Would Suffer if We Are Unable to Sell or Securitize the Mortgage Loans that
We Originate” and “Risk Factors—We Face Competition that Could Adversely Affect Our Market Share and Revenues” in Item 1A of this Report.
Our competitors can offer lower interest rates and fees, operate with less stringent underwriting standards to attract borrowers, provide enhanced convenience in obtaining a loan, emphasize customer service, focus on amounts, terms and
variety of loan products, and concentrate on marketing and distribution channels. If we are faced with pervasive price competition, then we may be forced to lower the interest rates that we charge borrowers, which could reduce the value of the loans
that we sell or retain in our portfolio. If our competitors adopt less stringent underwriting standards, then we may be pressured to do so as well or risk losing market share, or our expansion into our targeted markets may be adversely affected. If
we relax our underwriting standards, then we will also be exposed to higher credit risk, which could adversely affect our operating results if our pricing does not adequately compensate us for the increased risk.
Government Regulation
We are subject to the laws, rules and
regulations, as well as judicial and administrative decisions, of each jurisdiction in which we originate mortgage loans. We are also subject to many federal laws, rules and regulations. The federal, state and local laws, rules and regulations are
different, complex and, in some cases, in direct conflict with each other. In addition, the number of laws, rules and regulations with which we must comply is growing. This presents us with a challenge in effectively training our personnel and
avoiding risks of non-compliance.
Our failure to comply with these laws, rules and regulations can lead to, among other things:
•
civil and criminal liability, including potential monetary penalties;
•
loss of licenses or permits to do business in certain jurisdictions;
•
legal defenses giving borrowers the right to rescind or cancel loan transactions;
•
demands for indemnification or loan repurchases from purchasers of our loans; and/or
•
administrative orders and enforcement actions by our regulators.
Some states in which we operate may impose regulatory requirements on our officers and directors. If any officer or
director fails to meet or refuses to comply with a state’s applicable regulatory requirements for mortgage lending, we could lose our authority to conduct business in that state or the services of such person.
In addition, as the result of the deteriorating conditions in the mortgage industry generally, and especially in the subprime and nonprime mortgage lending
industry, there has been recent media and legislative attention paid to developing a new system of regulation for mortgage lenders. Any such legislation or other regulation could have a significant effect on our business. We cannot predict whether
any such legislation ultimately will be adopted, or, if adopted, what effect such legislation could have on our business.
Predatory Lending Laws
Many jurisdictions have increased their focus on certain “predatory” lending practices and have enacted legislation related to curbing this
activity. In some cases, these laws, rules or regulations can disrupt common lending activities, or restrict them altogether, and, therefore, impose additional costs and compliance requirements upon us. Some of these laws, rules and regulations
impose certain restrictions on loans that charge certain points and fees or that have an annual percentage rate (“APR”) that equals or exceeds specified statutory thresholds. These restrictions could expose us to risks of litigation and
regulatory sanctions, regardless of how carefully loans are originated.
The continued enactment of these laws, rules and regulations may prevent us from
making certain loans and may cause us to reduce the APR or the points and fees we charge on the mortgage loans that we originate. We are also faced with new compliance risks. We may face additional costs in developing means and procedures by which
we must comply with these new requirements to prevent violations. Recently, some members of Congress have introduced federal predatory lending legislation, which, if adopted, would preempt inconsistent state laws. We cannot predict the effects, if
any, of this legislation or whether or not it will be adopted.
In addition, these state laws, rules and regulations may be preempted and not applicable to
the mortgage loan operations of national banks and federally-chartered thrifts, which provides these institutions with competitive advantages in terms of costs and risk aversion.
We intend to avoid originations of loans that meet or exceed the APR or points and fees thresholds of these laws, rules and regulations in the jurisdictions where we operate. Our predatory lending policies require
that we:
•
avoid steering applicants to loan products which we believe are inappropriate for them;
•
determine that all applicants have the financial ability to repay their respective mortgage loans;
•
entertain the refinancing of mortgage loans only in the event applicants would enjoy an identifiable economic benefit;
•
avoid the imposition of excessive fees and/or interest rates;
•
fully advise applicants of all loan terms and conditions and engage in marketing practices which are neither deceptive nor exploitive; and
•
fully comply with all state and federal predatory lending regulations. USA PATRIOT Act
On October 26, 2001, the federal USA PATRIOT Act became effective, establishing new and
enhanced ways of combating international terrorism. The provisions that most directly affect financial institutions are contained in Title III of the USA PATRIOT Act. Title III amends the current law with respect to financial institutions to give
the Secretary of the Treasury and other departments and agencies of the federal government enhanced authority to identify, deter and punish international money laundering and other crimes.
Among other things, the USA PATRIOT Act requires financial institutions to follow new minimum verification of identity
standards for all new accounts and permits financial institutions to share information with law enforcement authorities under circumstances that were not previously permitted. The Secretary of the Treasury and various federal banking agencies are
responsible for promulgating the regulations necessary to implement the provisions as they become effective. We and the closing settlement agents that handle our closings are subject to certain provisions of the USA PATRIOT Act, although, to date,
our compliance with this legislation has not had a material adverse effect on our business, and we have not incurred any material costs related to our compliance.
Fair Credit Reporting Act, as Amended by the Fair and Accurate Credit Transactions Act of 2003
The Fair Credit Reporting Act
(“FCRA”) was enacted by Congress to promote accuracy and fairness in credit reporting. To this end, consumer reporting agencies, users of consumer reports and those who furnish information to consumer reporting agencies are subject to
certain procedures and requirements to safeguard the confidentiality, accuracy, relevancy and proper utilization of consumer credit information. The FCRA was amended by the Fair and Accurate Credit Transaction Act of 2003, which provides additional
consumer protection through, among other things, new rights for consumers regarding identity theft and new regulations regarding the disposal of consumer information. These laws govern our use of information contained in consumer credit reports or
obtained from one of our affiliates and require us to provide certain information to a consumer if we take any adverse action regarding the consumer’s account or application. See “Risk Factors—We Use Consumer Credit Reports, Which Are
Subject to Regulation and May Expose Us to Litigation or Enforcement Actions.”
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act imposes privacy obligations on our origination and servicing activities with respect to our applicants and customers. In particular, we have
privacy policies regarding safekeeping and sharing with third parties of non-public personal customer information that we obtain from our applicants and customers. Our applicants and customers must receive our privacy policy and must have the right
to “opt out” of permitting us to share their personal information. Various states also have considered from time to time privacy legislation, and, if any of the states in which we operate were to adopt significant privacy regulations, we
would bear any additional costs necessary to make our operations and treatment of the personal information of applicants and customers comply with such new state laws.
The Real Estate Settlement Procedures Act
RESPA, as implemented by HUD Regulation X, is designed to provide
consumers with timely and accurate information regarding the nature and costs associated with residential real estate transactions. The other primary purpose of RESPA is to prohibit abusive practices such as kickbacks, referral fees and excessive
escrow requirements that might add to the cost of settlement. RESPA applies to all “federally related mortgage loans,” which includes any loans made by us and secured by a first or subordinate lien on residential real property (including a
refinance of such a loan) upon which there is located or placed a structure designed for one to four family occupancy (including individual units of condominiums or cooperatives). Exemptions to RESPA coverage are set forth in Regulation X, including
the exception that one may pay reasonable value for services actually performed and facilities actually provided. RESPA neither prohibits referrals of real estate settlement services, like residential mortgage loans, nor payments of fees or things
of value to persons who may make referrals; rather, RESPA prohibits the payment of a fee or thing of value in exchange for referrals. HUD enforces RESPA, and violations of the provisions regarding kickbacks, referral fees and unearned fees may be
subject to civil and criminal penalties.
Environmental Matters
HBMC has not had any material claims for environmental liabilities. In the future, we could have possible exposure to liabilities for environmental matters, especially if we were to foreclose on a property with
environmental risks. Our practice is to avoid foreclosures on properties with known or suspected environmental risks.
Minimum Net Worth Requirements
HBMC is required to satisfy minimum net worth or capital requirements with various governmental agencies and GSEs. HBMC is also subject to various capital requirements in connection with seller/servicer agreements
that it has entered into with secondary market investors. Failure to maintain minimum capital requirements could result in our inability to originate and service loans for the respective investor and, therefore, could have a direct material effect
on our financial statements. We were in compliance with all such minimums as of December 31, 2006.
Certain Federal Income Tax Considerations
General
HomeBanc, beginning with the filing of
its initial federal income tax return for its short taxable year ended December 31, 2004, elected to be treated as a REIT for federal income tax purposes. In each year that HomeBanc qualifies as a REIT, it generally will not be subject to
federal income tax on that portion of its REIT taxable income or capital gain that it distributes to shareholders, but taxable income generated by HomeBanc’s TRSs, including HBMC, will be subject to regular corporate income tax. HomeBanc is
subject to corporate level taxation on any undistributed taxable income. In addition, HomeBanc faces corporate level taxation: (1) due to any failure to make timely distributions; (2) on the income from any property that it takes in
foreclosure and on which it makes a foreclosure property election; (3) on the gain from the sale or other disposition of any property, other than foreclosure property, that HomeBanc holds primarily for sale to customers in the ordinary course
of business (i.e., “dealer property”); and (4) on transactions with a TRS that are not conducted on an arm’s-length basis. The benefit of our tax treatment as a REIT is the avoidance of the federal “double taxation,” or
taxation at both the corporate and stockholder levels, which generally applies to income distributed by a corporation to its shareholders.
A REIT
generally may avoid disqualification for failures to meet REIT requirements if the failure is due to reasonable cause and not due to willful neglect and the REIT pays a penalty. HomeBanc cannot predict, however, whether in all circumstances it would
qualify for the relief provisions.
If HomeBanc fails to qualify as a REIT in any taxable year, and no relief provision applies, it would be subject to
federal income tax and any applicable alternative minimum tax on its taxable income at regular corporate rates. In calculating HomeBanc’s taxable income in a year in which it fails to qualify as a REIT, HomeBanc would not be able to deduct
amounts paid out to shareholders. HomeBanc’s corporate tax liability would reduce its funds available for distribution to shareholders. Unless HomeBanc qualified for relief under specific statutory provisions, HomeBanc also would be
disqualified from taxation as a REIT for the four taxable years following the year during which it ceases to qualify as a REIT. HomeBanc cannot predict whether in all circumstances it would qualify for such statutory relief. HomeBanc believes that
it has satisfied or will satisfy the requirements for qualification as a REIT for its short taxable year ended December 31, 2004 and the full taxable years ended December 31, 2005 and December 31, 2006.
Requirements for Qualification as a REIT
To qualify for tax
treatment as a REIT under the Code, HomeBanc must meet certain tests, as described briefly below.
