued by FNMA, FHLMC or such Approved Private Investor, as applicable, that represent interests in such pools; (b) Said servicing contract is in full force and effect, is genuine in all respects as appearing on its face or as represented in the books and records of the Company, is free of any default of the Company and of counterclaims, offsets and defenses and from any rescission, cancellation or avoidance, and all right thereof, whether by operation or law or otherwise, and there does not exist any fact or circumstance that would entitle FNMA, FHLMC or the Approved Private Investor party thereto, as applicable, to suspend or terminate said servicing contract with cause; (c) The assignment by the Company of its rights under said servicing contract as Collateral for the Obligations, consistent with the requirements of the Loan Documents, will not violate any Requirement of Law, the effect of which violation is to render void or voidable such assignment or to permit the suspension or termination of the rights of the Company under said servicing contract, and FNMA, FHLMC and/or the Approved Private Investor, as the case may be, has consented to the assignment of the applicable servicing contract pursuant to a Required Investor Consent; (d) The servicing obligations under said servicing contract are being performed, on a non-recourse basis, directly by the Company, or by a subservicer approved by the Majority Lenders; 39 (e) The Mortgage Loans being serviced under said servicing contract, to the extent included as part of the Encumbered Eligible Servicing Portfolio in any computation of the Collateral Value of the Borrowing Base, are not home equity loans, are not owned by the Company or, except in the case of Approved Private Investors, any Affiliate of the Company, and are all first priority Mortgage Loans; (f) Said servicing contract is not subject to any Liens except the Lien of the Security Agreement, which Lien is a first priority perfected Lien in favor of the Lenders; and (g) Said servicing contract, and the Mortgage Loans and pools of Mortgage Loans subject thereto, have been accurately described on a schedule to the Security Agreement. "Assigned Servicing Rights" shall mean all now existing and hereafter ------------------------- arising rights of the Company to service, collect and administer Mortgage Loans under the Assigned Servicing Contracts (whether directly or as assignee of the rights of the original servicer thereunder). "Book Net Worth" shall mean at any date consolidated net worth of the -------------- Company and its Subsidiaries determined in accordance with GAAP. "Borrowing Base" shall mean at any date all Assigned Servicing Rights -------------- of Assigned Servicing Contracts included in the Encumbered Servicing Portfolio in which the Collateral Agent for the benefit of the Lenders holds a first priority perfected security interest under the Security Agreement as collateral security for the Obligations. "Borrowing Base Certificate" shall mean a certificate in the form of -------------------------- that attached hereto as Exhibit I. --------- "Business Day" shall mean any day other than a Saturday, a Sunday or a ------------ day on which banks in Los Angeles, California, Chicago, Illinois, or New York, New York are authorized or obligated to close their regular banking business. "Buy-Down Deposits" shall mean, with respect to any calendar month, ----------------- the average daily amount of free collected balances maintained in non-interest bearing accounts in the name of the Company (or held by the Company in trust for third parties) with a Lender (after deducting float and balances required by such Lender under its normal practices to compensate such Lender for the maintenance of such accounts and taking into consideration reserve requirements (including but not limited to any FDIC premium) applicable to such accounts) and which balances are not included in determining "Buy-Down Deposits" or other similar classification under any other credit arrangements between such Lender and the Company. "Buy-Down Letter" shall mean a letter agreement between the Company --------------- and each Lender, individually, establishing the terms applicable to such Lender's agreement to make Loans hereunder at the Buy-Down Rate, including any applicable fees. 40 "Buy-Down Rate" shall mean one and one-half of one percent (1.50%) per ------------- annum. "Buy-Down Rate Loan" shall mean a Loan made and/or maintained at the ------------------ Buy-Down Rate. "Cash" shall mean the dollar amount of "Cash" of the Company set forth ---- in the most recent balance sheet of the Company. "Code" shall mean the Internal Revenue Code of 1986, as amended. ---- "Collateral" shall have the meaning given such term in Paragraph 2 of ---------- the Security Agreement. "Collateral Agent" shall have the meaning given such term in the ---------------- introductory paragraph hereof, or such other Person which may be designated as such in accordance with the terms of the Security Agreement. "Collateral Value of the Borrowing Base" shall mean at any date: -------------------------------------- (a) With respect to Assigned Servicing Rights under Assigned Servicing Contracts between the Company and FNMA or the Company and FHLMC, the lesser of: (1) Seventy percent (70%) multiplied by the Quoted Market Value of such Assigned Servicing Rights; or (2) Three-quarters of one percent (0.75%) multiplied by the aggregate outstanding principal balance of Mortgage Loans being serviced under such Assigned Servicing Rights on such date; and (b) With respect to Assigned Servicing Rights under Assigned Servicing Contracts between the Company and an Approved Private Investor, the least of: (1) Sixty-five percent (65%) multiplied by the Quoted Market Value of such Assigned Servicing Rights; (2) Seven-tenths of one percent (0.70%) multiplied by the aggregate outstanding principal balance of Mortgage Loans being serviced under such Assigned Servicing Rights on such date; or (3) Forty percent (40%) of the Revolving Loan Credit Limit on such date. "Combined Percentage Shares" shall have the meaning given such term in -------------------------- Paragraph 2 of the Pledge Agreement. 41 "Commonly Controlled Entity" of a Person shall mean a Person, whether -------------------------- or not incorporated, which is under common control with such Person within the meaning of Section 414(c) of the Code. "Company" shall have the meaning given such term in the introductory ------- paragraph hereof. "Contractual Obligation" as to any Person shall mean any provision of ---------------------- any security issued by such Person or of any agreement, instrument or undertaking to which such Person is a party or by which it or any of its property is bound. "Conversion Date" shall mean November 4, 1997. --------------- "Conversion Term Loan" shall have the meaning given such term in -------------------- Paragraph 1(b) above. "Conversion Term Loan Credit Limit" shall mean $8,000,000.00. --------------------------------- "Corporate Base Rate" shall mean a rate per annum equal to the ------------------- corporate base rate of interest publicly announced by FNBC from time to time, changing when and as said corporate base rate changes. "Current Ratio" shall mean at any date the ratio of current assets to ------------- current liabilities of the Company and its Subsidiaries, determined on a consolidated basis in accordance with GAAP; provided, however, that in determining the Company's current assets for purposes hereof, the aggregate outstanding principal amount of all loans and advances outstanding to officers and employees of the Company and its Subsidiaries shall be excluded. "Debt Service Cash Flow Coverage Ratio" shall mean at any date, as to ------------------------------------- the Company and its Subsidiaries, determined on a consolidated basis in accordance with GAAP, the net income after taxes minus all non-cash revenue items plus depreciation, amortization, rent expenses and interest expenses in connection with the Conversion Term Loan for the four consecutive immediately preceding calendar quarters, divided by the sum of rent expenses and the aggregate principal and interest amounts due under the Conversion Term Loan during the same period. "Effective Date" shall mean the date on which all of the conditions -------------- set forth in Paragraph 5(a) above are satisfied and the initial Loans shall be funded. "Effective Net Worth" shall mean at any date, as to the Company and ------------------- its Subsidiaries, (a) Book Net Worth (including the value of excess servicing net of reserves), minus (b) the aggregate outstanding principal amount of all loans and advances outstanding to officers and employees of the Company and its Subsidiaries, plus (c) the aggregate outstanding principal amount of all Subordinated Debt, minus (d) the capitalized value of the Company's servicing portfolio, minus (e) fifteen percent (15%) of the aggregate unpaid principal balance of all 42 Mortgage Loans held by the Company for long-term investment purposes, all determined on a consolidated basis in accordance with GAAP. "Eligible Servicing Portfolio" shall mean the Company's mortgage/trust ---------------------------- deed servicing portfolio, exclusive of the following: (a) any servicing of Mortgage Loans owned by the Company, (b) any servicing performed pursuant to subservicing arrangements (other than that technically styled as subservicing but performed under a contract directly between the Company and FNMA, FHLMC or the master servicer under a private mortgage-related security program), (c) any servicing of Mortgage Loans which the Company has a direct obligation to repurchase from the applicable investor pursuant to a recourse arrangement, (d) any servicing subject to any Lien (other than the Liens in favor of the Collateral Agent for the benefit of the Lenders under the Loan Documents), (e) any servicing of Mortgage Loans in foreclosure or the payments in respect of which are past due more than sixty (60) days, and (f) any servicing of Mortgage Loans which are not first priority Mortgage Loans and which have an aggregate outstanding principal balance in excess of $350,000,000.00. "Encumbered Eligible Servicing Portfolio" shall mean that portion of --------------------------------------- the Eligible Servicing Portfolio consisting of all Assigned Servicing Rights under all Assigned Servicing Contracts pledged from time to time as collateral security hereunder or under the Security Agreement. "ERISA" shall mean the Employee Retirement Income Security Act of ----- 1974, as the same may from time to time be supplemented or amended. "ERISA Affiliate" shall mean, with respect to any Person, any trade or --------------- business (whether or not incorporated) that is a member of the group of which such Person is a member and which is treated as a single employer under Section 414 of the Code and the rules and regulations thereunder in effect from time to time. "Eurodollar Business Day" shall mean a Business Day on which ----------------------- commercial banks in London, England are open for domestic and international business. "Eurodollar Interest Period" shall mean with respect to any Eurodollar -------------------------- Loan, the period commencing on the date advanced and ending fourteen days, one month, two months or three months thereafter, as designated in the related Loan Request; provided, however, that (a) any Eurodollar Interest Period which would otherwise end on a day which is not a Eurodollar Business Day shall be extended to the next succeeding Eurodollar Business Day unless by such extension it would fall in another calendar month, in which case such Eurodollar Interest Period shall end on the immediately preceding Eurodollar Business Day; (b) any one- month, two-month or three-month Eurodollar Interest Period which begins on a day for which there is no numerically corresponding day in the calendar month during which such Eurodollar Interest Period is to end shall, subject to the provisions of clause (a) above, end on the last day of such calendar month; and (c) no Eurodollar Interest Period shall extend beyond the Maturity Date. "Eurodollar Loans" shall mean Loans during such time as they are being ---------------- maintained at a rate of interest based upon the Eurodollar Rate. 43 "Eurodollar Rate" shall mean: (a) with respect to any fourteen-day --------------- Eurodollar Interest Period, the rate determined by the Administrative Agent as the rate at which deposits in immediately available U.S. dollars in an amount equal to the aggregate amount of Eurodollar Loans proposed to be subject to such rate having a maturity approximately equal to such Eurodollar Interest Period are offered by FNBC to first-class banks in the interbank market at or about 10:00 a.m. (Chicago time) two Eurodollar Business Days prior to the first day of such Eurodollar Interest Period, for delivery on the first day of such Eurodollar Interest Period, or (b) with respect to any one-month, two-month or three-month Eurodollar Interest Period, the rate at which deposits in immediately available U.S. dollars in an amount equal to the aggregate amount of Eurodollar Loans proposed to be subject to such rate and having a maturity approximately equal to such Eurodollar Interest Period are offered by FNBC to first-class banks in the London interbank market at approximately 11:00 a.m. (London time) two Eurodollar Business Days prior to the first day of such Eurodollar Interest Period, for delivery on the first day of such Eurodollar Interest Period. "Eurodollar Reserve Percentage" shall mean for any day, that ----------------------------- percentage, expressed as a decimal, which is in effect on such day, as specified by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum aggregate reserve requirement (including all basic, supplemental, marginal and other reserves) which is imposed on eurocurrency liabilities. "Eurodollar Spread" shall mean one and one-half of one percent ----------------- (1.50%). "Event of Default" shall have the meaning set forth in Paragraph 9 ---------------- above. "Existing Credit Agreement" shall have the meaning given such term in ------------------------- Recital A above. "Existing Security Agreement" shall have the meaning given such term --------------------------- in Paragraph 4(a) above. "Fair Market Value" shall mean at any date with respect to any ----------------- Assigned Servicing Rights, the Quoted Market Value thereof; provided, however, if a Servicing Contract Report is not delivered as required hereby, the term "Fair Market Value" shall mean such market value, expressed as a percentage, as the Majority Lenders shall, in their reasonable judgment, establish. "Federal Funds Funding Rate" shall mean for any Federal Funds Rate -------------------------- Loan on any day such Federal Funds Rate Loan is outstanding, the rate per annum equal to the consensus (or if no consensus exists, the arithmetic average) of the rates at which reserves are offered by first-class banks to other first- class banks at approximately 10:00 a.m. (Chicago time) on such day (or if such day is not a Business Day, on the immediately preceding Business Day) on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, received by the Administrative Agent from three Federal funds brokers of recognized standing selected by the Administrative Agent in its sole discretion. 44 "Federal Funds Pricing Spread" shall mean one and five-eighths of one ---------------------------- percent (1.625%). "Federal Funds Rate Loans" shall mean Loans during such time as they ------------------------ are being maintained at the Applicable Federal Funds Rate. "FHA" shall mean the Federal Housing Administration and any successor --- agency. "FHLMC" shall mean the Federal Home Loan Mortgage Corporation and any ----- successor agency. "FNBC" shall have the meaning given such term in the introductory ---- paragraph hereof. "FNMA" shall mean the Federal National Mortgage Association and any ---- successor agency. "Funding Account" shall mean Account No. 5268192 maintained in the --------------- Company's name alone with the Administrative Agent at its office at One First National Plaza, Chicago, Illinois 60670. "GAAP" shall mean generally accepted accounting principles in the ---- United States of America in effect from time to time. "GNMA" shall mean the Government National Mortgage Association and any ---- successor agency. "Governmental Authority" shall mean any nation or government, any ---------------------- state or other political subdivision thereof, or any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Hedge Contract" shall mean a bona fide, existing contract to buy or -------------- sell an instrument on the futures market, the options market or the forward mortgage-backed securities market or an option or financial future purchased over the counter for future delivery of such instrument, each of the above issued in accordance with the requirements of a Hedging Program. "Hedging Program" shall mean a program for hedging interest rate risks --------------- of the Company, which program shall provide, without limitation, that all Hedge Contracts will be placed with futures commission merchants or clearing houses, if applicable, with whom the Company has written, assignable agreements. "HMSI" shall mean Headlands Mortgage Securities, Inc., a Delaware ---- corporation. "HUD" shall mean the Department of Housing and Urban Development and --- any successor thereto. 45 "Increasing Lender" shall have the meaning given such term in ----------------- Paragraph 11(k) above. "Indebtedness" of any Person shall mean all items of indebtedness ------------ which, in accordance with GAAP and practices, would be included in determining liabilities as shown on the liability side of a statement of condition of such Person as of the date as of which indebtedness is to be determined, including, without limitation, all obligations for money borrowed and capitalized lease obligations, and shall also include all indebtedness and liabilities of others assumed or guaranteed by such Person or in respect of which such Person is secondarily or contingently liable (other than by endorsement of instruments in the course of collection) whether by reason of any agreement to acquire such indebtedness or to supply or advance sums or otherwise. "Interim Date" shall mean July 31, 1997. ------------ "Lender" shall have the meaning given such term in the introductory ------ paragraph hereof. "Lien" shall mean any security interest, mortgage, pledge, lien, claim ---- on property, charge or encumbrance (including any conditional sale or other title retention agreement), any lease in the nature thereof, and the filing of or agreement to give any financing statement under the Uniform Commercial Code of any jurisdiction. "Loan" shall mean a Revolving Loan or the Conversion Term Loan, as ---- applicable, and "Loans" shall mean all such Loans, collectively and severally. ----- "Loan Documents" shall mean this Agreement, the Notes, the Security -------------- Agreement, the Pledge Agreement, and each other document, instrument or agreement executed by the Company in connection herewith or therewith, as any of the same may be amended, extended or replaced from time to time. "Loan Request" shall mean a request in form acceptable to the ------------ Administrative Agent for a Loan which is conveyed to the Administrative Agent by telephone or telefax from a duly authorized officer of the Company, with such request to be confirmed in writing upon the request of the Administrative Agent. "Majority Lenders" shall mean: (a) prior to the occurrence of an ---------------- Event of Default and termination of the obligations of the Lenders to fund additional Loans hereunder, the Lenders holding not less than sixty-six and two- thirds percent (66.6666667%) of the Percentage Shares, and (b) thereafter, the Lenders holding not less than sixty-six and two-thirds percent (66.6666667%) of Loans outstanding. "Maximum Commitment" shall mean, with respect to any Lender, the ------------------ dollar amount set forth next to its signature below or as increased or decreased from time to time pursuant to the provisions of this Agreement and notified in writing to such Lender. 46 "Mortgage-Backed Security" shall mean (a) any security (including, ------------------------ without limitation, a participation certificate) guaranteed by GNMA that represents an interest in a pool of mortgages, deeds of trusts or other instruments creating a Lien on Property which is improved by a completed single family residence, including but not limited to a condominium, planned unit development or townhouse, (b) a security (including a participation certificate) issued by FNMA or FHLMC that represent interests in such a pool, and (c) a privately-placed security representing undivided interests in or otherwise supported by such a pool. "Mortgage Loan" shall mean a residential real estate secured loan, ------------- including, without limitation: (a) a promissory note, any reformation thereof and related deed of trust (or mortgage) and/or security agreement; (b) all guaranties and insurance policies, including, without limitation, all mortgage and title insurance policies and all fire and extended coverage insurance policies and rights of the Company to return premiums or payments with respect thereto; and (c) all right, title and interest of the Company in the Property covered by said deed of trust (or mortgage). "Multiemployer Plan" shall mean, as to the Company or any of its ERISA ------------------ Affiliates, a Plan of such Person which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA. "Notes" shall have the meaning given such term in Paragraph 3(c) ----- above. "Obligations" shall mean any and all debts, obligations and ----------- liabilities of the Company to the Administrative Agent, the Collateral Agent and the Lenders (whether now existing or hereafter arising, voluntary or involuntary, whether or not jointly owed with others, direct or indirect, absolute or contingent, liquidated or unliquidated, and whether or not from time to time decreased or extinguished and later increased, created or incurred), arising out of or related to the Loan Documents. "Obligor" shall mean the Person or Persons obligated to pay the ------- Indebtedness which is the subject of a Mortgage Loan. "Operating Account" shall mean Account No. 5240204 maintained in the ----------------- Company's name alone with the Administrative Agent at its office at One First National Plaza, Chicago, Illinois 60670. "Participant" shall have the meaning given such term in Paragraph ----------- 11(i) above. "Paul Subordinated Debt" shall mean that Indebtedness of the Company ---------------------- described in Paragraph 5 of the schedule of Permitted Other Debt. "PBGC" shall mean the Pension Benefit Guaranty Corporation established ---- pursuant to Subtitle A of Title IV of ERISA and any successor thereto. 