Accredited Home Lenders Holding (LEND)

 
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Accredited Home Lenders Holding 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-10.2
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

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

 

For the quarterly period ended September 30, 2005

 

or

 

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

 

For the transition period from                      to                     

 

Commission File Number 0-50179

 


 

ACCREDITED HOME LENDERS HOLDING CO.

(Exact name of registrant as specified in its charter)

 


 

Delaware   04-3669482

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

15090 Avenue of Science

San Diego, California 92128

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: 858-676-2100

 

Former name, former address and former fiscal year, if changed since last report: Not applicable.

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    or    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    or    No  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    or    No  x

 

The number of outstanding shares of the registrant’s common stock as of November 4, 2005 was 21,920,446.

 



Table of Contents

TABLE OF CONTENTS

 

          Page

PART I

         

Item 1.

   Financial Statements of Accredited Home Lenders Holding Co:     
    

Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004

   4
    

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004

   5
    

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004

   6
    

Notes to Consolidated Financial Statements

   7
     Financial statements of Accredited Mortgage Loan REIT Trust (the “REIT”):     
    

Balance Sheets as of September 30, 2005 and December 31, 2004

   30
    

Statements of Operations for the Three Months Ended September 30, 2005 and 2004 and the Nine Months Ended September 30, 2005 and from inception (May 4, 2004) to September 30, 2004

   31
    

Statements of Cash Flows for the Nine Months Ended September 30, 2005 and from inception (May 4, 2004) to September 30, 2004

   32
    

Notes to Unaudited Financial Statements

   33

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    45

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    77

Item 4.

   Controls and Procedures    77

PART II

         

Item 1.

   Legal Proceedings    78

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    79

Item 3.

   Defaults Upon Senior Securities    79

Item 4

   Submission of Matters to a Vote of Security Holders    79

Item 5.

   Other Information    79

Item 6.

   Exhibits    79
     Signatures    80
     Exhibit Index    81
     Certifications     

 

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Table of Contents

FORWARD-LOOKING STATEMENTS

 

This report contains certain forward-looking statements. When used in this report, statements which are not historical in nature, including the words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend” and similar expressions are intended to identify forward-looking statements. They also include statements containing a projection of revenues, earnings or losses, capital expenditures, dividends, capital structure or other financial terms.

 

The forward-looking statements in this report are based upon our management’s beliefs, assumptions and expectations of our future operations and economic performance, taking into account the information currently available to them. These statements are not statements of historical fact. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us, that may cause our actual results, performance or financial condition to be materially different from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. Some of the important factors that could cause our actual results, performance or financial condition to differ materially from expectations are:

 

    the degree and nature of our competition;

 

    a general deterioration in economic or political conditions;

 

    changes in demand for, or value of, mortgage loans due to the attributes of the loans we originate; the characteristics of our borrowers; and fluctuations in the real estate market, interest rates or the market in which we sell or securitize

 

    our ability to protect and hedge our mortgage loan portfolio against adverse interest rate movements;

 

    changes in government regulations that affect our ability to originate and service mortgage loans;

 

    changes in the credit markets, which affect our ability to borrow money to originate mortgage loans;

 

    our ability to employ and retain qualified employees; and

 

    the other factors referenced in this report, including, without limitation, under the section entitled “ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report might not occur. We qualify any and all of our forward-looking statements entirely by these cautionary factors.

 

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Table of Contents

In this Form 10-Q, unless the context requires otherwise, “Accredited,” “Company,” “we,” “our,” and “us” means Accredited Home Lenders Holding Co. and its subsidiaries.

 

PART I

 

ITEM 1. Financial Statements

 

ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except par value)

 

     September 30,
2005


   

December 31,

2004


 
     (unaudited)        
ASSETS                 

Cash and cash equivalents

   $ 21,525     $ 35,155  

Restricted cash

     139,285       4,589  

Mortgage loans held for sale, net of reserve of $20,734 and $17,065, respectively

     2,349,385       1,790,134  

Mortgage loans held for investment, net of reserve of $95,728 and $60,138 respectively

     6,581,439       4,690,758  

Furniture, fixtures and equipment, net

     35,798       34,763  

Other receivables

     98,426       57,658  

Deferred income tax asset, net

     —         34,250  

Prepaid expenses and other assets

     65,791       41,070  
    


 


Total assets

   $ 9,291,649     $ 6,688,377  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

LIABILITIES:

                