•
Ownership of Common Stock . For all taxable years after the first taxable year for which HomeBanc elects to be a REIT, a minimum of 100
persons must hold shares of capital stock of HomeBanc for at least 335 days of a 12-month year (or a proportionate part of a short tax year). In addition, at all times during the last half of each taxable year other than HomeBanc’s first
taxable year, no more than 50% in value of HomeBanc’s capital stock may be owned directly or indirectly, through the application of certain attribution rules, by five or fewer individuals, which the federal income tax laws define to include
certain entities. HomeBanc is required to maintain records regarding the ownership of its shares and to demand statements regarding their ownership of shares from persons who own more than a certain percentage of its
Index to Financial Statements
shares. HomeBanc must keep a list of those shareholders who fail to reply to such a demand. HomeBanc is also required to use the calendar year as its taxable
year for income tax purposes.
•
Nature of Assets . On the last day of each calendar quarter, at least 75% of the value of HomeBanc’s assets and any assets held by
a QRS must consist of qualified REIT assets (primarily, interests in real property and interests in mortgage loans secured by real property) (“Qualified REIT Assets”), government securities, cash and cash items. HomeBanc expects that
substantially all of its assets, other than securities issued by its TRSs, will be Qualified REIT Assets. On the last day of each calendar quarter, except for securities included in the foregoing 75% assets test and securities of HomeBanc’s
TRSs, the value of HomeBanc’s interests in any one issuer’s securities may not exceed 5% of the value of HomeBanc’s total assets, and HomeBanc may not own more than 10% of the voting power or value of any one issuer’s outstanding
securities. No more than 20% of the value of HomeBanc’s total assets may consist of the securities of TRSs. HomeBanc regularly monitors its assets in an effort to comply with the above asset tests.
•
Sources of Income . HomeBanc must meet both of the following income tests for each year with respect to which it elects to be treated
as a REIT:
•
At least 75% of HomeBanc’s gross income for the taxable year must be derived from Qualified REIT Assets, including interest (other than interest based in whole
or in part on the income or profits of any person) on obligations secured by mortgages on real property or interests in real property. The investments that HomeBanc has made give rise primarily to mortgage interest qualifying under the 75% income
test.
•
At least 95% of HomeBanc’s gross income for each taxable year must consist of income that is qualifying income for purposes of the 75% gross income test, other
types of interest and dividends, gain from the sale or disposition of stock or securities or any combination of these. Gross income from servicing loans for third parties and loan origination fees is not qualifying income for purposes of either
gross income test. Income from derivative financial instruments is non-qualifying income for purposes of the 75% gross income test. It will generally be disregarded for purposes of the 95% gross income test if certain requirements are met. HomeBanc
monitors the amount of its non-qualifying income and manages its portfolio to attempt to comply at all times with the gross income tests. Income earned by HomeBanc’s TRSs is not taken into account in applying the income tests. HomeBanc’s
REIT status may limit the type of assets, including derivative financial instrument contracts and other assets, which it otherwise might acquire.
•
Distributions. Each taxable year, HomeBanc must distribute dividends on a pro rata basis, other than capital gain dividends and deemed
distributions of retained capital gain, to its shareholders in an aggregate amount at least equal to the sum of:
•
90% of HomeBanc’s “REIT taxable income,” computed without regard to the dividends paid deduction and any net capital gain or loss, and
•
90% of HomeBanc’s after-tax net income, if any, from foreclosure property, in excess of the special tax on income from foreclosure property, minus the sum of
certain items of non-cash income. HomeBanc intends, for as long as it maintains its REIT election, to make distributions
to its shareholders in sufficient amounts to meet the distribution requirement. To the extent that we distribute at least 90%, but less than 100%, of our REIT taxable income in a calendar year, we will be subject to federal corporate income tax on
our undistributed income. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which the distributions paid by us with respect to any calendar year are less than the sum of:
•
85% of our ordinary income for that year;
•
95% of our capital gain net income for that year; and
•
100% of our undistributed REIT taxable income from prior years.
Our taxable income may exceed our cash available for distribution, and the requirement to distribute a
substantial portion of our net taxable income could cause us to:
•
sell assets in adverse market conditions;
•
borrow on unfavorable terms; or
•
distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt in order to comply with the REIT distribution
requirements. This distribution policy is subject to revision at the discretion of our board of directors. All
distributions, including those in excess of those required for us to maintain REIT status, will be made at the discretion of our board of directors and will depend on our taxable income, our financial condition and such other factors as our board of
directors deems relevant. We have not established a minimum distribution level beyond what is necessary to maintain our status as a REIT.
All distributions will depend upon a number of factors, including:
•
our results of operations;
•
our financial condition, including our cash, liquidity and borrowing capacity;
•
the timing of interest and principal we receive from our loans and securities;
•
our debt service obligations on our borrowings;
•
needs to fund our operations;
•
the annual distribution requirements under the REIT provisions of the Code; and
•
other factors that our board of directors determine relevant from time to time. Taxation of Taxable U.S. Shareholders
For any taxable year in which HomeBanc is treated as a REIT for federal
income tax purposes, the amounts that HomeBanc distributes to its taxable U.S. stockholders out of current or accumulated earnings and profits will be includable by such shareholders as ordinary income for federal income tax purposes unless properly
designated by HomeBanc as capital gain dividends. These distributions are not eligible for the dividends received deduction for corporations and generally will not be eligible for preferential rates applicable to “qualified dividend
income” received by U.S. non-corporate shareholders in taxable years 2003 through 2010 (generally, a maximum rate of 15%). Further, shareholders may not deduct any of HomeBanc’s net operating losses or capital losses. We presently
anticipate that our distributions generally will be taxable as ordinary income to our shareholders, although a portion of our distributions may be designated by us as long-term capital gain or may constitute a return of capital. We will furnish
annually to each of our shareholders a statement setting forth distributions paid during the preceding year and the federal income tax status of such distributions.
To the extent HomeBanc holds a residual interest in a real estate mortgage investment conduit or all of the equity interests of a “taxable mortgage pool” (“TMP”), HomeBanc’s status as a REIT
will not be impaired, but a portion of the taxable income generated by the residual interest or TMP may be characterized as “excess inclusion” income, which would be allocated to HomeBanc’s shareholders. Any such excess inclusion
income: (1) may not be offset by the net operating losses of a stockholder; (2) will be subject to tax as unrelated business taxable income to a tax-exempt shareholder; (3) will result in the application of U.S. federal income tax
withholding at the maximum rate (without reduction for any otherwise applicable income tax treaty) on any excess inclusion income allocable to a shareholder that is not a “United States Person” (as defined in the Code); and (4) may
result in HomeBanc paying tax on excess inclusion income allocated to shareholders that are “disqualified organizations.” Of HomeBanc’s 2006 dividend, approximately 4% of the amount distributed or treated as distributed to
shareholders in 2006 was characterized as excess inclusion income.
If HomeBanc makes distributions to its taxable U.S. shareholders in excess of its current and accumulated earnings and
profits, those distributions will be considered first a tax-free return of capital, reducing the tax basis of a shareholder’s shares until the tax basis is zero. Distributions in excess of the tax basis will be taxable as gain realized from the
sale of HomeBanc’s shares. Any of these distributions will be made at the discretion of our board of directors.
Going Forward
We previously announced that, beginning with our 2007 taxable year, we intend to no longer operate our publicly held parent company as a REIT, and we presently are
considering and evaluating the most appropriate means of giving effect to that decision. Any change in our operating model would likely require that we solicit and obtain the approval of our shareholders and certain of our lenders, and pay a variety
of expenses including the cost of soliciting and obtaining such approval and the costs associated with any third party payments and capital restructuring. We may be unable to obtain such approvals, pay such expenses or otherwise change our operating
model on terms that are attractive to us, if at all. See “ Important Information Regarding our Strategic Plans ” in Part I of this Report as well as “Risk Factors” in item 1A of this Report.
The provisions of the Code are highly technical and complex. This summary is not intended to be a detailed discussion of the Code or the related rules and
regulations, or of related administrative and judicial interpretations. We have not obtained a ruling from the Internal Revenue Service with respect to tax considerations relevant to our organization or operation or to an acquisition of our common
stock. This summary is not intended to be a substitute for prudent tax planning, and each of our shareholders is urged to consult his or her own tax and other professional advisors with respect to these and other federal, state and local tax
consequences of the acquisition, ownership and disposition of shares of our stock and any potential changes in applicable law.
Website Availability
of Corporate Governance Materials and Reports Filed with the SEC
We maintain an Internet website located at www.homebanc.com on which, among
other things, we make available, free of charge, various corporate governance materials and reports that we file or furnish to the SEC. Our Corporate Governance Guidelines, Code of Conduct and Ethics and charters for each of the Audit Committee,
Compensation Committee, and Nominating and Governance Committee are all provided on our website. We will post any waivers of our Code of Conduct and Ethics granted to our directors or executive officers on the “Investor Relations” portion
of our website. Our reports and other filings, including, without limitation, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and all other documents, including amendments thereto, filed
with or furnished to the SEC, are made available as soon as practicable after their receipt by the SEC. We are not incorporating the information on our website into this Report, and our website and the information appearing on our website are not
included in, and are not part of, this Report.
Our shareholders may request free copies of our Corporate Governance Guidelines, Code of Ethics and Conduct
and charters for any of the committees listed above by contacting the following:
HomeBanc Corp.
Attention: Corporate Secretary
2002 Summit
Boulevard, Suite 100
Atlanta, Georgia 30319
(404) 459-7400
The New York Stock Exchange (“NYSE”) requires that the chief executive officer of each listed
company certify annually to the NYSE that he or she is not aware of any violation by the company of NYSE corporate governance listing standards as of the date of such certification. We submitted the certification of our former Chairman and
Chief Executive Officer, Patrick S. Flood, with our 2006 Annual Written Affirmation to the NYSE on June 20, 2006. In addition, filed as exhibits to this
Report are certifications signed by each of our Chief Executive Officer and Chief Financial Officer and our Deputy Chief Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002.
Item 1A. Risk Factors
In addition to the other information contained in this Report,
you should carefully consider, in consultation with your legal, financial and other professional advisors, the risks described below, as well as the risk factors and uncertainties discussed in our other public filings with the SEC, including,
without limitation, under the caption “Risk Factors,” in evaluating us and our business before making a decision regarding an investment in our securities.
The risks contained in this Report are not the only risks faced by us. Additional risks that are not presently known, or that we presently deem to be immaterial, also could have a material adverse effect on our
financial condition, results of operations, business and prospects. The trading price of our securities could decline due to the materialization of any of these risks, and you may lose all or part of your investment.
This Report also contains forward-looking statements that may not be realized as a result of certain factors, including, but not limited to, the risks described
herein and in our other public filings with the SEC. Please refer to the section in this Report entitled “Cautionary Notice Regarding Forward-Looking Statements” for additional information regarding forward-looking statements.