47 "Percentage Share" shall mean, for any Lender at any date, that ---------------- percentage which (a) the dollar amount of such Lender's Maximum Commitment bears to (b) the Revolving Loan Credit Limit or the Conversion Loan Credit Limit, as applicable. "Permitted Investments" shall mean those investments of the Company --------------------- described on Exhibit J attached hereto. --------- "Permitted Other Debt" shall mean that Indebtedness of the Company -------------------- described as "Permitted Other Debt" on Exhibit K attached hereto. --------- "Permitted Other Secured Debt" shall mean that Indebtedness which is ---------------------------- the subject of a Lien and described as "Permitted Other Secured Debt" on Exhibit ------- K attached hereto. - - "Person" shall mean any corporation, natural person, firm, joint ------ venture, limited liability company, partnership, trust, unincorporated organization or Governmental Authority. "Plan" shall mean, as to the Company or any of its ERISA Affiliates, ---- any pension plan that is covered by Title IV of ERISA and in respect of which such Person or a Commonly Controlled Entity of such Person is an "employer" as defined in Section 3(5) of ERISA. "Pledge Agreement" shall have the meaning given such term in Paragraph ---------------- 4(b) above. "Pledged Collateral" shall mean the collateral which is the subject of ------------------ the Pledge Agreement. "Potential Default" shall mean an event which but for the lapse of ----------------- time or the giving of notice, or both, would constitute an Event of Default. "Pre-Disbursement Account" shall mean DCS Clearing Account No. 247165 ------------------------ maintained in the Administrative Agent's name with FNBC at its office at One First National Plaza, Chicago, Illinois 60670. "Pre-Tax Income" shall mean for any period the positive consolidated -------------- net income of the Company for such period, determined in accordance with the methodology described on Schedule II. "Prime Rate" shall mean a rate per annum equal to the prime rate of ---------- interest publicly announced by FNBC from time to time, changing when and as of the date said prime rate changes. "Prime Rate Loan" shall mean Loans during such time as they are made --------------- and/or being maintained at a rate of interest based upon the Prime Rate. "Proceeds" shall mean whatever is receivable or received when -------- Collateral or proceeds are sold, collected, exchanged or otherwise disposed of, whether such disposition is 48 voluntary or involuntary, and includes, without limitation, all rights to payment, including return premiums, with respect to any insurance relating thereto. "Property" shall mean the real property, including the improvements -------- thereon, and the personal property (tangible and intangible) which are encumbered pursuant to a Mortgage Loan. "Quoted Market Value" shall mean with respect to each of the Eligible ------------------- Servicing Portfolio and the Encumbered Eligible Servicing Portfolio, at any date, the value of such Eligible Servicing Portfolio or Encumbered Eligible Servicing Portfolio, as applicable, as determined by an independent consulting firm acceptable to the Administrative Agent and set forth in a Servicing Contract Report. If, at any time, the value of such Eligible Servicing Portfolio or Encumbered Eligible Servicing Portfolio, as applicable, is expressed in terms of a range of values, the Quoted Market Value thereof shall be equal to the weighted average of the values quoted. "Regulation U" shall mean Regulation U of the Board of Governors of ------------ the Federal Reserve System (12 C.F.R. (S) 221), as the same may from time to time be amended, supplemented or superseded. "Reportable Event" shall mean a reportable event as defined in Title ---------------- IV of ERISA, except actions of general applicability by the Secretary of Labor under Section 110 of ERISA. "Required Investor Consent" shall have the meaning given such term in ------------------------- Paragraph 4(a) above. "Requirements of Law" shall mean, as to any Person, the Articles or ------------------- Certificate of Incorporation and Bylaws or other organizational or governing documents of such Person, and any law, treaty, rule or regulation, or a final and binding determination of an arbitrator or a determination of a court or other Governmental Authority, in each case applicable to or binding upon such Person or any of its property or to which such Person or any of its property is subject. "Revolving Loan" shall have the meaning given such term in Paragraph -------------- 1(a) above. "Revolving Loan Credit Limit" shall mean the sum of the Maximum --------------------------- Commitments of all the Lenders, with the Revolving Loan Credit Limit on the Effective Date being $12,000,000.00; provided, however, that the Revolving Loan Credit Limit may be increased pursuant to Paragraph 11(h) or 11(k) above up to a maximum of $20,000,000.00 in the event any Lender or Lenders agree with the Company and the Administrative Agent to increase such Lender's or Lenders' Maximum Commitments and/or through the inclusion as a "Lender" hereunder of an Applicant Financial Institution approved by the Company and the Administrative Agent. "Security Agreement" shall have the meaning given such term in ------------------ Paragraph 4(a) above. 49 "Servicing Contract Report" shall mean a report in form acceptable to ------------------------- the Administrative Agent setting forth the Quoted Market Value of each of the Eligible Servicing Portfolio and the Encumbered Eligible Servicing Portfolio. "Shareholder Notes" shall mean those certain promissory notes executed ----------------- by certain shareholders of the Company in favor of the Company, representing indebtedness of such shareholders to the Company, as described on Exhibit M --------- attached hereto. "Single Employer Plan" shall mean, as to the Company or any of its -------------------- ERISA Affiliates, any Plan of such Person which is not a Multiemployer Plan. "Statement Date" shall mean December 31, 1996. -------------- "Stock Pledge Documents" shall have the meaning given such term in ---------------------- Paragraph 4(b) above. "Subordinated Debt" shall mean all Indebtedness of the Company and its ----------------- Subsidiaries which is expressly subordinated to the Obligations in the manner and to the extent required by the Lenders pursuant to written subordination agreements satisfactory in form and substance to the Lenders. "Subsidiary" shall mean any corporation, partnership or joint venture ---------- more than fifty percent (50%) of the stock or other ownership interest of which having by the terms thereof ordinary voting power to elect the board of directors, managers or trustees of such corporation, partnership or joint venture (irrespective of whether or not at the time stock of any other class or classes of such corporation, partnership or joint venture shall have or might have voting power by reason of the happening of any contingency) shall, at the time as of which any determination is being made, be owned, either directly or through Subsidiaries. "Take-Out Commitment" with respect to any Mortgage Loan shall mean a ------------------- bona fide current, unused and unexpired forward sale whole loan commitment or forward sale Mortgage-Backed Security commitment issued by an Approved Investor in favor of and held by the Company, and any related delivery commitments, if applicable, under which said Approved Investor agrees, prior to the expiration thereof, upon the satisfaction of certain terms and conditions therein, to provide for the purchase of such Mortgage Loan or related Mortgage-Backed Security or to purchase such Mortgage Loan or related Mortgage-Backed Security at a specified price, which commitment is not subject to any term or condition which is not customary in commitments of like nature or which, in the reasonably anticipated course of events, cannot be fully complied with prior to the expiration thereof. "Term Out Amount" shall have the meaning given such term in Paragraph --------------- 1(b) above. "Total Liabilities" shall mean at any date consolidated total ----------------- liabilities of the Company and its Subsidiaries less the amount of any Subordinated Debt, determined in accordance with GAAP. "VA" shall mean the Veterans Administration and any successor agency. -- 50 "Warehousing Agreement" shall mean that certain Amended and Restated --------------------- Mortgage Loan Warehousing Agreement dated as of August 29, 1997 by and among the Company, the Administrative Agent, the Collateral Agent and other parties from time to time thereto (as amended, extended or replaced from time to time). IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By:_____________________________________ Name:___________________________________ Title:__________________________________ Maximum Commitment: THE FIRST NATIONAL BANK OF CHICAGO, a $4,000,000.00 national banking association, as Percentage Share: Administrative Agent, Collateral Agent 33.33333333% and a Lender By:_____________________________________ Name:___________________________________ Title:__________________________________ Maximum Commitment: BANK OF AMERICA NATIONAL TRUST AND $4,000,000.00 SAVINGS ASSOCIATION, a national banking Percentage Share: association, as a Lender 33.33333333% By:_____________________________________ Name:___________________________________ Title:__________________________________ 51 Maximum Commitment: THE BANK OF NEW YORK, a banking $4,000,000.00 corporation organized under the laws of Percentage Share: the State of New York, as a Lender 33.33333333% By:_____________________________________ Name:___________________________________ Title:__________________________________ 52 LIST OF SCHEDULES AND EXHIBITS ------------------------------ Schedule I Addresses for Purposes of Notices, Etc. Schedule II Methodology for Computation of Pre-Tax Income Exhibit A Form of Note Exhibit B Form of Security Agreement Exhibit C Form of Pledge Agreement Exhibit D Form of Officer's Certificate Exhibit E Litigation Schedule Exhibit F List of Subsidiaries Exhibit G Form of Compliance Certificate Exhibit H Form of Additional Lender Agreement Exhibit I Form of Borrowing Base Certificate Exhibit J Schedule of Permitted Investments Exhibit K Schedule of Permitted Other Debt and Permitted Other Secured Debt Exhibit L Schedule of Approved Private Investors 53 FIRST AMENDMENT TO AMENDED AND RESTATED --------------------------------------- SERVICING SECURED CREDIT AGREEMENT ---------------------------------- THIS FIRST AMENDMENT TO AMENDED AND RESTATED SERVICING SECURED CREDIT AGREEMENT (the "Amendment") is made and dated as of the 4th day of November, 1997, by and among THE FIRST NATIONAL BANK OF CHICAGO, a national banking association ("FNBC"), BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, THE BANK OF NEW YORK, a banking corporation organized under the laws of the State of New York (all of the above individually a "Lender" and, collectively, the "Lenders"), FNBC, as administrative agent for the Lenders (in such capacity, the "Administrative Agent"), and HEADLANDS MORTGAGE COMPANY, a California corporation (the "Company"). RECITALS -------- A. Pursuant to that certain Amended and Restated Servicing Secured Credit Agreement dated as of August 29, 1997 among the Administrative Agent, the Lenders and the Company (as amended to date, the "Agreement"), the Lenders agreed to extend credit to the Company on the terms and subject to the conditions set forth therein. All capitalized terms not otherwise defined herein shall have the meanings given to such terms in the Agreement. B. The Company and the Lenders desire to amend certain provisions of the Agreement, as more particularly described below. NOW, THEREFORE, in consideration of the foregoing Recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows: AGREEMENT --------- 1. Conversion Date. To reflect the agreement of the parties to extend --------------- the Conversion Date and the payment schedule and final maturity date of the Conversion Term Loan under the Agreement: (a) The defined term Conversion Date contained in Paragraph 12 of the Agreement is hereby amended to delete the date "November 4, 1997" appearing therein and to replace the same with the date "November 4, 1998". (b) Clauses (1) and (2) of Paragraph 1(b) of the Agreement are hereby amended to read in their entirety as follows: "(1) eleven (11) installments each in an amount equal to 1/12/th/ of the Term Out Amount, the first such installment to be payable on the 90/th/ day following the Conversion Date, each of the next ten (10) such installments to be payable quarterly on the first Business Day of each February, May, August and 1 November, commencing on the first such date following the initial payment date, and (2) one final installment in an amount equal to the remaining principal balance outstanding on the first Business Day of November, 2001." 2. Permitted Secured Other Debt. To reflect the agreement of the parties ---------------------------- to permit the maximum aggregate amount of Indebtedness owed under repurchase agreements and gestation repurchase credit facilities entered into by the Company from time to time to increase from $300,000,000.00 to $450,000,000.00, Exhibit K to the Agreement is hereby replaced by Replacement Exhibit K attached - --------- --------------------- hereto. 3. Reaffirmation of Other Loan Documents. The Company hereby affirms and ------------------------------------- agrees that (a) the execution and delivery by the Company of and the performance of its obligations under this Amendment shall not in any way amend, impair, invalidate or otherwise affect any of the obligations of the Company or the rights of the Secured Parties under the Security Agreement or any other Loan Document, (b) the term "Obligations" as defined in Paragraph 12 of the Agreement includes, without limitation, the Obligations of the Company under the Agreement as amended by this Amendment, (c) the Security Agreement remains in full force and effect and such agreement constitutes a continuing first priority security interest in and lien upon the Collateral, and (d) for any and all purposes, any reference to the Agreement following the effective date of this Amendment shall constitute a reference to the Agreement as amended to date, including, without limitation, by this Amendment. 4. Modification of Related Documents. All reports and other forms --------------------------------- utilized in connection with the day-to-day operations of the credit facility evidenced by the Agreement shall be deemed modified consistent with the provisions of this Amendment. 5. Effective Date. This Amendment shall be effective (with such -------------- effectiveness being retroactive to the day and year first above written) on the earliest date upon which the Administrative Agent has received (a) duly executed copies of this Amendment from each of the Lenders, the Administrative Agent and the Company, and (b) such board resolutions, incumbency certificates and other additional documentation as the Administrative Agent may request in connection herewith. 6. Representations and Warranties. The Company hereby represents and ------------------------------ warrants to the Administrative Agent and the Lenders as follows: (a) The Company has the corporate power and authority and the legal right to execute, deliver and perform this Amendment and has taken all necessary corporate action to authorize the execution, delivery and performance of this Amendment. This Amendment has been duly executed and delivered on behalf of the Company and constitutes the legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms. The execution, delivery and performance of this Amendment will not violate any Requirement of Law or Contractual Obligation or require any consent, approval or authorization of, or registration, declaration or filing with, any Governmental Authority. 2 (b) At and as of the date of execution hereof and at and as of the effective date of this Amendment and both prior to and after giving effect hereto: (1) the representations and warranties of the Company contained in the Loan Documents are accurate and complete in all respects, and (2) there has not occurred an Event of Default or Potential Default. 7. No Other Amendment. Except as expressly amended herein, the Loan ------------------ Documents shall remain in full force and effect as currently written. 8. Counterparts. This Amendment may be executed in any number of ------------ counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. 3 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first above written. HEADLANDS MORTGAGE COMPANY, a California corporation By:____________________________________ Name:__________________________________ Title:_________________________________ THE FIRST NATIONAL BANK OF CHICAGO, a national banking association, as Administrative Agent and a Lender By:____________________________________ Name:__________________________________ Title:_________________________________ BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking association, as a Lender By:____________________________________ Name:__________________________________ Title:_________________________________ THE BANK OF NEW YORK, a banking corporation organized under the laws of the State of New York, as a Lender By:____________________________________ Name:__________________________________ Title:_________________________________ 4 REPLACEMENT EXHIBIT K SCHEDULE OF PERMITTED OTHER DEBT AND (*) PERMITTED OTHER SECURED DEBT 1. Indebtedness owed under repurchase agreements and gestation repurchase credit facilities entered into by the Company from time to time with financial institutions approved by the Administrative Agent and the Majority Lenders in an aggregate amount not to exceed at any one time outstanding $450,000,000.00.* 2. Indebtedness owed under any servicing secured facility (including the Servicing Secured Credit Agreement) in an aggregate amount not to exceed at any one time outstanding $30,000,000.00.* 3. Indebtedness owed under credit facilities entered into by and between the Company and Residential Funding Corporation ("RFC") from time to time secured by Mortgage Loans that are delinquent or in foreclosure or subject to a Take-Out Commitment issued by RFC, manufactured housing loans and REO properties in an aggregate amount not to exceed at any one time outstanding $15,000,000.00.* 4. Indebtedness owed under any deposit-backed interest rate exchange agreements and/or investment arbitrage lines, entered into in the ordinary course of business.* 5. Unsecured Indebtedness of the Company to Peter Paul and/or Jessica Paul in an amount not to exceed $10,000,000.00 in the aggregate at any time outstanding and which Indebtedness is Subordinated Debt, it being agreed and understood that the required subordination shall be on terms and subject to conditions substantially similar to the terms and conditions set forth in that certain Subordination Agreement dated as of July 26, 1996 executed by Peter Paul and Jessica Paul. 6. Unsecured Indebtedness of the Company to Peter Paul in an amount not to exceed $5,000,000.00 in the aggregate at any time outstanding, the proceeds of which Indebtedness shall be used by the Company for funding short-term liquidity needs and which Indebtedness is Subordinated Debt, it being agreed and understood that the required subordination shall prohibit payments on account of such Indebtedness only if there shall either before or after such payment is made exist and Event of Default or Potential Default. 1 7. Indebtedness of HMSI to third party lenders in an amount not to exceed $5,000,000.00 in the aggregate at any time outstanding, the proceeds of which Indebtedness shall be used by HMSI to finance advance receivables.* 8. Indebtedness of HMSI secured by liens on the retained interests in securitizations of HMSI in connection with yield maintenance arrangements on securities issued through HMSI. 2 EX-10.6 14 MASTER PURCHASE AGREEMENT EXHIBIT 10.6 ------------ ================================================================================ PSA THE BOND MARKET TRADE ASSOCIATION MASTER REPURCHASE AGREEMENT SEPTEMBER 1996 VERSION ================================================================================ Dated as of ___________ ___, 1997 Between MERRILL LYNCH MORTGAGE CAPITAL INC. - ---------------------------------- and HEADLANDS MORTGAGE COMPANY - ---------------------------------- 1. APPLICABILITY From time to time the parties hereto may enter into transactions in which one party ("Seller") agrees to transfer to the other ("Buyer") securities or other assets ("Securities") against the transfer of funds by Buyer, with a simultaneous agreement by Buyer to transfer to Seller such Securities at a date certain or on demand, against the transfer of funds by Seller. Each such transaction shall be referred to herein as a "Transaction" and, unless otherwise agreed in writing, shall be governed by this Agreement, including any supplemental terms or conditions contained in Annex I hereto and in any other annexes identified herein or therein as applicable hereunder. 