Warehouse credit facilities

   $ 2,074,994     $ 2,204,860  

Asset backed commercial paper

     985,348       —    

Securitization bond financing

     5,550,348       3,954,115  

Income taxes payable, current

     20,879       22,310  

Deferred income tax liability, net

     2,204       —    

Accounts payable and accrued liabilities

     59,113       46,615  
    


 


Total liabilities

     8,692,886       6,227,900  
    


 


COMMITMENTS AND CONTINGENCIES (Note 13)

                

MINORITY INTEREST IN SUBSIDIARY

     97,922       97,922  

STOCKHOLDERS’ EQUITY:

                

Preferred stock, $.001 par value; authorized 5,000,000 shares; no shares issued or outstanding

     —         —    

Common stock, $.001 par value; authorized 40,000,000 shares; issued and outstanding 21,914,686 shares and 21,379,690 shares, respectively (including 771,885 and 585,545, respectively, of restricted stock awarded under the deferred compensation plan)

     22       21  

Additional paid-in capital

     101,598       84,281  

Unearned compensation

     (17,329 )     (12,058 )

Accumulated other comprehensive income

     16,130       2,042  

Retained earnings

     400,420       288,269  
    


 


Total stockholders’ equity

     500,841       362,555  
    


 


Total liabilities and stockholders’ equity

   $ 9,291,649     $ 6,688,377  
    


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)(Unaudited)

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2005

    2004

    2005

    2004

 

REVENUES:

                                

Interest income

   $ 164,147     $ 97,493     $ 430,194     $ 242,792  

Interest expense

     (84,571 )     (37,114 )     (207,022 )     (86,137 )
    


 


 


 


Net interest income

     79,576       60,379       223,172       156,655  

Provision for losses

     (19,168 )     (14,416 )     (56,465 )     (39,708 )
    


 


 


 


Net interest income after provision

     60,408       45,963       166,707       116,947  

Gain on sale of loans

     85,644       77,993       237,886       210,342  

Loan servicing income

     3,243       1,996       8,082       5,205  

Other income

     2,461       690       5,800       2,606  
    


 


 


 


Total net revenues

     151,756       126,642       418,475       335,100  
    


 


 


 


OPERATING EXPENSES:

                                

Salaries, wages and benefits

     48,378       42,772       140,501       117,885  

General and administrative expenses

     15,441       12,298       41,019       32,929  

Occupancy

     5,247       4,810       15,694       13,341  

Advertising and promotion

     5,388       3,580       13,480       9,073  

Depreciation and amortization

     3,999       2,911       10,929       6,934  
    


 


 


 


Total operating expenses

     78,453       66,371       221,623       180,162  
    


 


 


 


Income before income taxes and minority interest

     73,303       60,271       196,852       154,938  

Income tax provision

     29,517       23,234       77,217       61,101  

Minority interest—dividends on preferred stock of subsidiary

     2,495       1,160       7,484       1,160  
    


 


 


 


Net income

   $ 41,291     $ 35,877     $ 112,151     $ 92,677  
    


 


 


 


Earnings per common share:

                                

Basic

   $ 1.95     $ 1.75     $ 5.34     $ 4.57  

Diluted

   $ 1.87     $ 1.66     $ 5.11     $ 4.31  

Weighted average shares outstanding:

                                

Basic

     21,217       20,470       21,017       20,287  

Diluted

     22,059       21,580       21,932       21,516  

 

The accompanying notes are an integral part of these consolidated financial statements

 

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Table of Contents

ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)(Unaudited)

 

   

Nine Months Ended

September 30,


 
    2005

    2004

 

CASH FLOWS FROM OPERATING ACTIVITIES:

               

Net income

  $ 112,151     $ 92,677  

Adjustments to reconcile net income to net cash used in operating activities:

               

Depreciation and amortization

    10,929       6,934  

Provision for losses

    56,465       39,708  

Minority interest—dividends paid on preferred stock of subsidiary

    7,484       1,160  

Deferred income tax provision (benefit)

    29,042       (1,162 )

Unrealized loss (gain) on risk derivatives

    7,032       (16,910 )

Adjustment into earnings for gain on derivatives from other comprehensive income

    (10,029 )     —    

Amortization of deferred costs

    2,344       4,278  

Changes in operating assets and liabilities:

               

Restricted cash

    (134,696 )     (5,481 )

Mortgage loans held for sale originated, net of fees

    (11,870,478 )     (8,982,452 )