Risks Related to our Business
We originate
mortgage loans primarily in the Southeast, and the currently prevailing adverse mortgage market conditions in that region have negatively affected our loan originations and the ability of our customers to repay their loans.
Our mortgage loan originations have been, and are expected to be, concentrated in the Southeast United States. In 2006 and 2005, approximately 90.6% and 93.1%,
respectively, of our loan originations were made to borrowers in the states of Georgia and Florida. During 2006, existing home sales, a significant component of the purchase money market, decreased 5% in the Southeast region, according to the
National Association of Realtors, and 28.8% in the state of Florida, according to the Florida Association of Realtors, as compared to the prior year. Continued volume declines in the Southeast in general, and Florida in particular, would continue to
negatively affect our loan origination volume, which would significantly harm our business, financial condition and results of operations.
In addition,
any adverse market or economic conditions in the Southeast may increase the risk that our borrowers in that region are unable to timely make their mortgage payments, if at all. In addition, the market value of the real estate securing those mortgage
loans as collateral could be negatively impacted by adverse market and economic conditions in the Southeast. The regional concentration of loans that we originate, and subsequently securitize, may also adversely affect the terms of our
securitizations. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the Southeast could adversely affect both our net interest income from mortgage loans in our
portfolio as well as our ability to originate, sell and securitize mortgage loans, which would significantly harm our business, financial condition, results of operations and the price of our securities.
We are a relatively undiversified mortgage banking company that is heavily reliant upon the mortgage banking industry.
Our business is relatively undiversified, and we rely heavily upon our ability to originate new mortgage loans in our market areas. As a result, when conditions in the
national and local mortgage markets deteriorate, as has been the case in recent periods, we are unable to take advantage of other lines of business or other product offerings to mitigate the effects of those deteriorating conditions on our business
and the price of our securities. In addition, whether as a result of further negative changes in the mortgage banking industry, or as a result of regulatory
changes, we may be forced, or may elect, to change or limit the types of products that we offer. If the mortgage markets continue to deteriorate, or if we
are forced to limit the number of mortgage products that we offer, then our business, financial condition, results of operations and the price of our securities could be negatively affected.
Our decision to no longer elect to have our public company treated as a REIT beginning in 2007 could negatively affect our business, financial condition, results
of operations and the price of our securities.
We expect that our public company will no longer elect to be treated as a REIT, beginning in 2007.
This decision involves a number of risks, including, without limitation:
•
as a result of the change in our operating model, our new corporate structure will be less efficient from a tax perspective, and we would likely have a higher
effective tax rate;
•
we may incur significant costs in connection with this decision, including, without limitation, costs of soliciting and obtaining the approval of shareholders and
the costs associated with third party payments and capital restructuring; and
•
we may be unable to realize the anticipated short- and/or long-term benefits from our change in operating structure, or from the other transactions that we may
determine to pursue in conjunction with this change in corporate structure. If we are unable to complete in a timely fashion or in
a manner that is favorable to us any transaction associated with our decision to no longer elect to have our public company be treated as a REIT, our business, financial condition, results of operations and the price of our securities could be
negatively affected.
We presently are considering and evaluating changes in our corporate structure in connection with our determination that our
public company will no longer elect to be treated as a REIT beginning in 2007. We cannot, and do not, make any assurances as to when we will make any such determination the manner in which any such change in structure will be implemented, or as to
when we will conclude this process, if at all. Accordingly, the current uncertainty regarding our company’s business model may continue to exist for the foreseeable future.
Accordingly, we face a number of risks, including, without limitation, the following:
•
our management team and board of directors are heavily engaged in the process of reviewing and considering changes in our strategic plan and corporate model, and
the diversion of their attention from our day-to-day business and operations may detract from their business productivity;
•
we are incurring, and will continue to incur, significant expenses related to this process, including expenses related to our outside legal counsel and other
professional advisors;
•
our stock price has been, and may continue to be, negatively affected by the uncertainty in the market and the uncertainty regarding the future of our company;
•
we may be unable to complete any changes to our corporate structure on the timeline or terms that we anticipate, or on any timeline or terms that otherwise are
attractive to us;
•
current relationships with third parties may limit our ability to pursue certain alternatives and may result in additional expenses to us; and
•
we may be unable to realize the anticipated benefits of any such alternatives that we determine to pursue. If any of the foregoing risks were to occur or if we were unable to change our corporate model at all, then our business, results of operations and price of our
securities would be negatively affected.
Our debt facilities are subject to margin calls based on the lender’s valuation of our loan collateral. An
unanticipated large margin call could harm our liquidity and our business, financial condition, results of operations and the price of our securities could be negatively affected.
The amount of financing we receive under our credit facilities depends in large part on the lender’s valuation of the mortgage loans that secure the financings.
Each such facility provides the lender the right, under certain circumstances, to reevaluate the loan collateral that secures our outstanding borrowings at any time. In the event the lender determines that the value of the loan collateral has
decreased, it has the right to initiate a margin call. A margin call would require us to provide the lender with additional collateral or to repay a portion of the outstanding borrowings. Any such margin call could harm our liquidity, results of
operations, financial condition and business prospects.
If we do not generate sufficient liquidity, we will be unable to conduct our operations as
planned.
We derive our liquidity for our operations from the following sources:
•
our warehouse and aggregation facilities;
•
use of repurchase agreements;
•
receipt of principal and interest payments from loans that we retain during the period between origination and sale to a third-party investor;
•
issuance of MBS through our securitization program; and
•
net interest earned from our securitized loans. In
addition, in the first quarter of 2007, we realized $70.3 million in liquidity from the sale of substantially all of our MBS portfolio. We cannot assure you that any of our sources of liquidity will continue to be available to us or that we will be
able to negotiate and obtain future sources of liquidity on favorable terms or that we will be able to employ our liquidity effectively.
Our ability to
meet our long-term liquidity requirements is subject to the renewal of credit and repurchase facilities and/or obtaining other sources of financing, including additional debt or equity from time to time. In addition, our existing lines of credit and
future lines of credit will generally be short-term and, in certain cases, not fully committed (such that they can be terminated with minimal notice) and, in the case of repurchase facilities, subject to margin calls. Any decision by our lenders
and/or investors to make additional funds available to us in the future will depend upon a number of factors, such as our compliance with the terms of our existing credit arrangements, our financial performance, industry and market trends in our
various businesses, our operating model, the lenders’ and/or investors’ own resources and policies concerning loans and investments, and the relative attractiveness of alternative investment or lending opportunities. If we cannot raise
cash by selling debt or equity securities, we may be forced to sell our assets at unfavorable prices or discontinue various business activities. Our inability to access the capital markets in the future could negatively affect our business,
financial condition, results of operations and the price of our securities.
We may not realize the expected benefits from our recent expense
reduction measures.
As part of our efforts to reduce expenses and better position ourselves to compete in the current mortgage finance
environment, we recently implemented several expense reduction measures, including a reduction in our headcount, realignment of our sales management structure, a hiring freeze for administrative and other non-sales, non-revenue-generating personnel,
efforts to streamline our business and loan origination process, and efforts to improve efficiencies at our SMAs. These measures could have the unintended consequence of disrupting our business and/or reducing our loan origination volume, which
would negatively affect our business, financial condition and results of operations and the price of our securities. We cannot guarantee that these measures, or other expense reduction measures we take in the future, will result in the expected cost
savings. See “—We may not realize the expected results from SMAs.”
We may not be able to fully realize the expected tax benefits from the net operating losses realized at HBMC.
We may be unable to fully realize the anticipated tax benefits of our net operating losses that we have generated at HBMC, and we cannot make any
assurances that the income earned by HBMC in the future will result in our being able to fully or timely realize those benefits, if at all, especially if HBMC continues to suffer additional operating losses. To the extent we fail to partially or
fully utilize the losses and we are forced to write down our deferred tax asset through an additional valuation allowance, then our net income and net worth would be negatively affected, and our business, financial condition, results of operations
and the price of our securities would be negatively affected.
We are a defendant in purported class action lawsuits and may not prevail in these
matters.
The nature of our business requires compliance with various state and federal lending laws and exposes us to a variety of legal
proceedings and matters in the ordinary course of business, primarily related to foreclosures, bankruptcies, condemnation and quiet title actions, and alleged statutory and regulatory violations. We are also subject to legal proceedings from time to
time related to employee and employment issues. We have recorded litigation reserves where deemed necessary in accordance with GAAP, which includes subjective judgments on our part based upon the particular facts and status of the various matters as
we understand them at that time. In the future, we may need to record additional litigation reserves.
Over the past few years, the number and scope of
lawsuits directed at mortgage originators and other financial services companies alleging that loan originators, securities brokers and others with sales duties are required to be paid overtime under the Fair Labor Standards Act has increased. Such
claims include both lawsuits by single plaintiffs and collective actions involving multiple plaintiffs. We have received several such claims and currently have several lawsuits pending in multiple jurisdictions in which the plaintiffs claim that
they have been misclassified as being exempt from overtime payment and that they are owed back pay for unpaid overtime. In each of these actions, plaintiffs are seeking an unspecified dollar amount of damages to be determined under statutory
formulae. We cannot presently predict the outcome of any litigation pending or threatened against us, nor can we presently predict the effect that any of this litigation might have on us, our business, financial condition or results of operations,
although such effect could be materially adverse.
Our past operating results may not be indicative of our future operating results, due to several
key factors, including changes in our business model.
Our past operating results may not be indicative of our future operating results, due to the
following factors:
•
Our growth over the last five years has benefited from historically low interest rates and a long period of economic and population growth in our markets. However,
since June 30, 2004, the Federal Reserve has raised the federal funds rate of interest 17 times from 1.00% to 5.25%. Our historical performance may not be indicative of results in a less favorable interest rate environment.
•
Our rapid growth, especially the growth of our mortgage loan and MBS portfolio, as well as the growth in our mortgage loan origination volume, following our IPO in
2004 may distort some of our ratios and financial statistics, especially where short-term interest rates may be as high or higher than longer-term interest rates.
•
Our business model has undergone changes since our IPO, including, but not limited to, the following:
•
Prior to our IPO and reorganization in July 2004, HBMC sold substantially all of the mortgage loans that it originated to third parties in whole loan and
securitized form.
•
Following our IPO, we elected to be treated as a REIT for federal income tax purposes, which required us to distribute to our shareholders at least 90% of our REIT
taxable income.
•
Following our IPO, our strategy was to continue to sell a majority of the fixed-rate mortgage loans that we originated to third parties, while building a leveraged
portfolio of the prime adjustable-rate
Index to Financial Statements
mortgage loans that we originated and that met our investment criteria, including interest-only and hybrid ARM loans.