2. DEFINITIONS (a) "Act of Insolvency," with respect to any party, (i) the commencement by such party as debtor of any case or proceeding under any bankruptcy, insolvency, reorganization, liquidation, moratorium, dissolution, delinquency or similar law, or such party seeking the appointment or election of a receiver, conservator, trustee, custodian or similar official for such party or any substantial part of its property, or the convening of any meeting of creditors for purposes of commencing any such case or proceeding or seeking such an appointment or election, (ii) the commencement of any such case or proceeding against such party, or another seeking such an appointment or election, or the filing against a party of an application for a protective decree under the provisions of the 1 Securities Investor Protection Act of 1970, which (A) is consented to or not timely contested by such party, (B) results in the entry of an order for relief, such an appointment or election, the issuance of such a protective decree or the entry of an order having a similar effect, or (C) is not dismissed within 15 days, (iii) the making by such party of a general assignment for the benefit of creditors, or (iv) the admission in writing by such party of such party's inability to pay such party's debts as they become due; (b) "Additional Purchased Securities," Securities provided by Seller to Buyer pursuant to Paragraph 4(a) hereof; (c) "Buyer's Margin Amount," with respect to any Transaction as of any date, the amount obtained by application of the Buyer's Margin Percentage to the Repurchase Price for such Transaction as of such date; (d) "Buyer's Margin Percentage," with respect to any Transaction as of any date, a percentage (which may be equal to the Seller's Margin Percentage) agreed to by Buyer and Seller or, in the absence of any such agreement, the percentage obtained by dividing the Market Value of the Purchased Securities on the Purchase Date by the Purchase Price on the Purchase Date for Transaction; (e) "Confirmation," the meaning specified in Paragraph 3(b) hereof; (f) "Income," with respect to any Security at any time, any principal thereof and all interest, dividends or other distributions thereon; (g) "Margin Deficit," the meaning specified in Paragraph 4(a) hereof; (h) "Margin Excess," the meaning specified in Paragraph 4(b) hereof; (i) "Margin Notice Deadline," the time agreed to by the parties in the relevant Confirmation, Annex I hereto or otherwise as the deadline for giving notice requiring same-day satisfaction of margin maintenance obligations as provided in Paragraph 4 hereof (or, in the absence of any such agreement, the deadline for such purposes established in accordance with market practice); (j) "Market Value," with respect to any Securities as of any date, the price for such Securities on such date obtained from a generally recognized source agreed to by the parties or the most recent closing bid quotation from such a source, plus accrued Income to the extent not included therein (other than any Income credited or transferred to, or applied to the obligations of, Seller pursuant to Paragraph 5 hereof) as of such date (unless contrary to market practice for such Securities); (k) "Price Differential," with respect to any Transaction as of any date, the aggregate amount obtained by daily application of the Pricing Rate for such Transaction to the Purchase Price for such 2 Transaction on a 360-day-per-year basis for the actual number of days during the period commencing on (and including) the Purchase Date for such Transaction and ending on (but excluding) the date of determination (reduced by any amount of such Price Differential previously paid by Seller to Buyer with respect to such Transaction); (l) "Pricing Rate," the per annum percentage rate for determination of the Price Differential; (m) "Prime Rate," the prime rate of U.S. commercial banks as published in The Wall Street Journal (or, if more than one such rate is published, the average of such rates); (n) "Purchase Date," the date on which Purchased Securities are to be transferred by Seller to Buyer; (o) "Purchase Price," (i) on the Purchase Date, the price at which Purchased Securities are transferred by Seller to Buyer, and (ii) thereafter, except where Buyer and Seller agree otherwise, such price increased by the amount of any cash transferred by Buyer to Seller pursuant to Paragraph 4(b) hereof and decreased by the amount of any cash transferred by Seller to Buyer pursuant to Paragraph 4(a) hereof or applied to reduce Seller's obligations under clause (ii) of Paragraph 5 hereof; (p) "Purchased Securities," the Securities transferred by Seller to Buyer in a Transaction hereunder, and any Securities substituted therefor in accordance with Paragraph 9 hereof. The term "Purchased Securities" with respect to any Transaction at any time also shall include Additional Purchased Securities delivered pursuant to Paragraph 4(a) hereof and shall exclude Securities returned pursuant to Paragraph 4(b) hereof; (q) "Repurchase Date," the date on which Seller is to repurchase the Purchased Securities from Buyer, including any date determined by application of the provisions of Paragraph 3(c) or 11 hereof; (r) "Repurchase Price," the price at which Purchased Securities are to be transferred from Buyer to Seller upon termination of a Transaction, which will be determined in each case (including Transactions terminable upon demand) as the sum of the Purchase Price and the Price Differential as of the date of such determination; (s) "Seller's Margin Amount," with respect to any Transaction as of any date, the amount obtained by application of the Seller's Margin Percentage to the Repurchase Price for such Transaction as of such date; 3 (t) "Seller's Margin Percentage," with respect to any Transaction as of any date, a percentage (which may be equal to the Buyer's Margin Percentage) agreed to by Buyer and Seller or, in the absence of any such agreement, the percentage obtained by dividing the Market Value of the Purchased Securities on the Purchase Date by the Purchase Price on the Purchase Date for such Transaction. 3. INITIATION; CONFIRMATION; TERMINATION (a) An agreement to enter into a Transaction may be made orally or in writing at the initiation of either Buyer or Seller. On the Purchase Date for the Transaction, the Purchased Securities shall be transferred to Buyer or its agent against the transfer of the Purchased Price to an account of Seller. (b) Upon agreeing to enter into a Transaction hereunder, Buyer or Seller (or both), as shall be agreed, shall promptly deliver to the other party a written confirmation of each Transaction (a "Confirmation"). The Confirmation shall describe the Purchased Securities (including CUSIP number, if any), identify Buyer and Seller and set forth (i) the Purchase Date, (ii) the Purchase Price, (iii) the Repurchase Date, unless the Transaction is to be terminable on demand, (iv) the Pricing Rate or Repurchase Price applicable to the Transaction, and (v) any additional terms or conditions of the Transaction not inconsistent with this Agreement. The Confirmation, together with this Agreement, shall constitute conclusive evidence of the terms agreed between Buyer and Seller with respect to the Transaction to which the Confirmation relates, unless with respect to the Confirmation specific objection is made promptly after receipt thereof. In the event of any conflict between the terms of such Confirmation and this Agreement, this Agreement shall prevail. (c) In the case of Transactions terminable upon demand, such demand shall be made by Buyer or Seller, no later than such time as is customary in accordance with market practice, by telephone or otherwise on or prior to the business day on which such termination will be effective. On the date specified in such demand, or on the date fixed for termination in the case of Transactions having a fixed term, termination of the Transaction will be effected by transfer to Seller or its agent of the Purchased Securities and any Income in respect thereof received by Buyer (and not previously credited or transferred to, or applied to the obligations of, Seller pursuant to Paragraph 5 hereof) against the transfer of the Repurchase Price to an account of Buyer. 4. MARGIN MAINTENANCE (a) If at any time the aggregate Market Value of all Purchased Securities subject to all Transactions in which a particular party hereto is acting as Buyer is less than the aggregate Buyer's Margin Amount for all such Transactions (a "Margin Deficit"), then Buyer may by notice to Seller require Seller in such 4 Transactions, at Seller's option, to transfer to Buyer cash or additional Securities reasonably acceptable to Buyer ("Additional Purchased Securities"), so that the cash and aggregate Market Value of the Purchased Securities, including any such Additional Purchased Securities, will thereupon equal or exceed such aggregate Buyer's Margin Amount (decreased by the amount of any Margin Deficit as of such date arising from any Transactions in which such Buyer is acting as Seller). (b) If at any time the aggregate Market Value of all Purchased Securities subject to all Transactions in which a particular party hereto is acting as Seller exceeds the aggregate Seller's Margin Amount for all such Transactions at such time (a "Margin Excess"), then Seller may by notice to Buyer require Buyer in such Transactions, at Buyer's option, to transfer cash or Purchased Securities to Seller, so that the aggregate Market Value of the Purchased Securities, after deduction of any such cash or any purchased Securities so transferred, will thereupon not exceed such aggregate Seller's Margin Amount (increased by the amount of any Margin Excess as of such date arising from any Transactions in which such Seller is acting as Buyer). (c) If any notice is given by Buyer or Seller under subparagraph (a) or (b) of this Paragraph at or before the Margin Notice Deadline on any business day, the party receiving such notice shall transfer cash or Additional Purchased Securities as provided in such subparagraph no later than the close of business in the relevant market on such day. If any such notice is given after the Margin Notice Deadline, the party receiving such notice shall transfer such cash or Securities no later than the close of business in the relevant market on the next business day following such notice. (d) Any cash transferred pursuant to this Paragraph shall be attributed to such Transactions as shall be agreed upon by Buyer and Seller. (e) Seller and Buyer may agree, with respect to any or all Transactions hereunder, that the respective rights of Buyer or Seller (or both) under subparagraphs (a) and (b) of this Paragraph may be exercised only where a Margin Deficit or a Margin Excess, as the case may be, exceeds a specified dollar amount or a specified percentage of the Repurchase Prices for such Transactions (which amount or percentage shall be agreed to by Buyer and Seller prior to entering into any such Transactions). (f) Seller and Buyer may agree, with respect to any or all Transactions hereunder, that the respective rights of Buyer and Seller under subparagraphs (a) and (b) of this Paragraph to require the elimination of a Margin Deficit or a Margin Excess, as the case may be, may be exercised whenever such a Margin Deficit or a Margin Excess exists with respect to any single Transaction hereunder (calculated without regard to any other Transaction outstanding under this Agreement). 5 5. INCOME PAYMENTS Seller shall be entitled to receive an amount equal to all Income paid or distributed on or in respect of the Securities that is not otherwise received by Seller, to the full extent it would be so entitled if the Securities had not been sold to Buyer. Buyer shall, as the parties may agree with respect to any Transaction (or, in the absence of any such agreement, as Buyer shall reasonably determine in its discretion), on the date such Income is paid or distributed either (i) transfer to or credit to the account of Seller such Income with respect to any Purchased Securities subject to such Transaction or (ii) with respect to Income paid in cash, apply the Income payment or payments to reduce the amount, if any, to be transferred to Buyer by Seller upon termination of such Transaction. Buyer shall not be obligated to take any action pursuant to the preceding sentence (A) to the extent that such action would result in the creation of a Margin Deficit, unless prior thereto or simultaneously therewith Seller transfers to Buyer cash or Additional Purchased Securities sufficient to eliminate such Margin Deficit, or (B) if an Event of Default with respect to Seller has occurred and is then continuing at the time such Income is paid or distributed. 6. SECURITY INTEREST Although the parties intend that all Transactions hereunder be sales and purchases and not loans, in the event any such Transactions are deemed to be loans, Seller shall be deemed to have pledged to Buyer as security for the performance by Seller of its obligations under each such Transaction, and shall be deemed to have granted to Buyer a security interest in, all of the Purchased Securities with respect to all Transactions hereunder and all Income thereon and other proceeds thereof. 7. PAYMENT AND TRANSFER Unless otherwise mutually agreed, all transfers of funds hereunder shall be in immediately available funds. All Securities transferred by one party hereto to the other party (i) shall be in suitable form for transfer or shall be accompanied by duly executed instruments of transfer or assignment in blank and such other documentation as the party receiving possession may reasonably request, (ii) shall be transferred on the book-entry system of a Federal Reserve Bank, or (iii) shall be transferred by any other method mutually acceptable to Seller and Buyer. 8. SEGREGATION OF PURCHASED SECURITIES To the extent required by applicable law, all Purchased Securities in the possession of Seller shall be segregated from other securities in its possession and shall be identified as subject to this Agreement. Segregation may be accomplished by appropriate identification on the books and records of the holder, including a financial or securities 6 intermediary or a clearing corporation. All of Seller's interest in the Purchased Securities shall pass to Buyer on the Purchase Date and, unless otherwise agreed by Buyer and Seller, nothing in this Agreement shall preclude Buyer from engaging in repurchase transactions with the Purchased Securities or otherwise selling, transferring, pledging or hypothecating the Purchased Securities, but no such transaction shall relieve Buyer of its obligations to transfer Purchased Securities to Seller pursuant to Paragraph 3, 4 or 11 hereof, or of Buyer's obligation to credit or pay Income to, or apply Income to the obligations of, Seller pursuant to Paragraph 5 hereof. --------------------------------------------------------------------------- REQUIRED DISCLOSURE OF TRANSACTIONS IN WHICH THE SELLER RETAINS CUSTODY OF THE PURCHASED SECURITIES Seller is not permitted to substitute other securities for those subject to this Agreement and therefore must keep Buyer's securities segregated at all times, unless in this Agreement Buyer grants Seller the right to substitute other securities. If Buyer grants the right to substitute, this means that Buyer's securities will likely be commingled with Seller's own securities during the trading day. Buyer is advised that, during any trading day that Buyer's securities are commingled with Seller's securities, they [will]* [may]** be subject to liens granted by Seller to [its clearing bank]* [third parties]** and may be used by Seller for deliveries on other securities transactions. Whenever the securities are commingled, Seller's ability to resegregate substitute securities for Buyer will be subject to Seller's ability to satisfy [the clearing]* [any]** lien to obtain substitute securities. --------------------------------------------------------------------------- * Language to be used under 17 C.F.R. (S)403.4(e) if Seller is a government securities broker or dealer other than a financial institution ** Language to be used under 17 C.F.R. . (S)403.5(d) if Seller is a financial institution. 9. SUBSTITUTION (a) Seller may, subject to agreement with and acceptance by Buyer, substitute other Securities for any Purchased Securities. Such substitution shall be made by transfer to Buyer of such other Securities and transfer to Seller of such Purchased Securities. After substitution, the substituted Securities shall be deemed to be Purchased Securities. (b) In Transactions in which Seller retains custody of Purchased Securities, the parties expressly agree that Buyer shall be deemed, for purposes of subparagraph (a) of this Paragraph, to have agreed to and accepted in this Agreement substitution by Seller of other Securities for Purchased Securities; provided, however, that such other Securities shall have a Market Value at least 7 equal to the Market Value of the Purchased Securities for which they are substituted. 10. REPRESENTATIONS Each of Buyer and Seller represents and warrants to the other that (i) it is duly authorized to execute and deliver this Agreement, to enter into Transactions contemplated hereunder and to perform its obligations hereunder and has taken all necessary action to authorize such execution, delivery and performance, (ii) it will engage in such Transactions as principal (or, if agreed in writing, in the form of an annex hereto or otherwise, in advance of any Transaction by the other party hereto, as agent for a disclosed principal), (iii) the person signing this Agreement on its behalf is duly authorized to do so on its behalf (or on behalf of any such disclosed principal), (iv) it has obtained all authorizations of any governmental body required in connection with this Agreement and the Transactions hereunder and such authorizations are in full force and effect and (v) the execution, delivery and performance of this Agreement and the Transactions hereunder will not violate any law, ordinance, charter, bylaw or rule applicable to it or any agreement by which it is bound or by which any of its assets are affected. On the Purchase Date for any Transaction, Buyer and Seller shall each be deemed to repeat all the foregoing representations made by it. 11. EVENTS OF DEFAULT In the event that (i) Seller fails to transfer or Buyer fails to purchase Purchased Securities upon the applicable Purchase Date, (ii) Seller fails to repurchase or Buyer fails to transfer Purchased Securities upon the applicable Repurchase Date, (iii) Seller or Buyer fails to comply with Paragraph 4 hereof, (iv) Buyer fails, after one business day's notice, to comply with Paragraph 5 hereof, (v) an Act of Insolvency occurs with respect to Seller or Buyer, (vi) any representation made by Seller or Buyer shall have been incorrect or untrue in any material respect when made or repeated or deemed to have been made or repeated, or (vii) Seller or Buyer shall admit to the other its inability to, or its intention not to, perform any of its obligations hereunder (each an "Event of Default"): (a) The nondefaulting party may, at its option (which option shall be deemed to have been exercised immediately upon the occurrence of an Act of Insolvency), declare an Event of Default to have occurred hereunder and, upon the exercise or deemed exercise of such option, the Repurchase Date for each Transaction hereunder shall, if it has not already occurred, be deemed immediately to occur (except that, in the event that the Purchase Date for any Transaction has not yet occurred as of the date of such exercise or deemed exercise, such Transaction shall be deemed immediately canceled). The nondefaulting party shall (except upon the occurrence of an Act of Insolvency) give notice to the defaulting party of the exercise of such option as promptly as practicable. 8 (b) In all Transactions in which the defaulting party is acting as Seller, if the nondefaulting party exercises or is deemed to have exercised the option referred to in subparagraph (a) of this Paragraph, (i) the defaulting party's obligations in such Transactions to repurchase all Purchased Securities, at the Repurchase Price therefor on the Repurchase Date determined in accordance with subparagraph (a) of this Paragraph, shall thereupon become immediately due and payable, (ii) all Income paid after such exercise or deemed exercise shall be retained by the nondefaulting party and applied to the aggregate unpaid Repurchase Prices and any other amounts owing by the defaulting party hereunder, and (iii) the defaulting party shall immediately deliver to the nondefaulting party any Purchased Securities subject to such Transactions then in the defaulting party's possession or control. (c) In all Transactions in which the defaulting party is acting as Buyer, upon tender by the nondefaulting party of payment of the aggregate Repurchase Prices for all such Transactions, all right, title and interest in and entitlement to all Purchased Securities subject to such Transactions shall be deemed transferred to the nondefaulting party, and the defaulting party shall deliver all such Purchased Securities to the nondefaulting party. (d) If the nondefaulting party exercises or is deemed to have exercised the option referred to in subparagraph (a) of this Paragraph, the nondefaulting party, without prior notice to the defaulting party, may: (i) as to Transactions in which the defaulting party is acting as Seller, (A) immediately sell, in a recognized market (or otherwise in a commercially reasonable manner) at such price or prices as the nondefaulting party may reasonably deem satisfactory, any or all Purchased Securities subject to such Transactions and apply the proceeds thereof to the aggregate unpaid Repurchase Prices and any other amounts owing by the defaulting party hereunder or (B) in its sole discretion elect, in lieu of selling all or a portion of such Purchased Securities, to give the defaulting party credit for such Purchased Securities in an amount equal to the price therefor on such date, obtained from a generally recognized source or the most recent closing bid quotation from such a source, against the aggregate unpaid Repurchase Prices and any other amounts owing by the defaulting party hereunder; and (ii) as to Transactions in which the defaulting party is acting as Buyer, (A) immediately purchase, in a recognized market (or otherwise in a commercially reasonable manner) at such price or prices as the nondefaulting party may reasonably deem satisfactory, securities ("Replacement Securities") of the same class and amount as any Purchased Securities that are not delivered by the defaulting party to the nondefaulting party as required hereunder or (B) in its sole discretion elect, in lieu of purchasing Replacement Securities, to be deemed to have 9 purchased Replacement Securities at the price therefor on such date, obtained from a generally recognized source or the most recent closing offer quotation from such a source. Unless otherwise provided in Annex I, the parties acknowledge and agree that (1) the Securities subject to any Transaction hereunder are instruments traded in a recognized market, (2) in the absence of a generally recognized source for prices or bid or offer quotations for any Security, the nondefaulting party may establish the source therefor in its sole discretion and (3) all prices, bids and offers shall be determined together with accrued Income (except to the extent contrary to market practice with respect to the relevant Securities). (e) As to Transactions in which the defaulting party is acting as Buyer, the defaulting party shall be liable to the nondefaulting party for any excess of the price paid (or deemed paid) by the nondefaulting party for Replacement Securities over the Repurchase Price for the Purchased Securities replaced thereby and for any amounts payable by the defaulting party under Paragraph 5 hereof or otherwise hereunder. (f) For purposes of this Paragraph 11, the Repurchase Price for each Transaction hereunder in respect of which the defaulting party is acting as Buyer shall not increase above the amount of such Repurchase Price for such Transaction determined as of the date of the exercise or deemed exercise by the nondefaulting party of the option referred to in subparagraph (a) of this Paragraph. (g) The defaulting party shall be liable to the nondefaulting party for (i) the amount of all reasonable legal or other expenses incurred by the nondefaulting party in connection with or as a result of an Event of Default, (ii) damages in an amount equal to the cost (including all fees, expenses and commissions) of entering into replacement transactions and entering into or terminating hedge transactions in connection with or as a result of an Event of Default, and (iii) any other loss, damage, cost or expense directly arising or resulting from the occurrence of an Event of Default in respect of a Transaction. (h) To the extent permitted by applicable law, the defaulting party shall be liable to the nondefaulting party for interest on any amounts owing by the defaulting party hereunder, from the date the defaulting party becomes liable for such amounts hereunder until such amounts are (i) paid in full by the defaulting party or (ii) satisfied in full by the exercise of the nondefaulting party's rights hereunder. Interest on any sum payable by the defaulting party to the nondefaulting party under this Paragraph 11(h) shall be at a rate equal to the greater of the Pricing Rate for the relevant Transaction or the Prime Rate. (j) The nondefaulting party shall have, in addition to its rights hereunder, any rights otherwise available to it under any other agreement or applicable law. 10 12. SINGLE AGREEMENT Buyer and Seller acknowledge that, and have entered hereunto and will enter into each Transaction hereunder in consideration of and in reliance upon the fact that, all Transactions hereunder constitute a single business and contractual relationship and have been made in consideration of each other. Accordingly, each of Buyer and Seller agrees (i) to perform all of its obligations in respect of each Transaction hereunder, and that a default in the performance of any such obligations shall constitute a default by it in respect of all Transactions hereunder, (ii) that each of them shall be entitled to set off claims and apply property held by them in respect of any Transaction against obligations owing to them in respect of any other Transactions hereunder and (iii) that payments, deliveries and other transfers made by either of them in respect of any Transaction shall be deemed to have been made in consideration of payments, deliveries and other transfers in respect of any other Transactions hereunder, and the obligations to make any such payments, deliveries and other transfers may be applied against each other and netted. 