Cost of loans sold, net of fees

    7,850,953       5,789,582  

Principal payments received on loans held for sale

    98,718       52,405  

Other receivables

    (45,928 )     (15,659 )

Prepaid expenses and other assets

    29,467       (21,573 )

Income taxes payable

    2,311       2,676  

Accounts payable and accrued liabilities

    9,549       3,691  
   


 


Net cash used in operating activities

    (3,844,686 )     (3,050,126 )
   


 


CASH FLOWS FROM INVESTING ACTIVITIES:

               

Principal payments received on loans held for investment

    1,403,442       581,562  

Capital expenditures

    (12,132 )     (18,952 )
   


 


Net cash provided by investing activities

    1,391,310       562,610  
   


 


CASH FLOWS FROM FINANCING ACTIVITIES:

               

Net proceeds from warehouse credit facilities

    (129,866 )     896,220  

Net proceeds from issuance of asset backed commercial paper

    985,348       —    

Proceeds from issuance of securitization bond financing, net of fees

    3,003,173       2,167,569  

Payments on securitization bond financing

    (1,417,245 )     (616,071 )

Payments on capital leases

    —         (12 )

Proceeds from sale of common stock through employee stock plans

    4,354       3,226  

Proceeds from preferred stock offering of consolidated subsidiary

    —         84,094  

Payment by consolidated subsidiary of preferred stock dividends

    (7,484 )     (1,160 )
   


 


Net cash provided by financing activities

    2,438,280       2,533,866  

Effect of exchange rate changes on cash

    1,466       —    
   


 


Net (decrease) increase in cash and cash equivalents

    (13,630 )     46,350  

Beginning balance, cash and cash equivalents

    35,155       27,119  
   


 


Ending balance, cash and cash equivalents

  $ 21,525     $ 73,469  
   


 


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

               

Cash paid during the period for:

               

Interest

  $ 212,664     $ 74,772  

Income taxes

  $ 45,864     $ 78,194  

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

               

Transfer of mortgage loans held for sale to mortgage loans held for investment

  $ 3,233,710     $ 2,570,380  

Transfer of mortgage loans held for sale to real estate owned, net of reserve, included in other assets

  $ 12,318     $ 4,721  

Transfer of mortgage loans held for investment to real estate owned, net of reserve, included in other assets

  $ 5,537     $ —    

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Accredited Home Lenders Holding Co. (“AHLHC”), a Delaware corporation, its wholly owned subsidiaries, Accredited Home Lenders, Inc. (“AHL”) and Accredited Home Lenders Canada, Inc., and AHL’s subsidiary Accredited Mortgage Loan REIT Trust (the “REIT”) (collectively referred to as “Accredited”).

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. All intercompany balances and transactions are eliminated in consolidation. The unaudited consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in AHLHC’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

Accredited engages in the business of originating, financing, securitizing, servicing and selling non-prime mortgage loans secured by residential real estate. Accredited focuses on borrowers who may not meet conforming underwriting guidelines because of higher loan-to-value ratios, the nature or absence of income documentation, limited credit histories, high levels of consumer debt, or past credit difficulties. Accredited originates loans primarily based upon the borrower’s willingness and ability to repay the loan and the adequacy of the collateral.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates and assumptions included in our consolidated financial statements relate to the provision for loan losses, hedging policies and income taxes.

 

Cash and Cash Equivalents

 

For purposes of financial statement presentation, Accredited considers all liquid investments with an original maturity of three months or less to be cash equivalents. All liquid assets with an original maturity of three months or less which are not readily available for use, including cash deposits, are classified as restricted cash.

 

Mortgage Banking Activities

 

Accredited originates, finances, securitizes, services and sells mortgage loans secured by residential real estate. Accredited recognizes interest income on loans held for sale and investment from the time that it originates the loan until the time the loans are sold. Interest income is also recognized over the life of the loans that Accredited has securitized in structures that require financing treatment. Gains on sale of loans are

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

recognized upon the sale of loans for a premium to various third-party investors under purchase and sale agreements. Loan sales may be either on a servicing retained or released basis. Loan servicing income represents fees from interim servicing for whole loan buyers, and ancillary servicing revenue for loans that Accredited securitizes net of external servicing costs and amortization of mortgage servicing rights. We do not recognize loan servicing income on our mortgage loans held for investment.

 

In the ordinary course of business, an investor may request that Accredited refund a portion of the premium paid on the sale of mortgage loans if a loan is prepaid in full within a certain amount of time from the date of sale. Accredited records a reserve for estimated premium recapture on loans sold, which is charged to gain on sale of loans.