•
Since the beginning of 2006, we have sold a majority of the mortgage loans that we originated to unrelated third parties, primarily as the result of a desire to
lessen the difference between income for GAAP purposes and income for tax purposes.
•
As a result of selling these loans to third parties, we had fewer loans available to add to our investment portfolio, and, consequently, we chose to purchase and
hold MBS to supplement our investment portfolio.
•
In the first quarter of 2007, we sold substantially all of our MBS portfolio in order to improve our liquidity position, and we presently do not expect to purchase
any significant amount of additional MBS to hold in our REIT investment portfolio.
•
We presently anticipate that, during 2007, we will continue to sell substantially all of the mortgage loans that we originate to unrelated third parties.
•
There may continue to exist market pressures that will result in our inability to receive gain on sale income from the sale of our mortgage loans at levels that are
attractive to us.
•
We have incurred, and will continue to incur, additional costs related to our operation as a public company.
•
In late 2006, we announced our intention not to operate our public company as a REIT beginning in 2007, and we presently are considering and evaluating changes in
our corporate structure in connection with this proposed change in our operating model.
•
We expect to supplement our mortgage loan portfolio through purchases, from time to time, of mortgage loans, which meet our investment criteria, from other
originators;
•
We expect to originate mortgage loans through a direct lending channel; and
•
We expect to open a new store location in Nashville, Tennessee in April 2007, and we intend to open two new stores in other new markets in 2007. We can make no assurance that our current strategy will be successful or that we will not have to further change our strategy and/or
business model in the future. In light of these factors and the continuing changes in our business model, performance and market conditions, our historical performance and operating and origination data may not be predictive of our future
performance.
We sold substantially all of our MBS portfolio during the first quarter of 2007.
We sold substantially all of our MBS portfolio during the first quarter of 2007. Our sale of the MBS portfolio resulted in a decrease in size of our investment
portfolio, which, in turn, will result in a reduction in our net interest margin. The sale of the MBS portfolio provided us with additional short-term liquidity; however, we may be unable to successfully employ that liquidity. Likewise, while the
sale of the MBS portfolio had the effect of increasing our liquidity during the period in which it was sold, such increase is a short-term effect only and is not sustainable, with the long-term effect being that we no longer have those
income-earning assets.
We have used part of the net proceeds from the sale of our MBS portfolio to effect a stock repurchase program.
We have used a portion of the net proceeds from the sale of our MBS portfolio to effect a stock repurchase program. We believe that our common
stock presents an attractive investment opportunity at its current price and that by initiating a stock repurchase program, we may be able to improve our book value and stock performance. However, there is a risk that our stock price may decline
further, which would negatively affect our business, financial condition and results of operations, and we can make no assurances that we will achieve the anticipated benefits of our stock repurchase program.
To the extent we are unable or choose not to add new assets to our investment portfolio, the size of our investment
portfolio, and the net interest income that we realize from that portfolio, will decline substantially in future periods.
During the year ended
December 31, 2006, our mortgage loans held for investment prepaid at a constant prepayment rate of 22%. These principal repayments diminish the size of our investment portfolio and result in the accelerated repayment of our CDOs. We presently intend
to sell substantially all of the mortgage loans that we originate, and, even if we determine to retain some of those loans or to purchase loans or mortgage-related assets from third parties, we may be unable to do so. To the extent that we are
unable or choose not to add new loans or other assets to our investment portfolio, the size of our investment portfolio, and the amount of net interest income that we realize from that portfolio, will continue to decline at a substantial rate in
future periods, which would negatively affect our business, financial condition, results of operations and the price of our securities.
Certain of
the mortgage products that we offer may expose us to greater credit risks than traditional mortgage loans, including, without limitation, the risks of delinquencies and/or credit losses.
A substantial portion of the mortgage loans that we originated in 2005 and 2006 were ARMs or hybrid ARMs. Since 2005, these products have comprised substantially all of
the mortgage loans that we have held in our investment portfolio. In addition, we may from time to time introduce additional variable-rate mortgage loan products to address changes in market conditions and customer demand. For example, in July 2006,
we introduced a negative amortization mortgage loan product. Credit risks and the risk of delinquencies associated with certain types of mortgages, particularly those with non-traditional interest rate and/or amortization terms, may be greater than
those associated with traditional mortgage loans. As interest rates increase, borrowers may be more likely to refinance their mortgage loans when the applicable fixed-interest or interest-only period expires, resulting in increased prepayments. In
addition, once a borrower’s monthly payment has been increased to include principal amortization, the delinquency or default rate on these mortgage loans may be appreciably higher. With respect to negative amortization loans, during a period of
rising interest rates, the amount of interest accruing on the principal balance of the related mortgage loan may exceed the amount of the scheduled monthly payment, and the amount of the deferred accrued interest will increase the principal balance
of the loan over time. This will increase the monthly payments to be paid by the borrower when principal must be repaid, making refinancing more difficult and increasing the potential adverse effect of macroeconomic trends. In offering these
products, we assume the potential risk of increased delinquency and prepayment rates and/or credit losses, which may negatively affect our business, financial condition, results of operations and the price of our securities.
Increases in interest rates may adversely affect our costs and the market values of our assets.
Increases in interest rates may negatively affect borrowers’ ability to timely pay their mortgage loan obligations, residential property values and the fair values
of our assets. Although we generally only hold fixed-rate loans for a short period of time pending sale, the values of fixed-rate loans will be affected negatively by these increases. GAAP requires us to reduce our income and, therefore, our
shareholders’ equity, or book value, by the amount of any decrease in the aggregate fair value of our mortgage loans held for sale. We may also have to increase our Allowance if higher interest rates and monthly payments increase
customers’ delinquencies and defaults in our mortgage loans held for investment portfolio. Our net income also could be negatively affected as short-term interest rates have increased faster than long-term rates, which also may tend to speed
prepayments of mortgage loans held for investment. Faster prepayments may adversely affect our earnings and assets growth. See “—An increase in loan prepayments may negatively affect the yields on our assets.”
Changes in interest rates also may affect our net interest income, which is the dollar difference between the interest income that we earn on our interest-earning assets
and the interest expense that we incur in financing our assets through debt, including CDOs. Absent risk mitigation strategies, including hedging with derivative financial instruments, in a period of rising interest rates, our interest expense could
increase in different amounts and at different rates and times than the interest that we earn on our earning assets. If the net differential between our interest income on our mortgage loans held for investment and our interest expense to carry such
loans and
investments was reduced, our net income would be reduced. Interest rate fluctuations resulting in our interest expense exceeding our interest income could
result in operating losses for us. Changes in the level of interest rates may negatively affect our volume of mortgage loan originations, the value of our assets and our ability to realize gains from the sale of loans we originate for resale, all of
which ultimately would negatively affect our business, financial condition, results of operations and the price of our securities.
Increases in
interest rates may negatively affect our asset mix and earnings and could increase our competition in the purchase money mortgage market.
As
interest rates increase, the demand for consumer credit, including mortgage loans, generally decreases. Interest rates have been at historically low levels in recent years. However the Federal Reserve raised interest rates 17 times from
June 30, 2004 through June 29, 2006, the last date at which an increase occurred. The MBA predicted in the February 12, 2007 Mortgage Finance Forecast that total residential mortgage loan originations will decrease approximately 5.0%
in 2007, due to higher interest rates and related decreases in mortgage loan refinancings, as well as a slowdown in housing construction. The MBA further projects that purchase money mortgage originations will decrease approximately 4.8% in 2007 and
that refinancings will decline by approximately 5.2%.
Although we presently believe that purchase money mortgage loan origination volume is affected less
by changes in interest rates than the volume of mortgage loan refinancings in a period of rising interest rates, the industry generally expects to originate fewer mortgage loans in future periods, and, accordingly, we may be adversely affected by
any slow-down in our industry. In addition, during any period of rising interest rates, the number of refinancings in the market likely would decrease dramatically. Any decreases in the market’s total mortgage loan volume could result in
increased competition in the market generally, and especially in the purchase money mortgage market, which is our focus. During 2005 and subsequently, we have experienced a change in the mix of loans that we originate, as well as higher early payoff
rates among the ARM and hybrid ARM loans that we hold for investment, as investors seek to avoid future interest rate hikes by using fixed-rate mortgages. Accordingly, a period of rising interest rates may negatively affect our industry through
fewer mortgage loan originations, increased competition and a slow-down in ARM loan volume. Delinquencies and possible losses also could increase if borrowers under our ARM and hybrid ARM loans cannot or do not pay higher mortgage payments as the
interest rates on their mortgage loans increase. All of these factors could adversely affect our business, financial condition, results of operations and the price of our securities.
We may be unable to effectively mitigate the risk of changes in interest rates.
We attempt to reduce
potential interest rate risks through various risk mitigation activities, including entering into forward contracts to sell our loans in the secondary market, options to deliver MBS to the secondary market, and interest rate swaps and other interest
rate protection contracts. The use of these transactions to mitigate the effects of changes in interest rates involves the costs of certain types of derivative financial instruments and has risks, including the risk that the derivative financial
instruments may not be effective in reducing interest rate risks. Our management determines the nature and quantity of derivative financial instruments based on various factors, including market conditions and the expected volume of mortgage loan
originations and sales. As a result, our ability to effectively mitigate the risk of changes in interest rates could be limited, and our earnings could be reduced and could vary more from period to period. The use of derivative financial instruments
may also involve transaction expenses that increase our costs. When we de-designate or lose hedge accounting treatment on our interest rate swaps and other interest rate protection devices, these instruments’ change in value affects our GAAP
income, which likely will fluctuate more from period to period as a result. If we are unable to effectively mitigate interest rate risk, our business, financial condition, results of operations and the price of our securities could be negatively
impacted.
Increases in interest rates may result in a decrease in our net interest margin because of the adjustable-rate borrowings that we utilize
to fund ARM and hybrid ARM loans, which may have interest rate caps and/or fixed interest rates for an initial period of time.
Our mortgage loan
portfolio includes ARMs and hybrid ARMs, which are mortgages with fixed interest rates for an initial period of time, after which they bear interest based upon short-term interest rate indices that adjust
periodically. We fund these mortgages with adjustable-rate borrowings having interest rates that are indexed to short-term interest rates and which adjust
periodically at various intervals. To the extent that there is an increase in the interest rate index used to determine our adjustable-rate borrowings and the interest rate on the ARM or hybrid ARM loan is fixed, our net interest margin, and
resulting net interest income, could be adversely affected.