13. NOTICES AND OTHER COMMUNICATIONS Any and all notices, statements, demands or other communications hereunder may be given by a party to the other by mail, facsimile, telegraph, messenger or otherwise to the address specified in Annex II hereto, or so sent to such party at any other place specified in a notice of change of address hereafter received by the other. All notices, demands and requests hereunder may be made orally, to be confirmed promptly in writing, or by other communication as specified in the preceding sentence. 14. ENTIRE AGREEMENT; SEVERABILITY This Agreement shall supersede any existing agreements between the parties containing general terms and conditions for repurchase transactions. Each provision and agreement herein shall be treated as separate and independent from any other provision or agreement herein and shall be enforceable notwithstanding the unenforceability of any such other provision or agreement. 15. NON-ASSIGNABILITY; TERMINATION (a) The rights and obligations of the parties under this Agreement and under any Transaction shall not be assigned by either party without the prior written consent of the other party, and any such assignment without the prior written consent of the other party shall be null and void. Subject to the foregoing, this Agreement and any Transactions shall be binding upon and shall inure to the benefit of the parties and their respective successors and assigns. This Agreement may be terminated by either party upon giving written notice to the 11 other, except that this Agreement shall, notwithstanding such notice, remain applicable to any Transactions then outstanding. (b) Subparagraph (a) of this Paragraph 15 shall not preclude a party from assigning, charging or otherwise dealing with all or any part of its interest in any sum payable to it under Paragraph 11 hereof. 16. GOVERNING LAW This Agreement shall be governed by the laws of the State of New York without giving effect to the conflict of law principles thereof. 17. NO WAIVERS, ETC. No express or implied waiver of any Event of Default by either party shall constitute a waiver of any other Event of Default and no exercise of any remedy hereunder by any party shall constitute a waiver of its right to exercise any other remedy hereunder. No modification or waiver of any provision of this Agreement and no consent by any party to a departure herefrom shall be effective unless and until such shall be in writing and duly executed by both of the parties hereto. Without limitation on any of the foregoing, the failure to give notice pursuant to Paragraph 4(a) or 4(b) hereof will not constitute a waiver of any right to do so at a later date. 18. USE OF EMPLOYEE PLAN ASSETS (a) If assets of an employee benefit plan subject to any provision of the Employee Retirement Income Security Act of 1974 ("ERISA") are intended to be used by either party hereto (the "Plan Party") in a Transaction, the Plan Party shall so notify the other party prior to the Transaction. The Plan Party shall represent in writing to the other party that the Transaction does not constitute a prohibited transaction under ERISA or is otherwise exempt therefrom, and the other party may proceed in reliance thereon but shall not be required so to proceed. (b) Subject to the last sentence of subparagraph (a) of this Paragraph, any such Transaction shall proceed only if Seller furnishes or has furnished to Buyer its most recent available audited statement of its financial condition and its most recent subsequent unaudited statement of its financial condition. (c) By entering into a Transaction pursuant to this Paragraph, Seller shall be deemed (i) to represent to Buyer that since the date of Seller's latest such financial statements, there has been no material adverse change in Seller's financial condition which Seller has not disclosed to Buyer, and (ii) to agree to provide Buyer with future audited and unaudited statements of its financial condition as they are issued, so long as it is a Seller in any outstanding Transaction involving a Party Plan. 12 19. INTENT (a) The parties recognize that each Transaction is a "repurchase agreement" as that term is defined in Section 101 of Title 11 of the United States Code, as amended (except insofar as the type of Securities subject to such Transaction or the term of such Transaction would render such definition inapplicable), and a "securities contract" as that term is defined in Section 741 of Title 11 of the United States Code, as amended (except insofar as the type of assets subject to such Transaction would render such definition inapplicable). (b) It is understood that either party's right to liquidate Securities delivered to it in connection with Transactions hereunder or to exercise any other remedies pursuant to Paragraph 11 hereof is a contractual right to liquidate such Transaction as described in Sections 555 and 559 of Title 11 of the United States Code, as amended. (c) The parties agree and acknowledge that if a party hereto is an "insured depository institution," as such term is defined in the Federal Deposit Insurance Act, as amended ("FDIA"), then each Transaction hereunder is a "qualified financial contract," as that term is defined in FDIA and any rules, orders or policy statements thereunder (except insofar as the type of assets subject to such Transaction would render such definition inapplicable). (d) It is understood that this Agreement constitutes a "netting contract" as defined in and subject to Title IV of the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and each payment entitlement and payment obligation under any Transaction hereunder shall constitute a "covered contractual payment entitlement" or "covered contractual payment obligation," respectively, as defined in and subject to FDICIA (except insofar as one or both of the parties is not a "financial institution" as that term is defined in FDICIA). 20. DISCLOSURE RELATING TO CERTAIN FEDERAL PROTECTIONS The parties acknowledge that they have been advised that: (a) in the case of Transactions in which one of the parties is a broker or dealer registered with the Securities and Exchange Commission ("SEC") under Section 15 of the Securities Exchange Act of 1934 ("1934 Act"), the Securities Investor Protection Corporation has taken the position that the provisions of the Securities Investor Protection Act of 1970 ("SIPA") do not protect the other party with respect to any Transaction hereunder; (b) in the case of Transactions in which one of the parties is a governmental securities broker or a government securities dealer registered with the SEC 13 under Section 15C of the 1934 Act, SIPA will not provide protection to the other party with respect to any Transaction hereunder; and (c) in the case of Transactions in which one of the parties is a financial institution, funds held by the financial institution pursuant to a Transaction hereunder are not a deposit and therefore are not insured by the Federal Deposit Insurance Corporation or the National Credit Union Share Insurance Fund, as applicable. MERRILL LYNCH MORTGAGE HEADLANDS MORTGAGE COMPANY CAPITAL INC. By:_________________________ By:_________________________ Title:______________________ Title:______________________ Date:_______________________ Date:_______________________ 14 EXECUTION COPY ANNEX I (continued) SUPPLEMENTAL TERMS TO MASTER REPURCHASE AGREEMENT, DATED AS OF SEPTEMBER 11, 1996, AMONG MERRILL LYNCH MORTGAGE CAPITAL INC. AND MERRILL LYNCH CREDIT CORPORATION AND HEADLANDS MORTGAGE COMPANY 1. APPLICABILITY. These Supplemental Terms (the "Supplemental Terms") to ------------- Master Repurchase Agreement (the "Master Repurchase Agreement", and collectively with these Supplemental Terms, the "Agreement") modify the terms and conditions under which the parties hereto, from time to time, enter into Transactions. To the extent that these Supplemental Terms conflict with the terms of the Master Repurchase Agreement, these Supplemental Terms shall control. 2. ADDITIONAL DEFINITIONS. ---------------------- Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Master Repurchase Agreement. Capitalized terms used in the Master Repurchase Agreement whose definitions are modified in these Supplemental Terms shall, for all purposes of the Agreement, be deemed to have such modified definitions. "Agency" shall refer to GNMA, FNMA or FHLMC, as the case may be. "B Quality Non-Conforming Mortgage Loans" shall refer to Mortgage Loans qualified under the "B First Lien Standard Program Parameters" described in the HMC Guide. "Buyer" shall mean MLCC, in the case of Home Equity Loans, and MLMCI in all other cases. "Buyer's Margin Amount" shall have the meaning set forth in the Master Repurchase Agreement except that the percentage referred to therein for each Transaction shall be specified in the related Confirmation. "C Quality Non-Conforming Mortgage Loans" shall refer to Mortgage Loans qualified under the "C First Lien Standard Program Parameters" described in the HMC Guide. 1 "Cash Purchase Price" shall refer the cash price, and to the corresponding cash proceeds, to be paid by a Trade Investor, under its cash purchase program, for Mortgage Loans sold by HMC that are the subject of a Transaction. "Committed Mortgage Loan" shall refer to a Mortgage Loan that has been assigned a commitment number by HMC, which commitment number has been communicated by HMC to the Custodian in accordance with the Custody Agreement, indicating that such Mortgage Loan (i) is the subject of a Trade Commitment that has been assigned to Buyer or (ii) is to be included in a pool of Mortgage Loans backing a Mortgage-Backed Security and evidence thereof, satisfactory to Buyer in its sole discretion, has been provided to Buyer. "Confirmation" shall have the meaning set forth in the Master Repurchase Agreement but shall be substantially in the form attached hereto as Exhibit A hereto. "Covenant Compliance Certificate" shall have the meaning set forth in Paragraph 12 of these Supplemental Terms. "Custody Agreement" shall refer to the Tri-Party Custody Agreement, dated as of September 11, 1996, by and among MLMCI, MLCC, HMC and the Custodian named therein, as the same may be modified and amended from time to time. "Custodian" shall refer to the custodian under the Custody Agreement. "Custody Receipt" shall refer to the Collateral Submission Summary substantially in the form attached as an exhibit to the Custody Agreement. "FHLMC" shall refer to the Federal Home Loan Mortgage Corporation. "First Mortgage Loans" shall refer to the fixed or adjustable rate mortgage loans secured by first liens on single family residential real property (including, without limitation, planned unit developments) certain documents relating to which have been delivered to the Custodian pursuant to the Custody Agreement. "FNMA" shall refer to the Federal National Mortgage Association. "Funding Request" shall refer to the request of HMC for the funding of a Transaction substantially in the form of Exhibit B. "GNMA" shall refer to the Government National Mortgage Association. "HMC" shall refer to Headlands Mortgage Company. I-2 "HMC Guide" shall refer to the HMC origination procedures previously provided in writing to Buyer, as such guide may hereafter from time to time be amended with the written approval of Buyer. "Home Equity Loans" shall refer to the fixed or adjustable rate, open or closed end, home equity credit line loans made or to be made in the future under certain home equity credit line loan agreements. "Jumbo Mortgage Loans" shall refer to any Mortgage Loans so designated by HMC and acceptable to Buyer, in its sole discretion, and which (i) have been underwritten generally in accordance with Agency standards and (ii) would be considered to be of not less than A- quality according to current industry standards. "MLCC" shall refer to Merrill Lynch Credit Corporation. "MLMCI" shall refer to Merrill Lynch Mortgage Capital Inc. "Mortgage-Backed Securities" shall refer to mortgage-backed securities backed by Mortgage Loans and issued by an issuer other than an Agency. "Mortgage Loans" shall refer to First Mortgage Loans or Home Equity Loans, as applicable. "Securities" shall, in addition to the definition set forth in the Master Repurchase Agreement, refer to Mortgage Loans; provided, however, that such Mortgage Loans shall not be deemed to be securities for the purposes of any securities or blue sky laws. "Seller" shall in all cases under the Master Repurchase Agreement and these Supplemental Terms, refer to HMC. "Seller's Margin Amount" shall have the meaning set forth in the Master Repurchase Agreement except that the percentage referred to therein for each Transaction shall be specified in the related Confirmation. "Trade Assignment" shall refer to an assignment, substantially in the form attached hereto as Exhibit C, executed by HMC in favor of Buyer assigning or pledging all of HMC's rights under a Trade Commitment. "Trade Commitment" shall refer to a trade confirmation or similar document from the Trade Investor to HMC confirming the details of a mandatory forward trade or similar arrangement reasonably acceptable to Buyer between the Trade Investor and HMC with I-3 respect to one or more Mortgage Loans, which trade confirmation or similar document shall be valid, binding and in full force and effect and relate to pools of Mortgage Loans that satisfy the "good delivery standard" of the Public Securities Association as set forth in the Public Securities ----------------- Association Uniform Practices Guide. ----------------------------------- "Trade Investor" shall refer to a securities dealer, financial institution or other entity, reasonably acceptable to Buyer, who has made a Trade Commitment. "Transaction" shall, in addition to the definition set forth in the Master Repurchase Agreement, refer to substitutions pursuant to Paragraph 9 of the Master Repurchase Agreement. "Warehouse Facilities" shall refer to the that certain Mortgage Loan Warehouse Agreement dated October 24, 1994 by and among HMC, The First National Bank of Chicago, as administrative agent, and the lenders named therein, as the same may be amended or modified from time to time. 3. MODIFICATIONS TO MASTER REPURCHASE AGREEMENT. -------------------------------------------- (a) All references to Buyer in the Master Repurchase Agreement shall be deemed to be references to MLMCI or MLCC, as applicable, and all references to Seller in the Master Repurchase Agreement shall be deemed to be references to HMC. (b) Paragraph 11(d)(ii) of the Master Repurchase Agreement is hereby deleted in its entirety and restated as follows: (ii) as to Transactions in which the defaulting party is Buyer, (A) purchase securities or mortgage loans (collectively, "Replacement Securities") of the same class and amount, in the case of securities, and of substantially the same maturity, principal amount and interest rate as any Mortgage Loans that are not delivered by the defaulting party to the nondefaulting party as required hereunder or (B) in its sole discretion elect, in lieu of purchasing Replacement Securities, to be deemed to have purchased Replacement Securities at the price therefor on such date, calculated as the average of the prices obtained from three nationally recognized registered broker/dealers that buy and sell comparable mortgage loans in the secondary market. I-4 4. FUNDING REQUESTS; CONFIRMATIONS. ------------------------------- (a) Each Funding Request shall be prepared and duly executed by HMC and delivered to Buyer prior to 5:00 p.m., New York City time, on the business day prior to the proposed Purchase Date for the related Transaction. Each such Funding Request delivered by HMC to Buyer shall be acceptable to Buyer in its sole discretion. (b) Each Confirmation shall be prepared and duly executed by HMC and delivered to Buyer prior to 5:00 p.m., New York City time, on the business day prior to the proposed Purchase Date for the related Transaction. Each such Confirmation delivered by HMC to Buyer shall be complete in every respect other than the Purchase Price, the Pricing Rate, the percentage used to determine Buyer's and Seller's Margin Amount and the execution thereof by Buyer. Buyer shall, as soon as practicable on the Buyer Purchase Date, deliver to HMC a completed Confirmation related to such Transaction executed by Buyer. (c) Each Confirmation shall be binding upon the parties hereto unless written notice of objection is given by the objecting party to the other party within one (1) business day after Buyer has delivered the completed Confirmation to HMC. (d) Notwithstanding the last sentence of Paragraph 3(b) of the Master Repurchase Agreement, in the event of any conflict between the terms of a Confirmation and the Agreement, such Confirmation shall prevail. 5. INCOME PAYMENTS. All payments and distributions, whether in cash or in --------------- kind, made on or with respect to the Mortgage Loans shall, unless otherwise mutually agreed by Buyer and HMC, be paid, delivered or transferred, so long as an Event of Default on the part of HMC or an Additional Event of Termination set forth in Paragraph 11 of these Supplemental Terms shall not have occurred and be continuing, directly to HMC from the related mortgagor. 6. MARKET VALUE DETERMINATION. Buyer shall determine the Market Value for the -------------------------- Mortgage Loans in its reasonable business judgment from time to time and at such time as it may elect in its sole discretion; provided, however, that Buyer shall not take into account any Mortgage Loan that has been delinquent for at least forty-five (45) days or any Mortgage Loan with respect to which there is a breach of a representation, warranty or covenant made by HMC in the Agreement or the Custody Agreement that materially and adversely affects Buyer's interest in such Mortgage Loan and which breach has not been cured prior to the date on which Market Value is being determined. I-5 7. INTENT OF THE PARTIES; SECURITY INTEREST. ---------------------------------------- (a) Each Transaction involving Mortgage Loans is entered into in contemplation of (i) the sale of Mortgage Loans to a Trade Investor or (ii) the issuance of Mortgage-Backed Securities. The parties intend that, in the case of clause (i) of the preceding sentence, the Cash Purchase Price relating to such Mortgage Loans will be paid by the related Trade Investor through the Custodian to Buyer. (b) In the event, for any reason, any Transaction is construed by any court as a secured loan rather than a purchase and sale, the parties intend that Buyer shall have a perfected first priority security interest in all of the Mortgage Loans. (c) HMC shall pay all fees and expenses associated with perfecting such security interest. 8. DELIVERY OF ADDITIONAL DOCUMENTS. -------------------------------- (a) HMC shall, simultaneously with the funding of each Transaction, deliver directly to Buyer, in the case of clause (iii) below and to Buyer through the Custodian the following documents: (i) A fully executed Custody Receipt and all other applicable documents required by the Custody Agreement; (ii) In the case of a Transaction involving Mortgage Loans that are Committed Mortgage Loans intended to be sold to a Trade Investor, and within one business day of its becoming such a Committed Mortgage Loan in the case of any Mortgage Loans that were not such Committed Mortgage Loans at the time the related Transaction was funded, evidence of the related Trade Commitment; and (iii) In the case of a Transaction involving Mortgage Loans that are Committed Mortgage Loans intended to back a Mortgage-Backed Security, and within one business day of its becoming such a Committed Mortgage Loan in the case of any Mortgage Loans that were not such Committed Mortgage Loans at the time the related Transaction was funded, evidence satisfactory to Buyer in its sole discretion that such Mortgage Loans will back a Mortgage-Backed Security. I-6 (b) HMC shall deliver to Buyer on a weekly basis (or more frequently if requested by Buyer), an investor commitment report, substantially in the form attached hereto as Exhibit D, listing the existing commitments of Trade Investors relating to any outstanding Funding Requests. 9. REPRESENTATIONS, WARRANTIES AND COVENANTS. ----------------------------------------- (a) Each party represents and warrants, and shall on and as of the Purchase Date of any Transaction be deemed to represent and warrant, as follows: (i) The execution, delivery and performance of the Agreement and the performance of each Transaction do not and will not result in or require the creation of any lien, security interest or other charge or encumbrance (other than pursuant hereto) upon or with respect to any of its properties; (ii) The Agreement is, and each Transaction when entered into under the Agreement will be, a legal, valid and binding obligation of it enforceable against it in accordance with the terms of the Agreement, subject to applicable bankruptcy, insolvency and similar laws affecting creditors' rights generally and subject, as to enforceability, to general principles of equity (regardless of whether enforcement is sought in a proceeding in equity or at law); and (iii) Since the date of the most recent balance sheet or financial statement delivered by it pursuant to Paragraph 12 hereof, there has been no material adverse change in its financial condition or results of operations. (b) HMC represents and warrants as to each Transaction and the Mortgage Loans relating thereto as of the Purchase Date of such Transaction as follows: (i) All information provided by HMC to Buyer concerning the Mortgage Loans is true and correct; (ii) All data and other information provided by or on behalf of HMC to the Custodian, whether in writing, by electronic transmission or on computer tape or diskette or otherwise, is true and correct; (iii) HMC is servicing each Mortgage Loan in strict conformity with the servicing standards described in Paragraph 16(b) of these Supplemental Terms; (iv) Each Mortgage Loan purchased by Buyer under the Agreement conforms to the requirements for securitization of whole loan collateral into publicly I-7 offered mortgage pass-through certificates pursuant to the shelf registration statements of such entities as may be acceptable to Buyer in its sole discretion; (v) With respect to each Transaction involving Home Equity Loans, Seller possesses all licenses, certificates, authorities or permits issued by the appropriate regulatory authorities necessary to originate, purchase, sell and hold such Home Equity Loans; (vi) Each Mortgage Loan conforms in all respects to either (1) Seller's underwriting guidelines, as set forth in the written description thereof supplied by Seller to Buyer on or prior to the date of this Agreement (with such amendments thereto, from time to time, as may be acceptable to Buyer and as are evidenced by the written acknowledgment of Buyer) or (2) such other standards as may be acceptable to Buyer, as evidenced by the written acknowledgment of Buyer; (vii) Each Mortgage Loan that is a Committed Mortgage Loan conforms in all respects with all requirements of any Trade Commitment or Mortgage-Backed Securities relating thereto; and (viii) Each Trade Commitment assigned or pledged by HMC to Buyer pursuant to a Trade Assignment is enforceable by Buyer against the related Trade Investor. (c) HMC covenants with Buyer as follows: (i) HMC shall notify Buyer of any changes in the terms of, or the parties to, the Warehouse Facilities within twenty-four (24) hours of HMC becoming aware of such changes, whether or not such changes have yet become effective; (ii) Without Buyer's express prior written approval, HMC shall not execute, in favor of any third party other than Buyer, any assignment of rights held or purportedly held by HMC under a given Trade Commitment; (iii) All financial and other covenants made by HMC under the Warehouse Facilities shall be deemed to be made directly to Buyer as though fully set forth herein; provided, however, that any -------- ------- such covenants that require HMC to obtain Buyer's consent prior to entering into financing arrangements (other than the Transactions contemplated hereby) shall be deemed to I-8 merely require prior written notice by HMC to Buyer of such financing arrangements without any requirement for the consent of Buyer; (iv) HMC shall, immediately prior to a Mortgage Loan becoming subject to the Agreement, own such Mortgage Loan free and clear of any lien, security interest, option or encumbrance; (v) HMC shall deliver to Buyer the Covenant Compliance Certificate referred to in Paragraph 12 of these Supplemental Terms by the same manner of delivery and at the same time as HMC is required to deliver it under the Warehouse Facilities, and Buyer may rely on such Covenant Compliance Certificate as if it were a direct addressee; (vi) HMC shall service the Mortgage Loans in accordance with the provisions of Paragraph 16 of these Supplemental Terms; (vii) HMC shall promptly notify Buyer after the occurrence of any change contemplated by Paragraph 11(a) of these Supplemental Terms; (viii) Each Mortgage Loan, other than a Home Equity Loan, that is not a Committed Mortgage Loan at the time it became subject to the Agreement will become a Committed Mortgage Loan within 90 days of its initially becoming subject to the Agreement and each Home Equity Loan that is not a Committed Mortgage Loan at the time it became subject to the Agreement will become a Committed Mortgage Loan within 120 days of its initially becoming subject to the Agreement; (ix) Notwithstanding any other provision of the Agreement and as of any date of determination, no more than 20% of the Mortgage Loans (determined on the basis of the outstanding principal amount of each Mortgage Loan on the date that such Mortgage Loan first becomes subject to the Agreement) shall have outstanding principal balances in excess of $500,000; (x) Notwithstanding any other provision of the Agreement, no B Quality Non-Conforming Mortgage Loan or C Quality Non-Conforming Mortgage Loan or Jumbo Mortgage Loan shall be subject to the Agreement or to the Custody Agreement for more than 120 days in aggregate; (xi) Notwithstanding any other provisions of the Agreement, if not sold within 120 days of the date hereof, no Home Equity Loan shall be subject to the I-9 Agreement or to the Custody Agreement for more than 180 days in aggregate; (xii) HMC will maintain on its Mortgage Loans which are Committed Mortgage Loans a Trade Commitment or evidence that such Committed Mortgage Loans will back a Mortgage-Backed Security in form and substance acceptable to Buyer; (xiii) HMC will provide Buyer upon reasonable request evidence satisfactory to Buyer of any Trade Commitment or evidence of securitization applicable to Mortgage Loans which are Committed Mortgage Loans; (xiv) On an ongoing basis, at HMC's expense without request of Buyer, HMC shall provide Buyer with HMC's audited year-end balance sheet and income statement within 120 days after the end of HMC's fiscal year and HMC's unaudited (or, if available, audited) quarterly balance sheet and income statement within 90 days after the end of each of HMC's three other fiscal quarters; (xv) Each Mortgage Loan that is not a Committed Mortgage Loan will at all times be the subject of hedging techniques established by HMC that are reasonable and customary in the mortgage banking industry; and (xvi) HMC shall, upon the request of Buyer, provide evidence in form and substance satisfactory to Buyer indicating that the Mortgage Loans referred to in clause (xv) above are in fact subject to hedging techniques established by HMC or by a firm that specializes in hedging techniques and is acceptable to Buyer. 10. EVENTS OF DEFAULT. ----------------- (a) The term "Event of Default" shall, in addition to the definition set forth in the Master Repurchase Agreement, include the following events: (i) Any governmental or self-regulatory authority shall take possession of Buyer or HMC or all or substantially all its property or appoint any such trustee, receiver, conservator or other official, or such party shall take any action to authorize any of the actions set forth in this clause (i). (ii) Buyer or HMC shall have reasonably determined that the other party is or will be unable to meet its commitments under the Agreement, shall have notified such other party of such determination and such other party shall not I-10 have responded with appropriate information to the contrary to the satisfaction of the notifying party within twenty-four (24) hours. (iii) A final judgment by any competent court in the United States of America for the payment of money in an amount of at least $100,000 is rendered against the defaulting party, and the same remains undischarged or unpaid for a period of 60 days during which execution of such judgment is not effectively stayed. (iv) The Agreement shall for any reason cease to create a valid, first priority security interest in any of the Mortgage Loans purported to be covered thereby; provided, however, that such circumstance -------- ------- shall not constitute an Event of Default if, after determining the Market Value of the Mortgage Loans without taking into account the Mortgage Loans with respect to which such circumstance has occurred, no other Event of Default shall have occurred and be continuing. (v) Any representation or warranty made by HMC in the Agreement or the Custody Agreement shall have been incorrect or untrue when made or repeated or when deemed to have been made or repeated and Buyer's interests shall have been materially adversely affected thereby. (vi) HMC shall breach any covenant in the Agreement or the Custody Agreement and Buyer's interests shall have been materially adversely affected thereby. (vii) An Act of Insolvency shall occur with respect to HMC or a controlling entity of HMC. (b) In addition to the other remedies available to Buyer or HMC upon the occurrence and during the continuance of an Event of Default by the other party, Buyer shall have the following additional remedies upon the occurrence and during the continuance of an Event of Default by HMC: (i) All rights of HMC to receive payments which it would otherwise be authorized to receive pursuant to Paragraph 5 of these Supplemental Terms shall cease, and all such rights shall thereupon become vested in Buyer, which shall thereupon have the sole right to receive such payments and apply them to the aggregate unpaid Repurchase Prices owed by HMC. I-11 (ii) All payments that are received by HMC contrary to the provisions of the preceding clause (i) shall be received in trust for the benefit of Buyer and shall be segregated from other funds of HMC. (c) Any sale of Mortgage Loans under Paragraph 11 of the Master Repurchase Agreement shall be conducted in a commercially reasonable manner. (d) Expenses incurred in connection with an Event of Default shall include without limitation those costs and expenses incurred by the nondefaulting party as a result of the early termination of any repurchase agreement or reverse repurchase agreement entered into by the nondefaulting party in connection with the Transaction then in default. (c) HMC acknowledges that any delay in the ability of Buyer to exercise its remedies pursuant to Paragraph 11 of the Master Repurchase Agreement shall result in irrep arable injury to Buyer. 11. ADDITIONAL EVENTS OF TERMINATION. -------------------------------- At the option of Buyer, exercised by written notice to HMC, the Repurchase Date for any or all Transactions under the Agreement shall be deemed to immediately occur (except as provided below with respect to subparagraph (d)) in the event that: (a) In the reasonable judgment of Buyer a material adverse change shall have occurred in the business, operations, properties, prospects or condition (financial or otherwise) of HMC; (b) Buyer shall request written assurances as to the financial well-being of HMC and such assurances shall not have been provided within twenty- four (24) hours of such request; (c) HMC shall be in default with respect to any normal and customary covenants under any material contract or agreement to which it is a party which default permits acceleration of the obligations of HMC under such contract or agreement by any other party thereto; (d) The senior debt obligations or short-term debt obligations of Merrill Lynch & Co., Inc. shall be rated below the four highest generic grades (without regard to any pluses or minuses reflecting gradations within such generic grades) by any nationally recognized statistical rating organization; I-12 (e) HMC shall merge or consolidate into any entity unless the surviving or resulting entity shall be satisfactory to Buyer and such entity expressly assumes by written agreement, executed and delivered to Buyer in form and substance satisfactory to Buyer, the performance of all of HMC's duties and obligations hereunder and under the Custody Agreement; (f) A firm of independent accountants shall have failed to issue an opinion or shall have issued a qualified opinion in connection with the most recent audited financial statements of HMC; (g) Any B Quality Non-Conforming Mortgage Loan or C Quality Non-Conforming Mortgage Loan or Jumbo Mortgage Loan shall have been subject to the Agreement or to the Custody Agreement for more than 120 days in aggregate; and (h) Any Home Equity Loan shall have been subject to the Agreement or to the Custody Agreement for more than 180 days in aggregate. In the event that the condition contemplated by subparagraph (d) shall occur and Buyer shall provide the aforementioned written notice to HMC, then the Repurchase Date for any or all Transactions under the Agreement designated by Buyer shall occur upon the earlier of (i) the date 30 days after Buyer provides such notice to HMC and (ii) the date that would otherwise be the Repurchase Date for each designated Transaction if no such notice had been given. The acceleration of the Repurchase Date as provided in this Paragraph 11 shall be in addition to any other rights of the parties to cause such an acceleration under the Agreement. 12. FINANCIAL STATEMENTS. -------------------- (a) As of the date hereof, Buyer and HMC shall each provide the other with its audited year-end financial statements and its most recent available interim financial statement. Buyer and HMC shall from time to time each provide the other with audited year-end financial statements and additional available interim financial statements upon such other party 's reasonable request. (b) HMC shall provide Buyer, at the expense of HMC without request of Buyer, with all periodic unaudited balance sheets and income statements from time to time as soon after the preparation thereof as practicable. In addition, HMC shall deliver to Buyer the quarterly certificate (the "Covenant Compliance Certificate") required to be delivered to the lending banks under the Warehouse Facilities and Buyer shall be permitted to rely on such Covenant Compliance Certificate to the same extent as such lending banks. I-13 (c) Each delivery of Mortgage Loans by HMC to Buyer hereunder will constitute a representation by HMC that there has been no material adverse change in HMC's financial condition not disclosed to Buyer since the date of HMC's most recent unaudited balance sheet or income statement delivered to Buyer. HMC shall provide Buyer, from time to time at HMC's expense, with such information of a financial or operational nature as Buyer may reasonably request promptly upon receipt of such request. 13. REPURCHASE PRICE; PRICE DIFFERENTIAL. The Price Differential shall be ------------------------------------ payable in arrears with respect to each Transaction, together with the Purchase Price therefor, on the termination date for the related Transaction or as may be otherwise mutually agreed upon by the parties and as specified in the related Confirmation. Payment of the Repurchase Price (including the Price Differential) shall be made by wire transfer in immediately available funds. 14. ADDITIONAL INFORMATION; CONFIDENTIALITY. --------------------------------------- (a) At any reasonable time HMC shall permit Buyer, its agents or attorneys, to inspect and copy any and all documents and data in their possession pertaining to each Mortgage Loan that is the subject of any Transaction. Such inspection shall occur upon the request of Buyer at a mutually agreeable location during regular business hours and on a date not more than two (2) business days after the date of such request. (b) HMC agrees to provide Buyer from time to time with such information concerning HMC of a financial or operational nature as Buyer may reasonably request. (c) HMC acknowledges that the Agreement and the Custody Agreement are confidential in nature and HMC agrees that, unless otherwise directed by a court of competent jurisdiction or as may be required by federal or state law (which determination as to federal or state law shall be based upon written advice of counsel), it shall limit the distribution of such documents to its officers, employees, attorneys, accountants and agents as required in order to conduct its business with Buyer. 15. MARGIN MAINTENANCE. Paragraph 4(a) of the Master Repurchase Agreement is ------------------ hereby modified to provide that if the notice to be given by Buyer to HMC under such paragraph is given at or prior to 10:00 a.m. New York City time on a business day, HMC shall transfer the cash or Additional Purchased Securities to Buyer (in the manner contemplated by the Agreement and the Custody Agreement) prior to the close of business in New York City on the date of such notice, and if such notice is given after I-14 10:00 a.m. New York City time, HMC shall transfer the cash or Additional Purchased Securities (in the manner as aforesaid) prior to the close of business in New York City on the business day following the date of such notice. 16. SERVICING ARRANGEMENTS. ---------------------- (a) The parties hereto agree and acknowledge that, notwith standing the purchase and sale of the Mortgage Loans contemplated hereby, HMC shall continue to service the Mortgage Loans for the benefit of Buyer and, if Buyer shall exercise its rights to sell the Mortgage Loans pursuant to the Agreement, Buyer's assigns; provided, however, that the -------- ------- obligation of HMC to service Mortgage Loans for the benefit of Buyer as aforesaid shall cease upon the repurchase of Mortgage Loans by or on behalf of HMC. (b) HMC shall service and administer the Mortgage Loans in accordance with prudent mortgage loan servicing standards and procedures generally accepted in the mortgage banking industry. HMC shall at all times maintain accurate and complete records of its servicing of the Mortgage Loans. (c) HMC shall provide Buyer and its permitted assigns with periodic reports concerning the Mortgage Loans with such frequency and containing such information as Buyer or its permitted assigns may reasonably request. In addition, HMC shall deliver to Buyer on each business day a schedule of Home Equity Loans reflecting current balances and such other information as Buyer may reasonably request. (d) Buyer shall, in connection with the exercise of its rights to sell the Mortgage Loans pursuant to Paragraph 11(d) of the Master Repurchase Agreement, have the option to sell the Mortgage Loans on a servicing released basis without the payment of any termination fee to HMC. 17. FURTHER ASSURANCES. HMC shall promptly provide such further assurances or ------------------ agreements as Buyer may request in order to effect the purposes of the Agreement and the Takeout Assignment. 18. BUYER AS ATTORNEY-IN-FACT. Buyer is hereby appointed to act after the ------------------------- occurrence and during the continuation of an Event of Default as the attorney-in-fact of HMC for the purpose of carrying out the provisions of this Agreement and taking any action and executing any instruments that Buyer may deem necessary or advisable to accomplish the purposes hereof, which appointment as attorney-in-fact is irrevocable and coupled with an interest. Without limiting the generality of the foregoing, Buyer shall have the right and power after the occurrence and during the continuation of any I-15 Event of Default to receive, endorse and collect all checks made payable to the order of HMC representing any payment on account of the principal of or interest on any of the Mortgage Loans and to give full discharge for the same. 19. TRANSACTION PROCEDURES. Buyer may, in its sole discretion, reject any ---------------------- Mortgage Loan from inclusion in a Transaction hereunder for any reason. 20. REPURCHASE TRANSACTIONS. Buyer may in its sole election engage in ----------------------- repurchase transactions with the Mortgage Loans or otherwise pledge or hypothecate the Mortgage Loans with a counterparty of Buyer's choice; provided, however, that no such transaction by Buyer shall relieve Buyer of -------- ------- its obligations to Seller in connection with the repurchase by Seller of any Mortgage Loans in accordance with the terms of the Agreement. 21. NEW YORK JURISDICTION; WAIVER OF JURY TRIAL. Seller agrees to submit to ------------------------------------------- personal jurisdiction in the State of New York in any action or proceeding arising out of the Agreement. Buyer and Seller each hereby waives the right of trial by jury in any litigation arising hereunder. 22. TERMINATION. Notwithstanding any provisions of Paragraph 15 of the Master ----------- Repurchase Agreement to the contrary, this Agreement and all Transactions outstanding hereunder shall terminate automatically without any requirement for notice on September 10, 1998; provided, however, that this Agreement and any Transaction outstanding hereunder may be extended by mutual agreement of Buyer and Seller; and provided further, however, that no such party shall be obligated to agree to such an extension. This Agreement may be cancelled by either party upon giving five (5) days' written notice to the other and so long as no Event of Default shall have occurred and be continuing, except that this Agreement shall, notwithstanding such notice, remain applicable to any Transactions then outstanding. 23. APPOINTMENT OF AGENT. MLCC hereby appoints MLMCI as its agent for purposes -------------------- of reviewing and executing Confirmations and Funding Requests, determining Market Value, exercising any termination option provided for in Paragraph 11 of these Supplemental Terms, exercising MLCC's rights under any margin maintenance provision of the Agreement, exercising MLCC's rights under the default provisions of the Agreement and such other purposes as MLCC may direct. The appointment of such agent shall not relieve MLCC of its obligations as Buyer hereunder. 24. BINDING TERMS. All of the covenants, stipulations, promises and agreements ------------- in the Agreement shall bind the successors and assigns of the parties hereto, whether expressed or not. I-16 25. NOTICES AND OTHER COMMUNICATIONS. Any provision of Paragraph 13 of the -------------------------------- Repurchase Agreement to the contrary notwithstanding, any notice required or permitted by the Agreement shall be in writing (including telegraphic, facsimile or telex communication) and shall be effective and deemed delivered only when received by the party to which it is sent; provided, -------- however, that a facsimile transmission shall be deemed to be received when ------- transmitted so long as the transmitting machine has provided an electronic confirmation of such transmission. Any such notice shall be sent to a party at the address or facsimile transmission number set forth in Annex II attached hereto. 26. MAXIMUM TRANSACTION AMOUNT. The aggregate outstanding Repurchase Price for -------------------------- the Mortgage Loans subject to the Agreement as of any date of determination shall not exceed $250,000,000. The aggregate outstanding Repurchase Price for the Mortgage Loans that are Home Equity Loans subject to this Agreement as of any date of determination shall not exceed $100,000,000. The aggregate outstanding Repurchase Price for the Mortgage Loans that are B Quality Non-Conforming Mortgage Loans or C Quality Non-Conforming Mortgage Loans subject to this Agreement as of any date of determination shall not exceed $50,000,000. The aggregate outstanding Repurchase Price for the Mortgage Loans that are Jumbo Mortgage Loans subject to this Agreement as of any date of determination shall not exceed $100,000,000. 27. EXPENSES. HMC shall pay its own expenses and all reasonable out-of-pocket -------- costs and expenses (including fees and disbursements of counsel): (1) of Buyer incident to the preparation and negotiation of the Agreement, the Custody Agreement, any documents relating thereto, any amendments or waivers thereto, and the protection of the rights of Buyer thereunder, and (2) of Buyer incident to the enforcement of payment of amounts due under the Agreement or the Custody Agreement, whether by judicial proceedings or otherwise, including, without limitation, in connection with bankruptcy, insolvency, liquidation, reorganization, moratorium or other similar proceedings involving HMC. Notwithstanding any provision hereof to the contrary, the obligations of HMC under this Paragraph 27 shall be effective and enforceable whether or not any Transaction remains outstanding and shall survive payment of all other obligations owed by HMC to Buyer. 28. COUNTERPARTS. This Agreement may be executed in any number of counterparts, ------------ each of which counterparts shall be deemed to be an original, and such counterparts shall constitute but one and the same instrument. 29. INCORPORATION OF TERMS. The Master Repurchase Agreement as supplemented ---------------------- hereby shall be read, taken and construed as one and the same instrument. I-17 EXHIBIT A CONFIRMATION TO: Headlands Mortgage Company 700 Larkspur Landing Circle Suite 250 Larkspur, CA 94939 Attention: Paul Casellini FROM: [Merrill Lynch Mortgage Capital Inc.] [Merrill Lynch Credit Corporation c/o Merrill Lynch Mortgage Capital Inc.] Merrill Lynch World Headquarters World Financial Center, North Tower New York, New York 10281-1208 RE: [Merrill Lynch Mortgage Capital Inc. ("MLMCI")] [Merrill Lynch Credit Corporation ("MLCC")] is pleased to confirm your sale and our purchase of the Mortgage Loans described below pursuant to the Master Repurchase Agreement (including the supplemental terms set forth in Annex I thereto), dated as of September 11, 1996 (the "Master Repurchase Agreement") among MLMCI, MLCC and Headlands Mortgage Company under the following terms and conditions: CREDIT LIMIT (IN THE CASE OF HOME EQUITY LOANS): ORIG. PRINCIPAL AMOUNT OF MORTGAGE LOANS: CURRENT PRINCIPAL AMOUNT OF MORTGAGE LOANS: PURCHASE DATE: REPURCHASE DATE: PURCHASE PRICE: PRICING RATE: MINIMUM REQUIRED MARGIN PERCENTAGE: PRICE DIFFERENTIAL DUE DATE: A-1 The Master Repurchase Agreement is incorporated by reference into this Confirmation and made a part hereof as if it were fully set forth herein. All capitalized terms used herein but not otherwise defined shall have the meanings specified in the Master Repurchase Agreement. [MERRILL LYNCH MORTGAGE CAPITAL INC.] [MERRILL LYNCH CREDIT CORPORATION BY: MERRILL LYNCH MORTGAGE CAPITAL INC.] BY: NAME: TITLE: A-2 EXHIBIT B FUNDING REQUEST =============== Request No. ___