ARMs typically have interest rate caps, which limit interest rates charged to the borrower
during any given period, and substantially all of the ARM and hybrid ARM loans that we originate contain interest rate caps. Our borrowings are not subject to similar restrictions. As a result, in a period of rapidly increasing interest rates, and
absent any hedging activities, the interest rates that we pay on our borrowings could increase, while the interest rates that we earn on our ARM assets would be capped. If this occurs, our net interest income could be significantly reduced or we
could suffer a net interest loss, which would negatively impact our business, financial condition, results of operations and the price of our securities.
We leverage our portfolio, which magnifies any income or losses that we incur in respect of our assets.
Our success is dependent,
in part, upon our ability to increase our assets through the use of leverage. Leverage creates an opportunity for increased net income, but at the same time creates risks. For example, leveraging magnifies potential changes in our income (up or
down). We leverage our portfolio of mortgage loans held for investment through borrowings, generally through the use of our warehouse, aggregation and other lines of credit, our repurchase financing facilities, CDOs and other borrowings. The amount
of leverage we incur will vary depending on our equity, our ability to obtain credit facilities and our lenders’ estimates of the value of our portfolio’s cash flow.
The return on our investments may be reduced to the extent that changes in market conditions cause the costs of our financings to increase relative to the income that can be derived from the assets we hold in our
portfolio. Further, the leverage on our equity may exacerbate any losses we incur. This is especially true when, as occurred at the end of 2005 and through most of 2006, short-term rates applicable to our financings were as high or higher than the
rates available on our long-term assets due to an “inverted” yield curve.
Our debt service payments reduce the net income available for
distribution to our shareholders. We may not be able to meet our debt service obligations in the future, and, to the extent that we cannot, we risk the loss of some or all of our assets to foreclosure or sale to satisfy our debt obligations, as well
as the risk of cross-defaults and acceleration of our other outstanding debt and securities. A decrease in the value of our assets may lead to margin calls which we will have to satisfy. We may not have the funds available to satisfy any such margin
calls. At December 31, 2006, we had a target overall leverage ratio of 18 to 25 times our equity, according to the method of calculation as dictated by our warehouse lending agreement, and our leverage ratio as of December 31, 2006 was
approximately 18 times our equity. We may change our target leverage ratio, up or down, subject to market conditions, covenants contained in our financing facilities and other factors. We had outstanding indebtedness, including obligations under our
warehouse facilities, mortgage loan repurchase facilities, loan aggregation facilities, CDOs and other sources of borrowing, of approximately $6.4 billion as of December 31, 2006.
Our financing facilities impose restrictions on our operations.
We have, and expect to continue to have,
various credit and financing arrangements with third parties to fund our operations. Our existing credit and financing arrangements impose, and the terms of future credit and financing arrangements likely will continue to impose, restrictions on our
operations. The agreements governing our existing credit and financing arrangements contain a number of covenants that, among other things, require us to:
•
satisfy prescribed financial ratios specific to each arrangement;
•
maintain a minimum level of tangible net worth, which is adversely affected by our consolidated GAAP net losses; and
•
maintain a minimum level of liquidity.
Our ability to comply with these ratios may be affected by events beyond our control. The agreements also contain
covenants that, among other things, limit our ability to:
•
pay dividends or make distributions in respect of the shares or our other ownership interests in our subsidiaries;
•
incur additional debt without obtaining prior consent;
•
guarantee the debt of others;
•
make material changes in the nature of our business; and/or
•
sell all or substantially all of our assets or effect a merger, consolidation, reorganization or other transaction to effect a corporate restructuring. A breach of any of these restrictive covenants, or our inability to comply with the required financial ratios, could, unless waived or
amended, result in a default under our credit and financing arrangements. If a default occurs, then the lenders may elect to declare all of our outstanding obligations, together with accrued interest and other fees, to be immediately due and
payable. If we are unable to repay outstanding borrowings when due, then the lenders under our credit and financing arrangements will have the right to proceed against the collateral granted to them to secure the debt. If our outstanding debt were
to be accelerated, our assets may not be sufficient to repay that debt in full, which would likely adversely affect our business, financial condition, results of operations and the price of our securities.
We may not be able to issue additional equity securities as a means of funding our operations.
Our business model is based in part on leveraging our portfolio through borrowings. The amount of leverage we may incur will vary depending upon our equity and the
covenants in our credit facilities requiring certain levels of equity and limiting our leverage. We cannot predict the amount of equity that may be required to leverage our portfolio to our targeted level or to otherwise fund our operations. Our
ability to issue additional equity securities will depend, among other things, upon market conditions and overall economic conditions, which are beyond our control, and also upon our financial condition, stock price and performance. If we cannot
issue equity securities in the future on favorable terms, or at all, we may be unable to execute our business strategy. As a result, our return on investments may be significantly reduced, which would negatively impact our business, financial
condition, results of operations and the price of our securities.
We have sought and received waivers and amendments to our financing facilities to
cure past defaults.
During 2003 and 2004, we breached certain of our net income, tangible net worth and leverage covenants, each of which
constituted defaults under those debt facilities. On January 24, 2005, we amended one aggregation repurchase facility, effective as of December 31, 2004, since we would not have met the GAAP net income covenant applicable at that date. We
have subsequently amended these facilities to provide us more flexibility and to include trust preferred securities as equity for certain covenants. While we were able to obtain waivers of these defaults or amendments to these financing facilities
that cured or avoided defaults, there is no assurance that we will not have further breaches or defaults or that any future breaches or defaults will be waived and not result in defaults under our financing facilities. Such defaults could result in
acceleration of all or substantially all our indebtedness and the loss of earning assets securing our indebtedness, which would adversely affect our business, financial condition, results of operations and the price of our securities. See
“—Our financing facilities impose restrictions on our operations.”
A prolonged economic slowdown or declining real estate values
could reduce our growth and profitability.
We believe that the risks associated with our business will be more acute during periods of economic
slowdown or recession, especially if these periods are accompanied by high interest rates and/or declining real estate values and home purchases. Declining real estate values likely will reduce our level of new mortgage loan originations since
borrowers often use increases in the value of their existing home to support the refinancing of their existing mortgage loans or the purchase of new homes at higher prices and/or levels of borrowings. Declining real estate
values also increase the likelihood that any losses on loans that we are holding in the event of a default by the borrower will be more severe. Any sustained
period of increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income from loans in our portfolio as well as our ability to originate, sell, finance and securitize mortgage loans, which would
significantly harm the value of our mortgage loan portfolio, our business, financial condition, results of operations and the price of our securities.
Our business would suffer if we are unable to sell or securitize the mortgage loans that we originate.
We presently intend to sell
substantially all of the mortgage loans that we originate. Our ability to sell mortgage loans depends on the availability of an active secondary market for residential mortgage loans, which, in turn, depends on the continuation of programs that
currently are offered by Fannie Mae, Freddie Mac and other institutional investors upon which we rely. These entities account for a substantial portion of the secondary market in residential mortgage loans. Some of the largest participants in the
secondary market, like Freddie Mac and Fannie Mae, are GSEs whose activities are governed by federal law, including capital adequacy requirements. As a result of accounting restatements at Fannie Mae that have reduced its capital and resulted in
closer regulatory and accounting scrutiny of Fannie Mae and the other mortgage GSEs, Fannie Mae and these other GSEs may reduce their purchases of mortgages, may purchase mortgages on less advantageous terms to the sellers, and may sell existing
mortgages and MBS. These changes may adversely affect the mortgage markets and our operations. Any future changes in laws or regulations, or other changes in the capital requirements, oversight or activities of these GSEs could harm our mortgage
business as these changes likely would disrupt the secondary markets for mortgage loans and the profits available in such markets.
Our ability to sell
mortgage loans also depends on our ability to remain eligible for the programs offered by Fannie Mae, Freddie Mac, and other institutional and non-institutional investors. The criteria for mortgage loans to be accepted under these programs may be
changed by the investors, and if we lose our eligibility for any reason, or if our eligibility is impaired, then our business would be harmed. Our profitability from participating in any of these programs may vary depending on a number of factors,
including our administrative costs of originating and selling qualifying mortgage loans, and the costs imposed upon us by the purchasers’ programs. Likewise, recent regulatory and Congressional scrutiny of the GSE mortgage programs could result
in changes such as limits on the size of the mortgage loan portfolios held by the GSEs. Any decline in our profitability from participating in these programs would harm our business, financial condition, results of operations and the price of our
securities.
The loss of key purchasers of our mortgage loans or a reduction in prices paid could harm our business, financial condition and results
of operations.
In 2006, 50.4% of the mortgage loans that we sold were to six large national financial institutions, two of which compete with us
directly for retail mortgage loan originations. If these financial institutions or any other significant purchaser of our mortgage loans cease to buy our mortgage loans and equivalent purchasers cannot be found on a timely and attractively
structured basis, then our business, financial condition and results of operations could be harmed. Our results of operations also could be harmed if the financial institutions that purchase the mortgage loans that we originate at HBMC lower the
price they pay to us or adversely change the material terms of their mortgage loan purchases from us. The prices at which we sell our mortgage loans vary over time. A number of factors determine the price we receive for our mortgage loans. These
factors include:
•
the number of institutions that are willing to buy our mortgage loans;
•
the amount of comparable mortgage loans available for sale;
•
the levels of prepayments of, or defaults on, mortgage loans;
•
the types and volume of mortgage loans that we sell;
•
the level and volatility of interest rates; and
•
the quality of our mortgage loans. The loss of any
such key purchaser could harm our business, financial condition, results of operations and the price of our securities.
We have limited experience servicing mortgage loans, which could lead to higher levels of delinquencies and losses.
While we are an experienced mortgage loan originator, we have limited experience servicing the mortgage loans we have originated. Prior to
December 2003, we routinely transferred the servicing responsibilities on mortgage loans that we originated, other than construction-to-permanent loans during the construction phase, to third-party servicers shortly after our origination of the
loans. Beginning in December 2003, we retained the servicing responsibilities for some of the mortgage loans that we originated, and we presently service the majority of the loans we sell. We also currently service all of the loans that we hold for
investment.
As a result of our limited experience servicing mortgage loans, we do not have representative historical delinquency, bankruptcy, foreclosure
or default experience that may be referred to for purposes of estimating the future delinquency and losses of the mortgage loans in the loan group that we service.
Our limited servicing experience could lead to higher levels of delinquencies and realized losses than would be the case if the mortgage loans were serviced by a more experienced servicer. Any higher default rate resulting from
delinquencies may negatively affect our earnings and our financial position. Our limited experience as a servicer could increase the interest expense and the subordination levels of our securitizations. Such higher costs and the greater funding
required to maintain larger subordinated interests in the securitizations may reduce our profitability and growth.
Our mortgage servicing rights may
increase the volatility of our earnings.