Product Wire Loan Borrower Loan Purchase Market Takeout Note Commitment Takeout Maturity Investor Type Date Number Last Name Amount Price Value Date Rate Number Price Date - -------- ---- ---- ------ --------- ----- ----- ----- ---- ---- ------ ----- ----
Amount to be funded by [MLMCI] [MLCC]: $____________ Headlands Mortgage Company By: ___________________________ Title: ___________________________ Date: ___________________________ B-1 EXHIBIT C [TRADE ASSIGNMENT] [TRADE INVESTOR] Gentlemen: Attached hereto is a true, correct and complete copy of your confirmation of commitment (the "Commitment"), trade-dated _______________, 19__, to purchase $___________ of mortgage loans (the "Mortgage Loans") referred to therein at a purchase price of ________________. This is to confirm that (i) the Commitment is in full force and effect, (ii) the Commitment has been assigned to Merrill Lynch Mortgage Capital Inc. ("MLMCI"), whose acceptance of such assignment is indicated below, (iii) you will accept delivery of such Mortgage Loans directly from MLMCI and (iv) MLMCI or its designee will receive the payment for such Mortgage Loans. Payment will be made "delivery versus payment" to MLMCI or its designee in immediately available funds. MLMCI shall have the right to require you to fulfill your obligation to purchase the Mortgage Loans. Notwithstanding the foregoing, the obligation to delivery the Mortgage Loans to you shall be that of Headlands Mortgage Company (the "Seller") and your sole recourse for the failure of such delivery shall be against the Seller. If you have any questions concerning this assignment, please call James B. Cason of MLMCI at (212) 449-1219 immediately. Very truly yours, HEADLANDS MORTGAGE COMPANY By: __________________________ Title: ___________________________ Date: ___________________________ Agreed to: MERRILL LYNCH MORTGAGE CAPITAL INC. By: ___________________________ Title: ___________________________ Date: ___________________________ C-1 EXHIBIT D INVESTOR COMMITMENT REPORT -------------------------- Trade Investor Outstanding Funding or Commitment Requests (listed by #) Securitization Number ---------------------- -------------- ------ D-1 ANNEX II Names and Addresses for Communications Between Parties MERRILL LYNCH MORTGAGE CAPITAL INC. Merrill Lynch World Headquarters World Financial Center North Tower - 8th Floor New York, New York 10281 Attention: James B. Cason Telephone: (212) 449-1219 Telecopy: (212) 449-6673 HEADLANDS MORTGAGE COMPANY 700 Larkspur Landing Circle Suite 250 Larkspur, California 94939 Attention: Paul Casellini Telephone: (415) 925-5422 Telecopy: (415) 461-1329 MERRILL LYNCH CREDIT CORPORATION c/o Merrill Lynch Mortgage Capital Inc. Merrill Lynch World Headquarters World Financial Center North Tower - 8th Floor New York, New York 10281 Attention: James B. Cason Telephone: (212) 449-1219 Telecopy: (212) 449-6673 II-1 [MERRILL LYNCH MORTGAGE CAPITAL INC. LETTERHEAD] September 11, 1997 Headlands Mortgage Company 700 Larkspur Landing Circle Suite 250 Larkspur, California 94939 Re: Master Repurchase Agreement among Merrill Lynch Mortgage Capital Inc., Merrill Lynch Credit Corporation and Headlands Mortgage ------------------------------------------------------------- Company ------- Gentlemen: Reference is made to the Master Repurchase Agreement, dated as of September 11, 1997 (the "Agreement"), among Merrill Lynch Mortgage Capital Inc. ("MLMCI"), Merrill Lynch Credit Corporation ("MLCC") and Headlands Mortgage Company (the "Company"). MLCC has appointed MLMCI as its agent under the Agreement. Capitalized terms used and not otherwise defined herein shall have the meanings ascribed in the Agreement. This letter is to confirm that MLMCI, acting on behalf of itself and MLCC, and the Company have agreed to renew the terms of the Agreement for a period of one year on an uncommitted basis such that the termination date for the Agreement is extended to September 10, 1998 (the "Revised Termination Date"). Any provision of the Agreement or any other document relating thereto to the contrary notwithstanding, MLMCI, acting on behalf of itself and MLCC, may in its discretion, but is not required to, enter into Transactions under the Agreement from the date hereof to the Revised Termination Date. Please confirm our mutual agreement as set forth herein and acknowledge receipt of this confirmation letter by executing the enclosed copy of this letter and returning it to Merrill Lynch Mortgage Capital Inc., Merrill Lynch World Headquarters, World Financial Center, North Tower, 15th Floor, New York, New York 10281, Attention: James B. Cason (telecopy number (212) 449- 3673). If you have any questions concerning this matter, please contact Mr. Cason at (212) 449-1219. Very truly yours, MERRILL LYNCH MORTGAGE CAPITAL INC. By: /s/ Michael Blum ----------------- Name: Michael Blum --------------- Title: Director --------- ACCEPTED, CONFIRMED AND ACKNOWLEDGED: HEADLANDS MORTGAGE COMPANY By: /s/ Paul Casellini -------------------- Name: Paul Casellini ----------------- Title: Senior Vice President/Treasurer ------------------------------- Dated: As of September 11, 1997 EX-10.7 15 TAX INDEMNIFICATION AGREEMENT EXHIBIT 10.7 ------------ TAX INDEMNIFICATION AGREEMENT This Tax Indemnification Agreement (this "Agreement"), is entered into this 15th day of October, 1997, by and between HEADLANDS MORTGAGE COMPANY, a California corporation ("Headlands"), THE JESSICA M. PAUL IRREVOCABLE TRUST, THE JESSICA M. PAUL GRANTOR TRUST, PETER T. PAUL LIVING TRUST, and JESSICA M. PAUL, an individual (collectively the "Paul Shareholders") and DENNIS M. HART, KATHERINE E. HART, D. MICHAEL HART, JR., ELIZABETH A. HART and CHRISTOPHER K. HART (collectively, the "Hart Shareholders"). The Paul Shareholders and the Hart Shareholders are collectively referred to as the "Shareholders" or individually "Shareholder". Recitals -------- WHEREAS, Headlands was and will be an S corporation within the meaning of Section 1361 of the Internal Revenue Code of 1986, as amended (the "Code"), and the corresponding provisions of state income tax law, for the period from inception of operations in 1986 through the closing date (the "Closing Date") of the Headlands initial public offering (the "S Period"); WHEREAS, immediately prior to the Closing Date the Shareholders held all the outstanding shares of common stock of Headlands (the "Common Stock"), which comprised the only class of capital stock of Headlands outstanding; WHEREAS, Headlands will be a C corporation within the meaning of Section 1361 of the Code and the corresponding provisions of state income tax law from the Closing Date and thereafter; WHEREAS, if Headlands completes an initial public offering and a tax audit increases or decreases the taxable income or non deductible items from Headlands allocated to any Shareholder, the parties intend that, if such audit results in a larger allocation of income or non deductible items to any Shareholder, Headlands shall make a distribution to such Shareholder to offset the tax payable as a result of such allocation and, if such audit results in a reduced allocation of income or non-deductible items to any Shareholder, such Shareholder will repay to Headlands the amount of any distribution Headlands made to such Shareholder to permit such Shareholder to pay the prior tax. Agreement --------- NOW, THEREFORE, in consideration of the premises and of the mutual agreements contained herein, the parties hereto agree as follows: 1. Contingent Effective Date. This Agreement shall only become ------------------------- effective upon the successful completion of an initial public offering by Headlands. 2. Representations, Warranties and Covenants of the Paul ----------------------------------------------------- Shareholders. The Paul Shareholders jointly and severally represent and warrant - ------------ to Headlands that: (a) During the S Period, the Paul Shareholders duly and timely filed all tax reports and returns required to be filed by them and shall duly and timely file all tax reports and returns required to be filed by them for any future tax year in the S period ("Paul Shareholder Tax Returns"). (b) The Paul Shareholders, to the best of their knowledge, have duly included, or will duly include, in their Paul Shareholder Tax Returns their allocable share of Headlands' taxable income from all sources through and including the last business day of the S Period (the "S Corporation Taxable Income") as reported to them on IRS Form K-1 issued by Headlands to each Paul Shareholder. (c) To the best of each Paul Shareholder's knowledge there are no pending audits, inquiries, investigations or examinations relating to any of the Paul Shareholder Tax Returns, and there are no claims which have been asserted relating to any of the Paul Shareholder Tax Returns which if determined adversely would result in the assertion by any entity of the federal government or California State government of any federal or California State income tax ("Tax") deficiency against Headlands. 3. Representations, Warranties and Covenants of the Hart ----------------------------------------------------- Shareholders. The Hart Shareholders jointly and severally represent and warrant - ------------ to Headlands that: (a) During the S Period, the Hart Shareholders duly and timely filed all tax reports and returns required to be filed by them and shall duly and timely file all tax reports and returns required to be filed by them for any future tax year in the S period ("Hart Shareholder Tax Returns"). (b) The Hart Shareholders, to the best of their knowledge, have duly included, or will duly include, in their Hart Shareholder Tax Returns their allocable share of S Corporation Taxable Income as reported to them on IRS Form K-1 issued by Headlands to each Hart Shareholder. (c) To the best of each Hart Shareholder's knowledge there are no pending audits, inquiries, investigations or examinations relating to any of the Hart Shareholder Tax Returns, and there are no claims which have been asserted relating to any of the Hart Shareholder Tax Returns which if determined adversely would result in the assertion by any entity of the federal government or California State government of any Tax deficiency against Headlands. 4. Representations, Warranties and Covenants of Headlands. ------------------------------------------------------ Headlands represents and warrants to the Shareholders that, to the best of its knowledge and except for an audit of the tax years 1993 and 1994, there are no pending audits, inquiries, investigations or examinations relating to any of the Paul Shareholder Tax Returns or the Hart Shareholder Tax Returns or any tax return of Headlands, and that there are no claims which have been asserted relating to any of the Paul Shareholder Tax Returns or the Hart Shareholders Tax Returns or any tax return of Headlands which if determined adversely would result in the assertion by any entity of the federal government or California state government of any federal or California state income tax deficiency against a Shareholder or Shareholders. 5. Indemnifications By Shareholders. -------------------------------- (a) The Paul Shareholders, jointly and severally, shall be responsible for and shall indemnify and save and hold harmless Headlands against all Tax (including interest and penalties and related costs and expenses) imposed on Headlands resulting from a final determination of an adjustment to any Paul Shareholders' taxable income resulting in a decrease in any Paul Shareholders' S Corporation Taxable Income and a corresponding decrease in Headlands' taxable income (whether with respect to the same tax year for which the adjustment is made or over future tax years) and such Paul Shareholders had received a distribution from Headlands relating to the prior overpayment of tax by such Paul Shareholder. (b) The Hart Shareholders, jointly and severally, shall be responsible for and shall indemnify and save and hold harmless Headlands against all Tax (including interest and penalties and related costs and expenses) imposed on Headlands resulting from a final determination of an adjustment to any Hart Shareholders' taxable income resulting in a decrease in the Hart Shareholders' S Corporation Taxable Income and a corresponding decrease in Headlands' taxable income (whether with respect to the same tax year for which the adjustment is made or over future tax years) and such Hart Shareholder had received distribution from Headlands relating to the prior overpayment of tax by such Paul Shareholder. 6. Indemnifications By Headlands. If after Headlands has filed its ----------------------------- federal or state tax return there is a final determination of an adjustment to Headlands' taxable income for any tax year during the S Period resulting in an increase in such Shareholder's S Corporation Taxable Income and a decrease in Headland's taxable income (whether with respect to the same tax year for which the adjustment is made or over future tax years) (the "Increase In Income"), Headlands shall indemnify and save and hold harmless each Shareholder from and against all Tax imposed (including interest and penalties and related costs and expenses) on each such Shareholder 3 resulting from such Increase In Income. Further, Headlands shall indemnify and hold harmless the Shareholders from and against Tax incurred by such Shareholders resulting from the receipt of any indemnification payments made to such Shareholders pursuant to the foregoing sentence. Notwithstanding the foregoing, the total indemnity provided by Headlands to the Shareholders by this Paragraph 6 shall not exceed the amount of the deferred tax liability which may be recorded on the balance sheet of Headlands upon termination of the S corporation status. 7. Time For Payments. The Shareholders or Headlands, as the case ----------------- may be, shall make any payment required under this Agreement within thirty (30) days after receipt of notice from the other party that a payment is due by such party to the appropriate taxing authority. Any such payment not so made shall thereafter bear interest at the rate of 10% per annum. 8. Deferred Tax Liability. Notwithstanding the foregoing, the ---------------------- Shareholders shall not be responsible for any portion of any deferred tax liability which may be recorded on the balance sheet of Headlands upon termination of the S corporation status. 9. Notice. All notices and other communications made in connection ------ with this Agreement shall be in writing and shall be deemed given when delivered personally or sent by facsimile transmission to the numbers indicated below (if physical confirmation of transmission is retained) or on the third succeeding business day after being mailed by registered or certified mail, deposited in the United States mail, postage prepaid, return receipt requested, to the appropriate party at its, his or her address below or at such other address for such party (as shall be specified by written notice when in fact delivered pursuant hereto): If to Headlands, at: Headlands Mortgage Company 700 Larkspur Landing Circle Suite 250 Larkspur, CA 94939 Attn: Peter T. Paul If to the Paul Shareholders, at: Peter T. Paul Headlands Mortgage Company 700 Larkspur Landing Circle Suite 250 Larkspur, CA 94939 4 If to the Hart Shareholders, at Hart Shareholders c/o J. Michael Shepherd Brobeck, Phleger & Harrison LLP Spear Street Tower One Market Street San Francisco, CA 94105 10. Enforceability; Consent to Jurisdiction. The rights of the --------------------------------------- parties under this Agreement shall be enforceable only in the state courts of the State of California. Each of the parties irrevocably consents to the jurisdiction of the courts of the State of California for all purposes in connection with any action or proceedings which arises out of or relates to this Agreement and each party agrees that any action instituted under this Agreement shall be brought only in the state courts of the State of California. 11. Choice of Law. This Agreement shall be governed by, and the ------------- provisions of this Agreement shall be construed in accordance with, the laws of the State of California as applied to contracts between California residents entered into and to be performed entirely within California. 12. Amendment. No amendment, modification, termination or --------- cancellation of this Agreement shall be effective unless made in a writing signed by each of the parties to this Agreement. 13. Successors and Assigns. This Agreement shall be binding upon ---------------------- each of the parties to this Agreement and their respective successors, and shall inure to the benefit of each of the parties and their successors, estates, heirs and legal representatives. The rights and obligations under this Agreement may not be assigned without the prior written consent of all the parties. 14. Attorneys' Fees. In the event that any action is instituted by a --------------- party under this Agreement to enforce or interpret any of the terms of this Agreement, the prevailing party shall be entitled to be paid all court costs and expenses, including reasonable attorneys' fees, incurred with respect to such action. 15. Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall constitute an original. 16. Severability. Any provision of this Agreement that is prohibited ------------ or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the 5 extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. IN WITNESS WHEREOF, the parties have executed this Agreement in San Francisco, California, as of this 15th day of October, 1997. "HEADLANDS" HEADLANDS MORTGAGE COMPANY By_______________________________________ PETER T. PAUL, President "PAUL SHAREHOLDERS" THE JESSICA M. PAUL IRREVOCABLE TRUST By_______________________________________ DANIEL W. PAUL, as Trustee of the Jessica M. Paul Irrevocable Trust dated May 21, 1997 THE JESSICA M. PAUL GRANTOR TRUST By______________________________________ GILBERT J. MACQUARRIE, as Trustee of the Jessica M. Paul Grantor Trust dated May 21, 1997 [Signatures Continued on Page 7] 6 [Signatures Continued from Page 6] PETER T. PAUL LIVING TRUST By______________________________________ PETER T. PAUL, as Trustee of the Peter T. Paul Living Trust dated May 21, 1997 ________________________________________ JESSICA M. PAUL "HART SHAREHOLDERS" ________________________________________ DENNIS M. HART ________________________________________ KATHERINE E. HART ________________________________________ D. MICHAEL HART, JR. ________________________________________ ELIZABETH A. HART ________________________________________ CHRISTOPHER K. HART 7 EX-10.8 16 FOUNDERS REGISTRATION RIGHTS AGREEMENT EXHIBIT 10.8 ------------ HEADLANDS MORTGAGE COMPANY FOUNDERS REGISTRATION RIGHTS AGREEMENT This REGISTRATION RIGHTS AGREEMENT (the "Agreement) is made and entered into as of December ___, 1997, by and among Headlands Mortgage Company, a California corporation (the "Company"), and the undersigned stockholders of the Company. In consideration of the mutual agreements contained herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto, intending to be legally bound, hereby agree as follows: SECTION 1. DEFINITIONS ----------- As used in this Agreement, the following capitalized terms shall have the following meanings: "Affiliate" of a specified person shall mean any other person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified person. For 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; and the terms "controlling" and "controlled have meanings correlative to the foregoing. "Common Stock" shall mean the Company's Common Stock. "Company" shall mean Headlands Mortgage Company, a California corporation, until a successor replaces it and thereafter means such successor. "Company Allotment" shall be as defined in Section 3(b). "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and the rules and regulations of the SEC promulgated thereunder. "Holders" shall be as defined in Section 2(b) hereof. "Holders Allotment" shall be as defined in 4(b). "NASD" means National Association of Securities Dealers, Inc. "NASDAQ/NMS shall mean Nasdaq National Market. "Other Holders Allotment" shall be as defined in Section 4(b). 1 "Person" shall mean an individual, trustee, corporation, partnership, limited liability company, joint stock company, trust, unincorporated association, union, business association, firm or other entity. "Piggyback Notice" shall have the meaning as set in forth Section 3(a) hereof. "Piggyback Underwritten Offering" shall have the meaning as set forth in Section 3(a) hereof. "Proceeding" shall mean an action, claim, suit or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), where commenced or threatened. "Prospectus" shall mean the prospectus included in any Registration Statement (including, without limitation, a prospectus that discloses information previously omitted from a prospectus filed as part of an effective Registration Statement in reliance upon Rule 430A promulgated under the Securities Act), as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by such Registration Statement, and all other amendments and supplements to Prospectus, including post-effective amendments, and all material incorporated by reference or deemed to be incorporated by reference in this Prospectus. "Registrable Securities" shall mean the shares of Common Stock held by such Holder on the date of this Agreement until such time as such shares of Common Stock shall have been effectively registered under the Securities Act and disposed of in accordance with the Registration Statement covering such shares, or are otherwise freely transferable by the holder without requirement of registration under the Securities Act. "Registration Statement" shall mean any registration statement of the Company that covers any of the Registrable Securities pursuant to the provisions of this Agreement, including the Prospectus, amendments and supplements of such Registration Statement and all exhibits and all material incorporated by reference or deemed to be incorporated by reference in such Registration Statement. "Rule 144" shall mean Rule 144 under the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the SEC. "SEC" shall mean the Securities and Exchange Commission. "Underwriter" shall mean any Underwriter, placement agent, selling broker, dealer manager, qualified independent Underwriter or similar securities industry professional. "Underwritten Registration or Underwritten Offering" shall mean a registration in which securities of the Company are sold to an Underwriter for re-offering to the public. 