We record MSRs when we sell loans and retain the servicing rights on those loans. We began to increase
our third-party servicing in 2005, and at December 31, 2006, we had mortgage loan servicing rights of approximately $43.9 million related to approximately $3.6 billion of loans serviced for third parties. As we expect to sell more loans on a
servicing-retained basis, the amount of our MSRs will increase. MSRs are carried at fair value, and their values are affected by interest rates and prepayment rates on the related mortgage loans. A growing amount of MSRs may result in greater
volatility (both decreases and increases) in our income.
Valuing MSRs also involves a number of estimates and judgments. If our estimates and judgments
are incorrect, the value we ascribe to our MSRs may also be incorrect, which could negatively impact our financial condition and results of operations.
We may be required to repurchase mortgage loans that we have sold or to indemnify the purchasers.
If any of the mortgage loans that
we originate and sell, or that we pledge to secure our MBS that we issue in our securitizations accounted for as sales, do not comply with the representations and warranties that we make about the characteristics of the loans, the borrowers and/or
the properties securing the loans, then we may be required to repurchase those loans or replace them with substitute loans or cash. If we were to breach any of our representations and warranties, then we may have to bear any associated losses
directly. In addition, in the case of breaches relating to loans that we have sold, we may be required to indemnify the purchasers of those loans for losses or expenses incurred as a result of a breach of a representation or warranty made by us.
If a borrower misses the first payment on a mortgage loan, or if the borrower pre-pays the mortgage loan within one year of its origination, we may be, in
some circumstances, required to repurchase the loan. Repurchased loans typically require working capital funding, and our ability to borrow against these assets is limited. This could limit the amount by which we can leverage our equity and our
returns on assets and equity. Any significant repurchases or indemnification payments could significantly harm our business, financial condition, results of operations and the price of our securities.
We may suffer losses from defaulted mortgage loans.
When a
mortgage loan held for investment goes on nonaccrual status, we must reverse previously recognized but uncollected interest income. In addition, we may suffer losses if the proceeds from a foreclosure sale of the property underlying a defaulted loan
are less than the loan’s outstanding principal balance, together with the costs of foreclosing on and selling the related property.
We also are affected by loan defaults and deficiencies on mortgage loans that we service. Under our servicing contracts,
the servicer customarily must make advances to the owner of the loan, even when the loan is delinquent. To protect their liens on mortgaged properties, owners of loans usually require the servicer to advance the cost of mortgage and hazard insurance
and tax payments on schedule, even if escrow account funds are insufficient. The servicer will be reimbursed by the mortgage owner or from liquidation proceeds for payments advanced that the servicer is unable to recover from the mortgagor, although
the timing of that reimbursement is typically uncertain. In the interim, the servicer must absorb the cost of funds advanced. The servicer must also bear the costs of attempting to collect on defaulted and delinquent loans. As a result, we may incur
higher expenses than anticipated. If we are unable to recover amounts due to us, including any increased expenses we may incur, our business, financial condition and results of operations would be negatively affected.
We may be subject to losses due to fraudulent and negligent acts on the part of loan applicants, vendors and our associates or in situations where we obtain less
than full documentation with respect to our mortgage loans.
When we originate mortgage loans, we rely upon information supplied by borrowers and
other third parties, including information contained in the applicant’s loan application, property appraisal reports, title information, and employment and income documentation. If any of this information is misrepresented or falsified and if
we do not discover it prior to funding a loan, then the actual fair value of a loan may be significantly lower than anticipated. As a practical matter, we generally bear the risk of loss associated with any misrepresentation, whether it is made by
the loan applicant, a third party or one of our associates. A loan subject to a material misrepresentation typically cannot be sold or is subject to repurchase or substitution if it is sold or securitized prior to detection of the misrepresentation.
Although we may have rights against persons and entities who made or knew about the misrepresentation, those persons and entities may be difficult to locate, and it is often difficult to collect any monetary losses that we may have suffered from
these persons.
During 2006, for approximately 28% of the mortgage loans that we originated, as measured by principal balance, we received less than full
documentation of the borrower’s income and/or assets. Instead, those applicants chose a loan product in which our credit decision was based on the borrower’s FICO score and credit history, the value of the property securing the loan, the
effect of the loan on the borrower’s debt service requirements, and the rates and terms charged by us on the loan. We believe that there is a higher risk of default on loans where there is less than full documentation of the borrower’s
income and/or assets. In the event of defaults on these loans, we likely would experience losses, which would negatively affect our business, financial condition, results of operations and the price of our securities as the losses are incurred.
We seek to price our mortgage loan products to reflect risk, but our pricing terms may not protect us from loss.
In pricing and determining customer eligibility for our mortgage loan products, we consider a variety of factors, including, among other things, the amount and type of
documentation of the borrower’s income and/or assets, the borrower’s FICO score and history, the property value securing the loan, the effect the loan may have on the borrower’s debt service requirements and the LTV ratio. We assess
the risks related to each of these factors and price our loan products according to our final risk assessment. The pricing and terms of our loan products, however, may not ultimately protect us from the risk of default on the loans that we
originate, as those loans carrying higher prices and more onerous terms present a higher risk of default. In the event of defaults on these loans, we likely would experience losses, which would negatively affect our business, financial condition,
results of operations and the price of our securities as the losses are incurred.
We face competition that could adversely affect our market share
and revenues.
The barriers to entry in the mortgage lending industry are relatively low, and we face competition from finance and mortgage banking
companies, mortgage REITs and Internet-based lending companies, as well as more traditional lenders such as banks, thrifts and securities brokers that are already active participants in the mortgage industry. As we seek to expand our loan
origination business further, we will face a significant number of additional competitors, many of which will be well established in the markets we seek to penetrate. Some of our
competitors are much larger than we are, have better name recognition than we do, have been established in certain market areas that we target, have far
greater financial and other resources than we do, may operate nationally or over larger markets than we do, and may have a greater ability to react to improving or deteriorating market conditions. We also face increased competition for strategic
alliances with realtors and home builders that may adversely affect our ability to maintain and expand our mortgage loan originations through SMAs, as well as adversely affecting the costs of securing and maintaining alliance partners in this
marketing channel.
Various Federal Home Loan Banks are also expanding their participation in the mortgage industry, and Fannie Mae and Freddie Mac remain
dominant participants in the residential mortgage markets. While these GSEs presently do not have the legal authority to originate residential mortgage loans, they do have the authority to buy and fund the same type of loans that we have held for
investment, and thereby indirectly compete for these products by providing purchase facilities to competitive mortgage loan originators. Fannie Mae and Freddie Mac dominate the secondary market and have lower capital costs and capital requirements
than non-GSEs, and loans made by our competitors pursuant to GSE programs could adversely affect our ability to compete in the mortgage industry, as well as the value of our securities. The recent accounting restatements and disclosures regarding
the accounting risk management practices of the GSEs and inquiries regarding such practices by their regulators and the press could also affect investor confidence in us and the value of our securities.
Competition in our industry can take many forms. Our competitors can offer lower interest rates and fees, apply less stringent underwriting standards, offer enhanced
customer service and convenience in obtaining loans, and offer a wide variety of loan products through diverse marketing and distribution channels. They may also seek to provide better terms to our existing and potential SMA partners. The need to
maintain mortgage loan origination volume in this competitive environment creates a risk of price and quality competition in the mortgage industry. Price competition could cause us to lower the interest rates that we charge borrowers, which could
reduce our profitability and the value of our loans that we sell or retain in our portfolio. If our competitors adopt less stringent underwriting standards, we may be pressured to do so as well. If we do not relax underwriting standards in response
to our competitors, then we may lose origination volume and market share. If we relax our underwriting standards in response to price competition, then we may be exposed to higher credit risk without receiving adequate fees and interest to
compensate for the higher risk. Any increase in these pricing and underwriting pressures could reduce the volume of our mortgage loan originations and sales and significantly harm our business, financial condition and results of operations.
Changes in U.S. economic conditions may adversely affect the performance of mortgage loans, particularly adjustable-rate mortgage loans.
Recently, an increasingly large proportion of residential mortgage loans originated in the United States have been ARM loans, including loans that
have interest-only or negative amortization features. ARMs may include any of the following types of loans:
•
mortgage loans whose interest rate adjusts on the basis of a variable index plus a margin, with the initial adjustment occurring after a specified period of time
from origination of the related mortgage loan and adjustments occurring periodically at specified intervals thereafter; these loans may or may not have a low introductory interest rate;
•
“hybrid ARM” loans, whose interest rate is fixed for the initial period specified in the related mortgage note, and thereafter adjusts periodically based
on the related index plus a margin;
•
“interest-only” mortgage loans, which provide for payment of interest at the related mortgage interest rate, but no payment of principal, for the period
specified in the related mortgage loan documentation; thereafter, the monthly payment is increased to an amount sufficient to amortize the principal balance of the mortgage loan over the remaining term and to pay interest at the applicable mortgage
interest rate;
•
“negative amortization” mortgage loans, which may have a low introductory interest rate, and thereafter have a mortgage interest rate which adjusts
periodically based on the related index plus a margin; however,
Index to Financial Statements
the borrower is only required to make a minimum monthly payment which may not be sufficient to pay the monthly interest accrued, resulting in an increase to
the principal balance of the mortgage loan by the amount of unpaid interest; and
•
“option ARMs,” which combine several of the features described above and permit the borrower to elect whether to make a monthly payment sufficient to pay
accrued interest and amortize the principal balance, make an interest-only payment or make a minimum payment that may be insufficient to pay accrued interest (with the unpaid interest added to the principal balance of the loan). We may include significant concentrations of some of these types of ARMs, which present special default and prepayment risks, in our
product offerings and our mortgage loan portfolio.
The primary attraction to borrowers of these ARM products is that initial monthly mortgage loan
payments can be significantly lower than fixed-rate or level-pay mortgage loans under which the borrower pays both principal and interest at an interest rate fixed for the life of the mortgage loan. As a result, many borrowers are able to incur
substantially greater mortgage debt using one of these ARM loan products than if they used a fixed-rate mortgage loan.
In addition, a substantial number
of these ARM loans have been originated in regions of the United States that have seen substantial residential housing price appreciation over the past few years and major metropolitan areas in other states. Many borrowers in these markets have used
ARM loan products to purchase homes that are comparatively larger or more expensive than they would otherwise have purchased with a fixed-rate mortgage loan with relatively higher monthly payments. These borrowers may have taken out these mortgage
loan products in the expectation that either: (1) their income will rise by the time their fixed-rate period or interest-only period expires, thus enabling them to make the higher monthly payments; or (2) in an appreciating real estate
market, they will be able to sell their property for a higher price or will be able to refinance the mortgage loan before the expiration of the fixed-rate or interest-only period.
Borrowers with ARM loans will likely be exposed to increased monthly payments: (1) if interest rates rise significantly; (2) in the case of interest-only mortgage loans, from the large increases in monthly
payments when the interest-only terms expire and the monthly payments on these loans are recalculated to amortize the outstanding principal balance over the remaining term; or (3) in the case of loans with negative amortization features, from
the large increases in monthly payments when the payments are recalculated to amortize the outstanding principal balance.
In recent years, mortgage
interest rates have been at historically low levels. Although short-term interest rates have increased from their lowest levels, long-term interest rates have remained low. If mortgage interest rates rise, borrowers will experience increased monthly
payments on their ARM loans. As the fixed interest rates on hybrid ARM loans expire and convert to adjustable rates, borrowers may find that the new minimum monthly payments are considerably higher and they may not be able to make those payments. In
addition, without regard to changes in interest rates, the monthly payments on mortgage loans with interest-only or negative amortization features will increase substantially when the principal must be repaid. Any of these factors, or a combination
of these factors, could cause mortgage loan delinquencies and defaults to increase substantially.
Borrowers who intend to avoid increased monthly payments
by refinancing their mortgage loans may find that lenders may not in the future be willing or able to offer these ARM loan products or to offer these products at relatively low interest rates. A decline in housing prices generally or in certain
regions of the United States could also leave borrowers with insufficient equity in their homes to permit them to refinance. In addition, if the recent rapid increase in house prices ceases or housing prices decline, borrowers who intend to sell
their properties on or before the expiration of the fixed-rate periods or interest-only periods on their mortgage loans may find that they cannot sell their properties for an amount equal to or greater than the unpaid principal balance of their
loans, especially in the case of negative amortization mortgage loans. These events could cause borrowers to default on their mortgage loans.
Any of the factors described above, alone or in combination, could adversely affect the credit quality of our mortgage
loans.
An increase in loan prepayments may negatively affect the yields on our assets.
The value of the mortgage loans that we hold will be affected by prepayment rates on those mortgage loans. Prepayment rates are influenced by changes in interest rates
and a variety of economic, geographic and other factors beyond our control. As a result, we are unable to predict prepayment rates with any certainty.
In
periods of declining mortgage loan interest rates, prepayments on mortgage loans generally increase. We likely would reinvest the proceeds that we receive from those prepayments in assets with lower yields than the yields on the mortgage loans that
were prepaid, which could negatively affect our business, financial condition and results of operations. As interest rates decline, the fair value of fixed-income assets generally increases. However, because of the risk of prepayment, the fair value
of mortgage and mortgage-related assets does not increase to the same extent as fixed-income securities in an environment of declining interest rates.
Conversely, in periods of rising interest rates, prepayments on fixed-rate mortgage loans generally decrease, in which case we would not have the prepayment proceeds available to invest in assets with higher yields and would thus continue
to hold assets generating a return that is low in comparison to other available assets in that rate environment. In a rising interest rate environment, borrowers under ARM and hybrid ARM loans may prepay these loans faster than expected, as they
seek to avoid further rate increases by switching to fixed-rate mortgages. We may fail to recoup fully our origination costs as a result of prepayment, which also adversely affects our asset and net income growth. See “Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Executive Overview—Trends” in Item 7 of this Report for more information on the impact of prepayments on our financial condition and results of operations.
The mortgage loans that we hold are subject to the risks of delinquency and foreclosure loss.
The mortgage loans held in our investment portfolio are secured by residential properties and are subject to risks of loss from delinquencies and foreclosures. The
ability of a borrower to repay a loan secured by residential property typically is dependent primarily upon the income or assets of the borrower. In addition, the ability of borrowers to repay their mortgage loans may be affected by, among other
things:
•
property location and condition;
•
competition and demand for comparable properties;
•
changes in zoning laws for the property or its surrounding area;
•
environmental contamination at the property;
•
the occurrence of any uninsured casualty at the property;
•
changes in national, regional or local economic conditions;
•
declines in regional or local real estate values;
•
increases in interest rates or real estate taxes;
•
availability and costs of municipal services;
•
changes in governmental rules, regulations and fiscal policies, including environmental legislation and changes in tax laws; and
•
acts of God, war or other conflict, terrorism, social unrest and civil disturbances, and natural disasters, such as hurricanes. In the event of a default under a mortgage loan held by us, we will bear a risk of loss of principal to the extent of any deficiency between: (1) the value of the
collateral that we can realize upon foreclosure and sale and (2) the
sum of the principal amount of the mortgage loan and the cost of foreclosing on the related property. Losses resulting from mortgage loan defaults and
foreclosures could have a material adverse effect on our income and cash flows. We are exposed to greater risks of loss where we make both a first- and second-lien mortgage loans on the same property and do not have the benefits of PMI.
In the event of the bankruptcy of a mortgage loan borrower, the related mortgage loan will be deemed to be secured only to the extent of the value of the underlying
collateral at the time of bankruptcy, as determined by the bankruptcy court. The lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under
state law. Foreclosure of a mortgage loan can be an expensive and lengthy process that can have a substantial negative effect on our originally anticipated return on the foreclosed mortgage loan. In addition, to the extent that the mortgage loans we
originate experience relatively high rates of delinquency and/or foreclosure, we may be unable to securitize our mortgage loans on terms that are attractive to us, if at all.
We have limited experience in making critical accounting estimates, and our financial statements may be materially affected if our estimates prove to be inaccurate.
Financial statements prepared in accordance with GAAP require the use of estimates, judgments and assumptions that affect the reported amounts. Different estimates,
judgments and assumptions reasonably could be used that would have a material effect on the financial statements, and changes in these estimates, judgments and assumptions are likely to occur from period to period in the future. Significant areas of
accounting requiring the application of management’s judgment include, but are not limited to:
•
assessing the adequacy of the Allowance;
•
determining the fair value of investment securities;
•
valuing MSRs;
•
assessing goodwill for impairment;
•
determining the need for and amount of any valuation allowance against deferred tax assets; and
•
determining the need for reserves for contingencies. These estimates, judgments and assumptions are inherently uncertain, and, if they prove to be wrong, then we face the risk that charges to income will be required. In addition, because we have limited operating history in some of these
areas and limited experience in making these estimates, judgments and assumptions, the risk of future charges to income may be greater than if we had more experience in these areas. Any such charges could significantly harm our business,
financial condition, results of operations and the price of our securities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in
Item 7 of this Report for a discussion of the accounting estimates, judgments and assumptions that we believe are the most critical to an understanding of our business, financial condition and results of operations.
Changes in state laws could adversely affect our mortgage loan originations, sales and securitization transactions.
Changes in laws regarding the rates and terms of mortgage loans and the regulation of mortgage loan originators, investors and lenders in the states where we operate
could adversely affect our ability to originate, finance, sell and securitize our loans. In recent years, states have passed laws that have made lenders to, and purchasers from, mortgage originators liable for various originators’ violations of
such laws. Enactment of similar laws applicable to the types of loans we originate could have a negative effect on our ability to finance, securitize or sell mortgage loans, which would negatively impact our business, financial condition, results of
operations and the price of our securities.
We rely on key personnel, the loss of whom could impair our ability to successfully operate our business.
Our future success depends, to a significant extent, on the continued services of our executive management team, especially Kevin D. Race, our
President, Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. Although we have an employment agreement with Mr. Race, he may not remain employed with us. We presently maintain a key person life insurance policy on
Mr. Race; however, this insurance policy would not fully offset the loss to our business, and our organization generally, that would result from our losing his services. As a result, the loss of services of one or more members of our senior
management team, especially Mr. Race, could adversely affect our business, financial condition, results of operations and the price of our securities.
Our Chief Executive Officer, Mr. Race, has a number of important management responsibilities, which could limit his ability to perform the functions required by the positions that he currently holds.
In January 2007, Mr. Race became our Chief Executive Officer following the departure of Mr. Patrick S. Flood. As a result of this appointment,
Mr. Race now serves as our President, Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and as a director. If Mr. Race is unable to perform the many functions required by each of these positions, then our business,
financial condition, results of operations and the price of our securities could be negatively impacted.
We face intense competition for qualified
personnel.
Generally, our business is dependent on the highly skilled, and often highly specialized, individuals that we employ. Our failure to
identify, recruit and retain qualified employees, including employees qualified to manage a portfolio of structured products, could harm our future operating results and may, in turn, negatively affect the market price of our securities.
Specifically, we depend on our associates to generate customers by, among other things, developing relationships with consumers, real estate agents and brokers,
builders, corporations, our SMA partners and others, which we believe leads to repeat and referral business. Accordingly, we must be able to attract, motivate and retain skilled associates. In addition, our growth strategy contemplates continually
attracting and hiring additional qualified associates. The market for such persons is highly competitive and historically has experienced a high rate of turnover. Competition for qualified associates may lead to increased costs to hire and retain
them, in addition to the expense and potential distraction to management, caused by filling vacancies. We cannot guarantee that we will be able to attract or retain qualified associates. If we cannot attract or retain a sufficient number of skilled
associates, or even if we can retain them but at higher costs, our business, financial condition, results of operations and the price of our securities could be harmed.
We have a limited operating history with respect to securitizing mortgage loans and managing a portfolio of mortgage loans and related mortgage assets, which may affect our ability to complete securitizations on
favorable terms.
Although certain members of our senior management team have past experience in mortgage banking, securitizing mortgage loans, and
investing in and managing portfolios of residential mortgage loans, we have a limited history with respect to securitizing mortgage loans and have managed an investment portfolio of mortgages commencing only after the completion of our IPO. Our
ability to complete securitizations in the future on favorable terms will depend upon a number of factors, including the skill of our management team, conditions in the securities markets generally and in the MBS segment specifically, the
performance of our portfolio of securitized loans, our ability to obtain leverage on terms that allow us to earn a reasonable spread over our interest costs and our decision to hold in our investment portfolio any of the mortgage loans that we
originate.
In addition, the poor performance of any pool of mortgage loans that we do securitize could increase the expense of any subsequent
securitization that we bring to market. Accordingly, lack of demand in the securitization markets generally, or a change in the market’s demand for our MBS, could have a material adverse effect on our business, financial condition and results
of operations. Although we presently intend to sell all of the loans that
we originate, if we are unable to securitize efficiently the mortgage loans that we originate, it would be more difficult and expensive to build our mortgage
loan portfolio, and our profitability would be adversely affected. Likewise, revenues for the duration of our investment in those loans would decline, which would lower our earnings from the loans in our portfolio. We cannot assure you that we will
be able to complete the issuance of MBS through securitizations in the future on favorable terms, if at all.
The loss of our SMAs, or our inability
to create SMAs in new markets, could negatively affect our mortgage loan origination volume.