2 SECTION 2. SECURITIES SUBJECT TO THIS AGREEMENT (a) Registrable Securities. The securities entitled to the ---------------------- benefits of this Agreement are the Registrable Securities. (b) Holders of Registrable Securities. A Person is deemed to be --------------------------------- a Holder of Registrable Securities (each, a "Holder") whenever such Person owns Registrable Securities. SECTION 3. PIGGYBACK REGISTRATION (a) Right to Piggyback. If the Company proposes to file a ------------------ Registration Statement under the Securities Act with respect to a firm commitment underwritten public offering of Common Stock (other than a Registration Statement (i) on Form S-4, Form S-8 or any successor forms thereto or (ii) filed solely in connection with an exchange offer or any employee benefit or dividend reinvestment plan), whether or not for its own account, then the Company shall give written notice of such proposed filing to the Holders of Registrable Securities at least fifteen (15) days before the anticipated filing date (the "Piggyback Notice"). The Piggyback Notice shall offer such Holders the opportunity to include in such Underwritten Offering such amount of Registrable Securities as each such Holder may request (a "Piggyback Underwritten Offering"). Subject to Section 3(b) hereof, the Company shall include in each such Piggyback Underwritten Offering all Registrable Securities with respect to which the Company has received written requests for inclusion therein within ten (10) days after notice has been given to the applicable Holder (which request shall specify the intended method of distribution). The Holders of Registrable Securities shall be permitted to withdraw all or part of the Registrable Securities from a Piggyback Underwritten Offering at any time prior to the effective date of such Piggyback Underwritten Offering. (b) Priority on Piggyback Underwritten Offerings. The Company -------------------------------------------- shall cause the managing Underwriter or Underwriters of a proposed Underwritten Offering to permit Holders of Registrable Securities to include all such Registrable Securities requested to be included in the Piggyback Underwritten Offering on the same terms and conditions as any other shares of Common Stock, if any, of the Company included therein. Notwithstanding the foregoing, if the managing Underwriter or Underwriters of such Piggyback Underwritten Offering have informed the Company in writing that it is their opinion that the total amount of securities that such Holders, the Company and any other Persons having rights to participate in such offering, intended to include in such offering is such as to materially and adversely affect the success of such offering, then the Common Stock to be offered in the Piggyback Underwritten Offering shall be the amount recommended by such managing Underwriter or Underwriters and the Common Stock to be included in such Piggyback Underwritten Offering shall be included in the following order of priority: (i) for the account of the Company, as many shares as the Company may desire or be permitted to sell at such time (the "Company Allotment"); (ii) for the account of all such other Persons (other than the Company), as many shares as such Persons may desire to sell at such time, (the "Other Holders Allotment"); and (iii) the remaining capacity, if any, for the account of the Holders (the "Holders Allotment"), to be divided among such Holders pro rata in production to the respective dollar amounts of such securities requested to be registered. 3 SECTION 4. HOLD-BACK AGREEMENTS (a) Restrictions on Public Sale by Holders of Registrable ----------------------------------------------------- Securities. Each Holder of Registrable Securities agrees, in connection with - ---------- any sale of securities by the Company and in connection with any Registration Statement filed pursuant to Section 3 hereof in which all or a portion of the Company Allotment is being sold, until such time as there are no remaining Registrable Securities, if requested (pursuant to a timely written notice) by the Company or the managing Underwriter or Underwriters in an Underwritten Offering, not to effect any public sale or distribution of any of its Registrable Securities, including a sale pursuant to Rule 144 (except as part of such Underwritten Offering), during the sale pursuant to Rule 144 (except as part of such Underwritten Offering), during the period beginning ten (10) days prior to, and ending ninety (90) days after, the closing date of such Underwritten Offering made by the Company or pursuant to such Registration Statement, unless a shorter time period is agreed to be the managing Underwriter or Underwriters. (b) Restrictions on Public Sale by the Company. The Company ------------------------------------------ agrees that without the written consent of the managing Underwriter or Underwriters in an Underwritten Offering of Registrable Securities as described in Section 3 hereof in which all or a portion of the Holders Allotment is being sold, it will not affect any public or private sale or distribution of its equity securities, including a sale pursuant to Regulation D under the Securities Act, during the ten (10) day period prior to, and the ninety (90) day period beginning on, the closing date of each such Underwritten Offering, unless a shorter time period is agreed to by the managing Underwriter or Underwriters (except (v) as part of such Underwritten Registration, (w) pursuant to registrations on Form S-4 or Form S-8 or any successor form to such forms or pursuant to any unregistered offering to the Company's employees or directors, or to employees of its subsidiaries, pursuant to any employee benefit plan (as defined in Rule 405 under the Securities Act) or dividend reinvestment plan, (x) pursuant to the conversion of preferred stock or exercise of warrants, (y) in connection with an exchange offer or (z) in connection with the acquisition of assets by the Company or its subsidiaries). SECTION 5. REGISTRATION PROCEDURES In connection with the Company's registration obligations pursuant to Section 3 hereof, the Company shall effect such registration(s) to permit the sale of such Registrable Securities in accordance with the intended method or methods of disposition thereof, as follows: (a) Prepare and file with the SEC a Registration Statement or Registration Statements on such form which shall be available for the sale of Registrable Securities in accordance with the intended method or methods of distribution thereof, and use its best efforts to cause such Registration Statement to become effective and to remain effective as provided herein; provided, however, that before filing a Registration Statement or Prospectus or any amendments or supplements thereof (including documents that would be incorporated or deemed to be incorporated therein by reference), the Company shall notify the Holders of the Registrable Securities covered by such Registration Statement, their counsel and managing Underwriters, if any, of its intention to file such documents, and upon request shall furnish to such parties so requesting copies of all such documents, and upon request shall furnish to such parties so requesting copies of all such documents proposed to be filed, which documents will be subject to the review of such Holders, their counsel and such Underwriters, if any, provided, however, that the Company shall not be required to deliver to such Holders a copy of any such document that has not been materially changed from a copy of such document that was previously delivered to such Holders. (b) Prepare and file with the SEC such amendments to each Registration Statement as may be necessary to cause such Registration Statement to become effective with respect to the disposition of all securities covered by such Registration Statement; and cause the related Prospectus to be supplemented by any required Prospectus supplement, and as so supplemented to be filed pursuant to Rule 424 (or any similar provisions then in force) under the Securities Act. (c) Notify the selling Holders of Registrable Securities, their counsel and the managing Underwriters, if any, promptly, and (if requested by any such Person), confirm such notice in writing, (i) when a Registration Statement or any amendment thereto has been filed, and, with respect to a Registration Statement, when the same has become effective, (ii) of any request by the SEC or any other Federal or state governmental authority for amendments or supplements to a Registration Statement or related Prospectus or for additional information (provided, the Company shall not be required to notify the Holders or their counsel of all "comment" letters received by the Company from the SEC or to deliver copies of such comment letters of the Company's responses thereto to the Holders or their counsel unless such letters request information from or about the Holders), (iii) of the issuance by the SEC of any stop order suspending the effectiveness of a Registration Statement or the initiation of any proceedings for that purpose, (iv) if at any time the representations and warranties of the Company contained in any agreement (including any underwriting agreement) contemplated by Section 5(n) below cases to be true and correct, (v) of the receipt by the Company of any notification with respect to the suspension of the qualification or exemption from qualification of any of the Registrable Securities for sale in any jurisdiction, or the initiation or threatening of any proceeding for such purpose, and (vi) of the happening of any event that makes any statement made in such Registration Statement or related Prospectus or any document incorporated or deemed to be incorporated therein by reference untrue in any material respect or that requires the making of any changes in such Registration Statement, Prospectus or documents so that, in the case of the Registration Statement, it will not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) Use its best efforts to obtain the withdrawal of any order suspending the effectiveness of a Registration Statement, or the lifting of any suspension of the qualification (or exemption from qualification) of any of the Registrable Securities for sale in any jurisdiction. (e) If requested by managing Underwriters, if any, or the Holders of a majority of the then outstanding Registrable Securities being sold in connection with an Underwritten Offering, promptly include in a Prospectus supplement or post-effective amendment such information as the managing Underwriters, if any, and such Holders may reasonably request in order to permit the intended method of distribution of such securities and make all required filings of such Prospectus supplement or such post-effective amendment as soon as practicable after the Company has received such request; provided however, that the Company shall not be required to take any actions under this Section 5(e) that are not, in the opinion of counsel for the Company, in compliance with applicable law. (f) Furnish to a selling Holder of Registrable Securities, their counsel and each managing Underwriter, if any, without charge, at lease one conformed copy of the Registration Statement and each post-effective amendment thereto, including financial statements (but excluding schedules, all documents incorporated or deemed to be incorporated therein by reference, and all exhibits, unless requested in writing by such holder, counsel or Underwriter). (g) Deliver to each selling Holder of Registrable Securities, their counsel, and the Underwriters, if any, without charge, as many copies of the Prospectus or Prospectuses (including each form of prospectus) and each amendment or supplement thereto as such Persons may reasonably request in connection with the distribution of the Registrable Securities; and the Company hereby consents to the use of such Prospectus and each amendment or supplement thereto by each of the selling Holders of Registrable Securities and the Underwriters, if any, in connection with the offering and sale of the Registrable Securities covered by such Prospectus and any such amendment or supplement thereto. (h) Use its best efforts to register or qualify, or obtain an exemption therefrom (or cooperate with the selling Holders of Registrable Securities, the Underwriters, if any, and their respective counsel in connection with the registration or qualification (or exemption from such registration or qualification)) of such Registrable Securities for offer and sale under the securities or Blue Sky laws of such jurisdictions within the United States as any seller (or Underwriter) reasonably requests in writing and to keep such registration or qualification (or exemption therefrom) effective during the period such Registration Statement is required to be kept effective; provided, however, that the Company will not be required to (A) qualify generally to do business in any jurisdiction where it is not then so qualified or (B) take any action that would subject it to general service of process or to taxation in any such jurisdiction where it is not then so subject. (i) Cooperate with the selling Holders of Registrable Securities and the managing Underwriters, if any, to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be sold, which certificates shall be in a form eligible for deposit with the Depository Trust Company; and enable such Registrable Securities to be in such denominations and registered in such names as the managing Underwriters, if any, or Holders may request at least two (2) business days prior to any sale of Registrable Securities in a firm commitment public offering, or in any other such sale within ten (10) business days. (j) Use its best efforts to cause the Registrable Securities covered by the Registration Statement to be registered with or approved by such other governmental agencies or authorities within the United States, except as may be required solely as a consequence of the nature of such selling Holder's business, in which case the Company will cooperate in all best 6 respects with the filing of such Registration Statement and the granting of such approvals as may be necessary to enable the seller or sellers thereof or the Underwriters, if any, to consummate the disposition of such Registrable Securities. (k) Upon the occurrence of any event contemplated by Section 5(c)(vi) above, prepare a supplement or post-effective amendment to the Registration Statement or a supplement to the related Prospectus or any document incorporated or deemed to be incorporated therein by reference, or file any other required document so that, as thereafter delivered to the purchasers of the Registrable Securities being sold thereunder, such Prospectus will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (l) Prior to the effective date of the Registration Statement relating to the Registrable Securities, provide a CUSIP number for the Registrable Securities. (m) Use its best efforts to cause all Registrable Securities covered by such Registration Statement to be authorized to be quoted on the NASDAQ/NMS or listed on a national securities exchange. (n) Enter into such agreements (including an underwriting agreement in form, scope and substance as is customary in Underwritten Offerings) and take all such other actions reasonably requested by the Holders of a majority of the Registrable Securities being sold in connection therewith (including those reasonably requested by the managing Underwriters, if any) in order to expedite or facilitate the disposition of such Registrable Securities, and in such connection, whether or not an underwriting agreement is entered into and whether or not the registration is an Underwritten Registration, (i) make such representations and warranties to the Holders of such Registrable Securities and the Underwriters, if any, with respect to the business of the Company and its subsidiaries, and the Registration Statement, Prospectus and documents, if any, incorporated or deemed to be incorporated by reference therein, in each case, in form, substance and scope as are customarily made by users to Underwriters in Underwritten Offerings, and if true, confirm the same if and when requested, (ii) use its reasonable efforts to obtain opinions of counsel to the Company and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to the managing Underwriters, if any, and counsel to the Holders of the Registrable Securities being sold), addressed to each selling Holder of Registrable Securities and each of the Underwriters, if any, covering the matters customarily covered in opinions requested in Underwritten Offerings and such other matters as may be reasonably requested by such counsel and Underwriters, (iii) use its reasonable efforts to obtain "cold comfort" letters and updates thereof from the independent certified public accountants of the Company (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements and financial data are, or are required to be, included in the Registration Statement), addressed to each selling Holder of Registrable Securities (unless such accountants shall be prohibited from so addressing such letters by applicable standards of the accounting profession) and each of the Underwriters, if any, such letters to be in customary form and covering matters of the type customarily covered in "cold comfort" letters in connection 7 with Underwritten Offerings, (iv) if an underwriting agreement is entered into, the same shall contain indemnification provisions and procedures substantially to the effect set forth in Section 7 hereof with respect to all parties to be indemnified pursuant to said Section and (v) deliver such documents and certificates as may be reasonably requested by the Holders of a majority of the Registrable Securities being sold, their counsel and the managing Underwriters, if any, to evidence the continued validity of the representations and warranties made pursuant to Section 5(b)(i) above and to evidence compliance with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company. The above shall be done at each closing under such underwriting or similar agreement, or as and to the extent required thereunder. (o) Make available for inspection by a representative of the Holders of Registrable Securities being sold, any Underwriter participating in any such disposition of Registrable Securities, if any, and any attorney or accountant retained by such selling Holders or Underwriter, at the offices where normally kept, during reasonable business hours, all financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries, and cause the officers, directors and employees of the Company and its subsidiaries to supply all information in each case reasonably requested by any such representative, Underwriter, attorney or accountant in connection with such Registration Statement; provided, however, that any information that is designated by the Company in writing as confidential at the time of delivery of such information shall be kept confidential by such Persons unless (i) disclosure of such information is required by court or administrative order, (ii) disclosure of such information, in the opinion of counsel to such Person, is required by law, or (iii) such information becomes generally available to the public other than as a result of a disclosure or failure to safeguard by such Person. Without limiting the foregoing, no such information shall be used by such Person as the basis for any market transactions in securities by the Company or its subsidiaries in violation of law. (p) Comply with all applicable rules and regulations of the SEC and make generally available to its securities Holders earning statements satisfying the provisions of Section 11(a) of the Securities Act and Rule 158 thereunder, or any similar rule promulgated under the Securities Act, no later than forty-five (45) days after the end of any twelve (12) month period (or ninety (90) days after the end of any twelve (12) month period if such period is a fiscal year) (i) commencing at the end of any fiscal quarter in which Registrable Securities are sole to Underwriters in a firm commitment or best efforts Underwritten Offering and (ii) if not sold to Underwriters in such an offering, commencing on the first day of the first fiscal quarter of the Company after the effective date of the Registration Statement, which statements shall cover said twelve (12) month periods. (q) Make every reasonable effort to obtain the withdrawal of any order suspending the effectiveness of the Registration Statement at the earliest possible moment. (r) Cooperate and assist in any filings required to be made with the NASD and in the performance of any due diligence investigation by any Underwriter (including any "qualified independent Underwriter" that is required to be retained in accordance with the rules and regulations of the NASD. 8 The Company may require each seller Registrable Securities as to which any registration is being effected to furnish to the Company such information regarding such seller and the distribution of such Registrable Securities as the Company may, from time to time, reasonably request in writing and the Company may exclude from such registration the Registrable Securities of any seller who unreasonably fails to furnish such information within a reasonable time after receiving such request. Each Holder of Registrable Securities agrees by acquisition of such Registrable Securities that, upon receipt of any notice from the Company of the happening of any event of the kind described in Section 5(c)(ii), (iii), (v) or (vi) hereof, such Holder will forthwith discontinue disposition of such Registrable Securities covered by such Registration Statement or Prospectus until such Holder's receipt of the copies of the supplemented or amended Prospectus contemplated by Section 5(k) hereof, or until it is advised in writing by the Company that the use of applicable Prospectus may be resumed, and has received copies of any additional or supplemental filings that are incorporated or deemed to be incorporated by reference in such Prospectus. SECTION 6. REGISTRATION EXPENSES (a) All expenses incident to the Company's performance of or compliance with this Agreement will be borne by the Company, regardless whether a Registration Statement filed pursuant to Section 3 herein becomes effective, including without limitation: (i) all registration and filing fees and expenses associated with any SEC filing; (ii) fees and expenses of compliance with federal securities or state blue sky laws (including fees and disbursements of counsel for the Underwriters or selling Holders in connection with the "blue sky" qualifications of the Registrable Securities pursuant to 5(h) herein); (iii) expenses of printing (including, without limitation, expenses of printing or engraving certificates for the Registrable Securities in a form eligible for deposit with The Depository Trust Company and of printing Prospectuses), messenger and delivery services and telephone. (iv) reasonable fees and disbursements of counsel for the Company and for the Holders of the Registrable Securities (subject to the provisions of Section 4(b) hereof); (v) fees and disbursements of all independent certified public accountants of the Company (including the expenses of any special audit and "cold comfort" letters required by or incident to such performance); (vi) fees and expenses associated with any NASD filing required to be made in connection with a Registration Statement, including, if applicable, the fees and expenses 9 of any "qualified independent Underwriter" (and its counsel) that is required to be retained in accordance with the rules and regulations of the NASD; and (vii) fees and expenses of listing the Registrable Securities on any securities exchange or quotation system in accordance with Section 5(m) hereof. All such expenses being herein called "Registration Expenses." The Company will, in any event, bear its internal expenses (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties), the expense of any annual audit, rating agency fees and the fees and expenses of any Person, including special experts, retained by the Company. The Holders of the Registrable Securities shall bear the expense of any broker's