Our SMAs with residential realtors and home builders
have provided us with a point-of-sale network in our markets and are a key component of our business. If we should lose certain of these SMAs, or if these alliances or the parties involved in these alliances were adversely affected, whether as a
result of changes in laws, regulations, regulatory interpretations or otherwise, we may experience a decline in our mortgage loan production, which would negatively affect our revenues and results of operations. In addition, if we are unable to
create and establish SMAs in new markets and add to those in our existing markets, or if we are unable to continue to successfully leverage our existing and future SMAs, then we likely would be unable to effect our business strategy, which could
negatively affect our results of operations. The profitability and success of our SMAs could be adversely affected to the extent other mortgage lenders adopt or promote similar strategies and offer more attractive terms to our existing and potential
alliance partners. Our business and prospects would be materially harmed if we were unable to maintain or enter into SMAs with similar economic effect as we have utilized historically, as a result of regulatory action or otherwise. HUD is charged
with interpreting RESPA, including arrangements between mortgage lenders and real estate brokers and home builders. We have received inquiries about our SMAs from HUD in the past, most recently in 2004. If HUD were to determine that any of our SMAs
violated RESPA, we could be forced to terminate those SMAs, which could negatively affect our business, financial condition, results of operations and the price of our securities. See “—Our business operations are subject to complex laws
and regulations.”
We may not realize the expected results from our SMAs.
SMAs represent a very important part of our marketing and business strategy, and, in the past, we devoted a significant amount of our resources, including expenditures of monies, to expand and maintain our SMA
relationships, especially in recent periods. In addition, we may enter into joint ventures with selected home builders as a further means to access to potential customers. We may not realize the expected benefits from this expansion of our SMAs or
from any joint ventures that we may pursue until future periods that are more than a year from now, and, in many cases, we may not realize the expected benefits at all. If we are unable to realize the expected benefits of our SMAs, then our
business, financial condition and results of operations could be harmed.
As part of our recent efforts to reduce expenses and better position ourselves to
compete in the current mortgage finance environment, we intend to manage our SMA alliance partnerships to reduce the overall cost of SMAs without diminishing the origination opportunities that these relationships present. In some cases, we may
determine to terminate certain SMA relationships. If we are unable to reduce expenses associated with our SMAs or if our efforts to reduce expenses result in the loss of SMAs, then our loan origination volume may suffer, and our business, financial
condition and results of operations could be harmed.
See “—The loss of our strategic marketing alliances, or our inability to create strategic
marketing alliances in new markets, could negatively affect our mortgage loan origination volume,” “—We may not realize the expected benefits from our expense reduction measures” and “—Our business operations are
subject to complex laws and regulations.”
Risks associated with the geographic expansion of our business may adversely affect our business,
financial condition and results of operations.
We have plans to open a full-service store in Nashville, Tennessee during the first half of 2007
and to open two additional new stores in locations that remain to be determined later in 2007. Any expansion into new markets
will require significant expenditures and may place additional demands on our management, operational and financial resources. If we are unable to manage
effectively any geographic expansion efforts, then our business, financial condition, results of operations and the price of our securities may be negatively affected.
Likewise, we have no experience operating in the Nashville, Tennessee market, and we may lack experience in any other market into which we may expand. Our lack of experience in such markets could result in additional
costs, levels of mortgage origination volume that are less than anticipated and other unforeseen difficulties as we attempt to build our business in those areas.
A decline in the fair value of our assets may limit our ability to borrow additional funds.
A decline in the fair value of our
assets may limit our ability to borrow additional funds or result in our lenders requiring additional collateral from us under our loan credit agreements. As a result, we could be required to sell some of our assets under adverse market conditions,
upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized costs of the investments, then we will incur losses, which could negatively impact our business, financial
condition and results of operations.
To the extent we are unable to adapt to and implement technological changes involving the loan origination
process, we may have difficulty remaining competitive, and our loan origination business may be adversely affected.
Our mortgage loan origination
business is dependent upon our ability to interface effectively with our borrowers and other third parties and to process loan applications efficiently. The origination process is becoming more dependent upon technological advancements, such as the
ability to process applications over the Internet, interface with borrowers and other third parties through electronic means, and underwrite loan applications using specialized software. Implementing new technology and maintaining the efficiency of
the current technology used in our operations may require significant capital expenditures. For example, as of December 31, 2006, we had invested $29.7 million in development of HomeBancWay II, of which $9.4 million was placed in service. The
total cost of this multi-year program is projected to be $32.9 million. Future technological changes may delay the development or implementation of HomeBancWay II or otherwise cause us not to realize the benefit of our investment in HomeBancWay II,
resulting in an impairment charge, which could negatively affect our business, financial condition and results of operation.
In addition, as
the result of the deteriorating conditions in the mortgage industry generally, and especially in the subprime and nonprime mortgage lending industry, there has been recent media and legislative attention paid to developing a new system of regulation
for mortgage lenders. Any such legislation or other regulation could have a significant effect on our business. We cannot predict whether any such legislation ultimately will be adopted, or, if adopted, what effect such legislation could have on our
business.
An interruption in service or breach in the security of our information systems could impair our ability to originate or service loans on
a timely basis and may result in lost business, which may never be recovered.
We rely heavily upon communications and information systems to
conduct our business. Failures or interruptions in service or breaches in security of our information systems or the third party information systems on which we may from time to time rely could cause delays in our underwriting, credit risk
assessments and other areas, could result in fewer loan applications being received and processed, and could reduce our efficiency in loan servicing. We cannot assure you that we will not experience material failures or interruptions or, if we
experience them, that we or the third parties on whom we rely will adequately and timely address them. The occurrence of any failures or interruptions, including a breach of our data security similar to the breaches suffered by several national
financial services firms in recent periods, could significantly harm our customer relations and could adversely affect our growth, our costs to service loans and our ability to profitably securitize our mortgage loan portfolio as well as our
business, financial condition, results of operations and the price of our securities.
Our business operations are subject to complex laws and regulations.
We must comply with the laws, rules and regulations, as well as judicial and administrative decisions, of all jurisdictions where we originate mortgage loans, as well as
an extensive body of federal laws, rules and regulations. The number of changes in legal licensing requirements applicable to our business has increased in recent years, and individual municipalities have also begun to adopt ordinances and
regulations that restrict or otherwise affect loan origination activities and, in some cases, loan servicing activities. The laws, rules and regulations of each of these jurisdictions are different, complex and, in some cases, in direct conflict
with each other, increasing the costs of compliance and the risks of non-compliance with these laws, rules and regulations. Unlike our national bank and federally-chartered thrift competitors, we have no ability to use federal law to preempt any of
these state and local laws.
Our failure to comply with these laws, rules and regulations can lead to, among other things:
•
civil and criminal liability, including potential monetary penalties;
•
loss of licenses or permits to do business in certain jurisdictions;
•
legal defenses giving borrowers the right to rescind or cancel loan transactions;
•
demands for indemnification or loan repurchases from purchasers of our mortgage loans; and/or
•
administrative orders and enforcement actions by our regulators. It is difficult to determine the effect that any of these outcomes could have on our business operations, and, even if without what we believe to be an appropriate legal basis, their occurrence would likely result in
unforeseeable expenses and diversions of management time.
Some states in which we operate may impose regulatory requirements on our officers and
directors. If any officer or director fails to meet or refuses to comply with a state’s applicable regulatory requirements for mortgage lending, then we could lose our authority to conduct business in that state or the services of that person.
In March 2004 and July 2003, we received letters from HUD and a HUD contractor, respectively, requesting information regarding our SMAs. The March 2004
letter sought information regarding whether flat monthly fees paid by us to realtors and home builders for the rental of space and the performance of services under our SMAs are consistent with RESPA restrictions on fees for the referral of business
incident to real estate settlement services. Any determination that our SMAs do not comply with applicable law could have a material adverse effect upon our business and results of operations unless and until we can develop alternative arrangements.
We use consumer credit reports, which are subject to regulation and may expose us to litigation or enforcement actions.
In connection with our loan file due diligence reviews, we have access to the personal financial information of the borrowers, which is highly sensitive and confidential
and subject to significant federal and state regulation. For example, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003, and related regulations govern our use of consumer credit reports, our
furnishing information to credit reporting agencies regarding our experience with our customers, and our sharing of information among affiliates and with third parties. If a third party were to misappropriate this information, we potentially could
be subject to both private and public legal actions.
Although we have policies and procedures designed to safeguard confidential information, we cannot
assure you that these policies and safeguards are sufficient to prevent the misappropriation of confidential information. We face costs of complying with these laws, and any failure by us to comply with these laws could result in government
enforcement actions, as well as private litigation, against us.
The privacy and treatment of consumer credit reports, and consumer financial information
generally, has received much recent media and legislative attention, and, in the future, we may face additional legal
requirements or prohibitions on how we use the information that we obtain from our customers and third parties. These compliance costs, and the costs
resulting from any enforcement actions or litigation, could negatively affect our business, financial condition and results of operations.
New
legislation may restrict our ability to make mortgage loans, which would negatively affect our revenues.
In recent years, federal and several
state and local laws, rules and regulations have been adopted, or are under consideration, that are intended to eliminate certain “predatory” lending practices, that are considered to be abusive. Several of these laws, rules and
regulations restrict commonly accepted lending activities and could impose additional costly and burdensome compliance requirements on us. Some of these laws, rules and regulations impose certain restrictions on loans that charge certain points and
fees or that have an APR that equals or exceeds specified thresholds. These restrictions could expose us to risks of litigation and regulatory sanctions regardless of how carefully a loan is underwritten.
In addition, an increasing number of these laws, rules and regulations seek to impose liability for violations on the purchasers of mortgage loans, regardless of whether
a purchaser knew of or participated in the violation. Accordingly, the third parties that buy our loans or provide financing for our loan originations may not want, and are not contractually required, to buy or finance loans that do not comply with
these laws, rules and regulations.
These laws, rules and regulations have required us to develop systems and procedures to ensure that we do not violate
any aspect of these new requirements and may prevent us from making certain loans and cause us to reduce the APR or the points and fees we charge on the mortgage loans that we originate. Our competitors that are banks or federal thrifts may not be
subject to these state laws, as federal bank regulators have preempted state laws for these competitors. Although these predatory lending laws currently are state or local laws, Congress has recently begun discussing possible federal predatory
lending legislation, which, if adopted, would preempt inconsistent state laws.
We intend to avoid originating loans that meet or exceed the applicable APR
or points and fees thresholds of these laws, rules and regulations in jurisdictions where we operate. If we elect to relax our self-imposed restrictions on originating loans subject to these laws, rules and regulations, we will be subject to greater
risks for actual or perceived non-compliance with these legal requirements, including demands for indemnification or loan repurchases from the parties to whom we broker or sell loans, class action lawsuits, increased defenses to foreclosure of
individual loans in default, individual claims for significant monetary damages and administrative enforcement actions. Any of these actions could impose additional costs that significantly harm our business, financial condition and results of
operations