commission or Underwriters' discount or commission. (b) In connection with the Registration Statement, the Company will reimburse the Holders of Registrable Securities being registered pursuant to such Registration Statement for the fees and disbursements of not more than one counsel chosen by a majority of the Holders of the for the fees and disbursements of not more than one counsel chosen by a majority of the Holders of the Registrable Securities to be included in the Registration Statement; provided, however, that in the case of an Underwritten Offering which includes shares of Common Stock, such counsel shall be chosen by the Holders of a majority of the shares of Common Stock to be included in such Underwritten Offering. Notwithstanding the provisions of this Section 6, each Holder of Registrable Securities shall pay all registration expenses to the extent required by applicable law. SECTION 7. INDEMNIFICATION (a) The Company agrees to indemnify and hold harmless each Holder (each such Holder an "Indemnified Holder") and each Underwriter participated in the distribution (each such Underwriter as "Indemnified Underwriter") and each person that controls each Indemnified Holder or Indemnified Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, and agents, employees, officers and directors or any such controlling person of any Indemnified Holder or Indemnified Underwriter from and against any and all losses, claims, damages, judgments, liabilities and expenses (including the reasonable fees and expenses of counsel and other expenses in connection with investigating, defending or setting any such action or claim) as they are incurred arising out of or based upon an untrue statement or alleged untrue statement of a material fact contained in any Registration Statement or the Prospectus (as amended or supplemented if the Company shall have furnished any amendments or supplements thereto) or any preliminary Prospectus 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 (i) the Company shall not be liable to any Indemnified Holder or Indemnified Underwriter in any such case insofar as such losses, claims, damages, judgments, liabilities or expenses arise out of, or are based upon, any such untrue statement or omission or alleged untrue statement or omission based upon information relating to such Indemnified Holder or Indemnified Underwriter furnished in writing by such Indemnified Holder or Indemnified Underwriter to the Company expressly for use 10 therein, and (ii) the Company shall not be liable to any Indemnified Holder or Indemnified Underwriter under the indemnity agreement in this Section 7(a) with respect to any preliminary Prospectus to the extent that any such loss, claim, damage, judgment, liability or expense results solely from the fact that any Indemnified Holder or Indemnified Underwriter sold Registrable Securities to a person to whom there was not sent or give, at or prior to the written confirmation of such sale, a copy of the Prospectus as then amended or supplemented, if the Company has previously furnished sufficient copies thereof to the Indemnified Holder or Indemnified Underwriter. (b) If any action or proceeding (including any governmental or regularly investigation or proceeding) shall be brought or asserted against any Indemnified Holder or Indemnified Underwriter with respect to which indemnity may be sought against the Company pursuant to Section 7(a) such Indemnified Holder or Indemnified Underwriter shall promptly notify the Company in writing, and the Company shall have the right to assume the defense thereof, including the employment of counsel reasonable satisfactory of such Indemnified Holder or Indemnified Underwriter and payment of all fees and expenses; provided, however, that the omission so to notify the Company shall not relieve the Company from any liability that they may have to any Indemnified Holder or Indemnified Underwriter (except to the extent that the Company is materially prejudiced or otherwise forfeits substantive rights or defenses by reason of such failure). An Indemnified Holder or Indemnified Underwriter shall have the right to employ separate counsel in any such action or proceeding and to participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of such Indemnified Holder or Indemnified Underwriter unless (i) the Company agrees in writing to pay such fees and expenses, (ii) the Company has failed to assume the defense and employ counsel satisfactory to the Indemnified Holder or Indemnified Underwriter or (iii) the named parties to any such action or proceeding (including any impleaded parties) include both the Indemnified Holder or Indemnified Underwriter and the Company and such Indemnified Holder or Indemnified Underwriter shall have been advised in writing by its counsel that representation of them and the Company by the same counsel would be inappropriate under applicable standards of professional conduct (whether or not such representation has been proposed) due to actual or potential differing interests between them (in which case the Company shall not have the right to assume the defense of such action on behalf of such Indemnified Holder or Indemnified Underwriter). It is understood that the Company shall not, in connection with any one such action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, be liable for the fees and expenses of more than one separate firm of attorneys (in addition to any local counsel) at any time for such Indemnified Holders or Indemnified Underwriters, which firm shall be designated in writing by the majority of Holders of the Registrable Securities on behalf of the Holders of all of the Registrable Securities, and that all such fees and expenses shall be reimbursed as they are incurred. The Company shall not be liable for any settlement of any such action effected without the written consent of the Company, but if settled with the written consent of the Company, or if there is a final judgment with respect thereto, the Company agrees to indemnify and hold harmless each Indemnified Holder or Indemnified Underwriter from and against any loss or liability by reason of such settlement or judgment. The Company shall not, without the prior written consent of each Indemnified Holder or Indemnified Underwriter affected thereby, effect any settlement of any pending or threatened proceeding in which such Indemnified Holder or Indemnified Underwriter has sought indemnity 11 hereunder, unless such settlement includes an unconditional release of such Indemnified Holder or Indemnified Underwriter from all liability arising out of such action, claim, litigation or proceeding. (c) Each Holder and Underwriter agrees to indemnify and hold harmless the Company, its directors, its officers who sign the Registration Statement and any person controlling the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act (collectively, the "Company Indemnified Parties") to the extent as the foregoing indemnity from the Company to any Indemnified Holder or Indemnified Underwriter, but only with respect to information relating to each Holder and Underwriter furnished to the Company in writing by each Holder or Underwriter, respectively, expressly for use in the Registration Statement, Prospectus (or any amendment or supplement thereto), or any preliminary Prospectus. In case any action shall be brought against any Company Indemnified Party based on the Registration Statement, Prospectus (or any amendment or supplement thereto), or any preliminary Prospectus and in respect of which indemnification may be sought against each Holder and Underwriter pursuant to this Section 7(c), each Holder and Underwriter shall have the rights and duties given to the Company by Section 7(a) (except that if the Company shall have assumed the defense thereof, each Holder and Underwriter may, but shall not be required to, employ separate counsel therein and participate in the defense thereof and the fees and expenses of such counsel shall be at the expense of the Holder or Underwriter) and the Company Indemnified Parties shall have the rights and duties given to the Indemnified Holders or Indemnified Underwriters by Section 7(b). (d) If the indemnification provided for in this Section 7 is unavailable to any party entitled to indemnification pursuant to Section 7(a) or (c), then each indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages, judgments, liabilities and expenses (i) in such proportion as is appropriate to reflect the benefits received by the Company on the one hand, and each Indemnified Holder or Indemnified Underwriter on the other, from the offering of the Registrable Securities or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company on the one hand and each Indemnified Holder or Indemnified Underwriter on the other in connection with the statement or omissions which resulted in such losses, claims, damages, judgments, liabilities or expenses, as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and each Indemnified Holder or Indemnified Underwriter on the other shall be deemed to be in the same proportions as the total net proceeds from the offering (before deducting expenses) received by the Company bear to the total net discounts and commissions received by each Indemnified Holder or Indemnified Underwriter, in each case as set forth in the table on the cover page of the Prospectus. The relative fault of the Company on the one hand each Indemnified Holder or Indemnified Underwriter on the other shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omissions or alleged omission to state a material fact relates to information supplied by the Company on the one hand or by each Indemnified Holder or Indemnified Underwriter on the other and the parties' relative intent, 12 knowledge, access to information and opportunity to correct or prevent such statement or omission. (e) The Company and each Indemnified Holder or Indemnified Underwriter agree that it would not be just and equitable if contribution pursuant to Section 7(d) were determined by pro rata allocation or by any other method of allocation that does not take account of the equitable considerations referred to in Section 7(d). The amount paid or payable by an indemnified party as a result of the losses, claims, damages, liabilities or expenses referred to in the immediately preceding paragraph shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. No person found guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not found guilty of such fraudulent misrepresentation. (f) The indemnity and contribution agreements contained in this Section 7 are in addition to any liability that any indemnifying party may otherwise have to any indemnified party. SECTION 8. PARTICIPATION IN UNDERWRITTEN REGISTRATIONS No Holder may participate in any Underwritten Offering hereunder unless such Holder (a) agrees to sell such Holder's Registrable Securities on the basis provided in any underwriting arrangements approved by the Persons entitled hereunder to approve such arrangements, (b) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements, hold-back agreements and other documents required under the terms of such underwriting arrangements, and (c) furnishes the Company in writing information in accordance with the second to the last paragraph of Section 5 and agrees to indemnify and hold harmless the Company, its directors, its officers who sign the Registration Statement and any person controlling the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act as contemplated by Section 7(c). SECTION 9. MISCELLANEOUS (a) Remedies. Each Holder of Registrable Securities, in addition -------- to being entitled to exercise all rights provided herein and granted by law, including recovery of damages, will be entitled to specific performance of such Holder's rights under this Agreement. The Company agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Agreement and hereby agrees to waive the defence in any action for specific performance that a remedy at law would be adequate. (b) No Inconsistent Agreements. The Company will not on or after -------------------------- the date of this Agreement enter into any agreement with respect to its securities that is inconsistent with the rights granted to the Holders of Registrable Securities in this Agreement or otherwise conflicts with the provisions hereof. The rights granted to the Holders of Registrable Securities 13 hereunder do not in any way conflict with and are not inconsistent with the rights granted to the Holders of the Company's securities under any other agreements. (c) Amendments and Waivers. The provisions of this Agreement, ---------------------- including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures with the provisions hereof may not be given unless the Company has obtained the written consent of a majority of the Holders of the Registrable Securities affected by such amendment, modification, supplement, waiver or departure. Notwithstanding the foregoing, a waiver or consent to departure from the provisions hereof that relates exclusively to the rights of Holders of Registrable Securities whose securities are being sold pursuant to a Registration Statement and that does not directly or indirectly affect the rights of other Holders of Registrable Securities shall be valid only with the written consent of Holders of at least 66-2/3% of the Registrable Securities sold. (d) Notices. All notices and other communications provided for or ------- permitted hereunder shall be made in writing by hand-delivery, first-class mail (registered or certified, return receipt requested), telex, telecopier, or air courtier guaranteeing overnight delivery: (i) if to a Holder of Registrable Securities, at the most current address given by such Holder to the Company; and (ii) if to the Company, to Headlands Mortgage Company 1100 Larkspur Landing Circle Suite 101 Larkspur, California 94939 Attn: President with a copy to: Tobin & Tobin One Montgomery Street, 15th Floor San Francisco, CA 94104 Attn: Phillip R. Pollock All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; five (5) business days after being deposited in the mail, postage prepaid, if mailed; when answered back, if telexed; when receipt acknowledged, if telecopied; and on the next business day, if timely delivered to an air courier guaranteeing overnight delivery. (e) Successors and Assigns. This Agreement shall inure to the benefit ---------------------- of and be binding upon the successors and assigns of each of the parties, including without limitation and without the need for an express assignment, and subsequent Holders of Registrable Securities; provided, however, that this Agreement shall not inure to the benefit of or be binding 14 upon a successor or assign of a Holder of Registrable Securities unless and to the extent such successor or assign acquired Registrable Securities from such Holder. If any transferee of any Holder shall acquire Registrable Securities, in any manner, whether by operation of law or otherwise, such Registrable Securities shall be held subject to all the terms of this Agreement and by taking and holding such Registrable Securities such person shall be conclusively seemed to have agreed to be bound by and to perform all of the terms and provisions of this Agreement and such Person shall be entitled to receive the benefits hereof. (f) Counterparts. This Agreement may be executed in any number of ------------ counterparts and by the parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. (g) Headings. The headings of this Agreement are for convenience of -------- reference only and shall not limit or otherwise affect the meaning hereof. (h) Governing Law. This Agreement shall be governed by and construed ------------- in accordance with the laws of the state of New York, without regard to the conflict of law rules thereof. (i) Severability. In the event that any one or more of the ------------ provisions contained herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. (j) Entire Agreement. This Agreement is intended by the parties as a ---------------- final expression of their agreement and intended to be a complete and exclusive statement of the agreement and understanding of the parties hereto in respect of the subject matter contained herein. There are no restrictions, promises, warranties or undertakings, other than referred to herein with respect to the registration rights granted by the Company with respect to Registrable Securities. This Agreement supersedes all prior agreements and understandings between the parties with respect to such subject matter. 15 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. COMPANY: HEADLANDS MORTGAGE COMPANY By____________________________________ Peter T. Paul, President STOCKHOLDERS: JESSICA M. PAUL IRREVOCABLE TRUST By * ------------------------------------ Daniel W. Paul, as Trustee of the Jessica M. Paul Irrevocable Trust dated May 21, 1997 THE JESSICA M. PAUL GRANTOR TRUST By * ------------------------------------ Gilbert J. MacQuarrie, as Trustee of the Jessica M. Paul Grantor Trust dated May 21, 1997 PETER T. PAUL LIVING TRUST By * ------------------------------------ Peter T. Paul, as Trustee of the Peter T. Paul Living Trust dated May 21, 1997 * -------------------------------------- DENNIS M. HART * -------------------------------------- KATHERINE E. HART * -------------------------------------- D. MICHAEL HART, JR. * -------------------------------------- ELIZABETH A. HART * -------------------------------------- CHRISTOPHER K. HART __________________________________________ /*/By Peter T. Paul as Voting Trustee Pursuant to the Voting Trust Agreement Dated as of September 15, 1997, as Amended 16 EX-11.1 17 STATEMENT - COMPUTATION PER SHARE EXHIBIT 11.1 HEADLANDS MORTGAGE COMPANY STATEMENT RE COMPUTATION OF PRO FORMA PER SHARE EARNINGS
FOR THE NINE MONTHS ENDED FOR THE SEPTEMBER YEAR ENDED 30, DECEMBER 1997 31, 1996 ----------- ----------- Primary and fully diluted pro forma income per share: Pro forma net income available to common Stockholders(1) $22,201,556 $10,614,060 =========== =========== Weighted average shares outstanding(2)....... 15,631,128 15,631,128 Pro forma net income per share............... $1.42 $0.68 =========== ===========
- -------- (1) Prior to the closing of the Offering, the Company will be treated as an S corporation for federal and state income tax purposes. The pro forma presentation reflects the provision for income taxes as if the Company had always been fully subject to federal and state taxes as a C corporation at the effective tax rate of 42%. (2) Options have been considered to be outstanding for all periods presented and an estimated initial offering of $15.00 per share and an assumed option exercise price of $4.06 per share has been used in applying the treasury stock method. Weighted average shares outstanding includes the effect of the assumed issuance of 1,253,334 shares of common stock to generate sufficient cash to pay the Shareholder Distribution Amount of $18.8 million. The assumed issuance of common stock was based on an assumed price of $15.00, the midpoint of the estimated range of the initial public offering price. STATEMENT RE COMPUTATION OF SUPPLEMENTAL PRO FORMA PER SHARE EARNINGS GIVING EFFECT TO RETIREMENT OF DEBT Supplemental pro forma net income available to com- mon Stockholders(1)................................... 22,577,363 10,812,289 ========== ========== Supplemental weighted average shares outstand- ing(2)............................................ 16,331,128 15,922,795 Supplemental pro forma net income per share........ 1.38 0.68 ========== ==========
- -------- (1) The supplemental pro forma presentation reflects (a) the provision for income taxes described in Note (1) above; and (b) the effect on earnings during the periods presented if the Notes payable to stockholders and related accrued and unpaid interest ($10.5 million at September 30, 1997) were retired in July 1996, the inception of such Notes. (2) Weighted average shares outstanding includes (a) the effect of the options and payment of the Shareholder Distribution Amount described in Note (2) above; and (b) the effect of the assumed issuance of 700,000 shares of common stock in July 1996 to retire the Notes payable to stockholders. EX-23.2 18 INDEPENDENT AUDITORS' CONSENT EXHIBIT 23.2 INDEPENDENT AUDITORS' CONSENT The Board of Directors Headlands Mortgage Company: We consent to the use of our report dated March 21, 1997, except as to Note 21, which is as of December 10, 1997, included herein and to the reference to our firm under the heading "Experts" in the prospectus. Our report refers to a change to the Company's method of accounting for originated mortgage servicing rights in 1995. (signed) KPMG Peat Marwick LLP San Francisco, California December 10, 1997 EX-27 19 FINANCIAL DATA SCHEDULE
9 9-MOS 12-MOS DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1996 SEP-30-1997 DEC-31-1996 3,137,927 2,701,333 0 0 0 0 13,838,713 7,438,958 262,295,837 238,171,841 0 0 0 0 0 0 0 0 349,998,329 288,990,472 723,799 155,412 0 0 274,247,758 250,176,230 9,670,000 9,670,000 0 0 0 0 1,000 1,000 66,079,571 29,143,241 349,998,329 288,990,472 0 0 0 0 0 0 0 0 0 0 0 0 8,826,202 5,624,446 2,358,764 3,640,727 0 0 0 0 38,278,545 18,300,104 0 0 0 0 0 0 36,936,330 17,659,600 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
EX-99.1 20 CONSENT OF MARK L. KORELL EXHIBIT 99.1 ------------ CONSENT OF DIRECTOR PURSUANT TO RULE 438 OF THE SECURITIES ACT OF 1933 I hereby consent to serve as a Director of Headlands Mortgage Company, a California corporation (the "Company"), upon completion of its initial public offering of Common Stock. I further consent to being named as a future director of the Company in an Amendment to the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on October 20, 1997 (Registration No. 333-38267). Dated: November 26, 1997 /s/ Mark L. Korell ------------------ Mark L. Korell EX-99.2 21 CONSENT OF LEONARD AUERBACH EXHIBIT 99.2 ------------ CONSENT OF DIRECTOR PURSUANT TO RULE 438 OF THE SECURITIES ACT OF 1933 I hereby consent to serve as a Director of Headlands Mortgage Company, a California corporation (the "Company"), upon completion of its initial public offering of Common Stock. I further consent to being named as a future director of the Company in an Amendment to the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on October 20, 1997 (Registration No. 333-38267). Dated: November 26, 1997 /s/ Leonard Auerbach -------------------- Leonard Auerbach EX-99.3 22 CONSENT OF MARK LACHTMAR EXHIBIT 99.3 ------------ OF THE SECURITIES ACT OF 1933 I hereby consent to serve as a Director of Headlands Mortgage Company, a California corporation (the "Company"), upon completion of its initial public offering of Common Stock. I further consent to being named as a future director of the Company in an Amendment to the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on October 20, 1997 (Registration No. 333-38267). Dated: November 25, 1997 /s/ Mark E. Lachtman -------------------- Mark E. Lachtman EX-99.4 23 CONSENT OF STEVEN ABREU EXHIBIT 99.4 ------------ OF THE SECURITIES ACT OF 1933 I hereby consent to serve as a Director of Headlands Mortgage Company, a California corporation (the "Company"), upon completion of its initial public offering of Common Stock. I further consent to being named as a future director of the Company in an Amendment to the Company's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on October 20, 1997 (Registration No. 333-38267). Dated: December 4, 1997 /s/ Steven M. Abreu ------------------- Steven M. Abreu -----END PRIVACY-ENHANCED MESSAGE-----