 

Mortgage Loans Held for Sale

 

Mortgage loans held for sale are carried at the lower of aggregate cost (including hedge basis adjustments) or market. Market is determined by current investor commitments or, in the absence of such commitments, upon current investor commitments for loans of similar credit quality. Market valuation reserves have been provided on certain non-performing loans and other loans held for sale based upon Accredited’s estimate of probable losses, generally based on Accredited’s loss history for such loans. Valuation adjustments are charged against operations.

 

Gains or losses resulting from loan sales are recognized at the time of sale, based on the difference between the net sales proceeds and the book value of the loans sold. During the three months ended September 30, 2005 and 2004, Accredited sold $3.0 billion and $2.3 billion, respectively, of loans with mortgage servicing rights released. During the nine months ended September 30, 2005 and 2004, Accredited sold $7.9 billion and $5.8 billion, respectively, of loans with mortgage servicing rights released.

 

Mortgage Loans Held for Investment and Securitization Bond Financing

 

Mortgage loans held for investment include loans that Accredited has securitized in structures that require financing treatment as well as mortgage loans held for a scheduled securitization. During each of the three-month periods ended September 30, 2005 and 2004, Accredited completed one securitization of mortgage loans totaling $1.1 billion and $1.0 billion, respectively, that were structured as financings under SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilitiesa replacement of FASB Statement No. 125. During each of the nine-month periods ended September 30, 2005 and 2004, Accredited completed securitizations of mortgage loans totaling $3.0 billion and $2.2, respectively, that were structured as financings for accounting purposes.

 

These securitizations are structured legally as sales, but for accounting purposes are treated as financings under SFAS No. 140. These securitizations do not meet the qualifying special purpose entity criteria under SFAS No. 140 and related interpretations because after the loans are securitized, the securitization trusts may acquire derivatives relating to beneficial interests retained by Accredited and, Accredited, as servicer, subject to applicable contractual provisions, has discretion, consistent with prudent mortgage servicing practices, to determine whether to sell or work out any loans securitized through the securitization trusts that become troubled. Accordingly, the loans remain on the balance sheet as “loans held for investment”, retained interests are not created, and securitization bond financing replaces the warehouse debt or asset backed commercial paper originally associated with the loans held for investment. Accredited records interest income on loans held for investment and interest expense on the bonds issued in the securitizations over the life of the securitizations. Deferred debt issuance costs and discounts related to the bonds are amortized on a level yield basis over the estimated life of the bonds.

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Accredited periodically evaluates the need for or the adequacy of the allowance for loan losses on its loans held for investment. Provision for loan losses on loans held for investment is made in an amount sufficient to maintain credit loss allowances at a level considered appropriate to cover probable losses in the portfolio. Accredited defines a loan as non-accruing at the time the loan becomes 90 days or more delinquent under its payment terms. Probable losses are determined based on segmenting the portfolio relating to their contractual delinquency status and applying Accredited’s historical loss experience. Accredited also uses other analytical tools to determine the reasonableness of the allowance for loan losses. Loss estimates are reviewed periodically and adjustments are reported in earnings. As these estimates are influenced by factors outside of Accredited’s control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change. Carrying values are written down to fair value when the loan is foreclosed upon or deemed uncollectible.

 

Derivative Financial Instruments

 

As part of Accredited’s interest rate management process, Accredited uses derivative financial instruments such as futures contracts, options contracts, interest rate swap and interest rate cap agreements. It is not Accredited’s policy to use derivatives to speculate on interest rates. In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted, derivative financial instruments are reported on the consolidated balance sheets at their fair value.

 

Fair Value Hedges

 

Accredited designates certain derivative financial instruments as hedge instruments under SFAS No. 133, and at trade date, these instruments and their hedging relationship are identified, designated and documented. For derivative financial instruments designated as hedge instruments, Accredited evaluates the effectiveness of these hedges against the mortgage loans being hedged to ensure that there remains adequate correlation in the hedge relationship. To hedge the effect of interest rate changes on the fair value of mortgage loans held for sale or securitization, Accredited uses derivatives as fair value hedges under SFAS No. 133. Once the hedge relationship is established, the realized and unrealized changes in fair value of both the hedge instrument and mortgage loans are recognized in the period in which the changes occur. Any change in the fair value of mortgage loans held for sale recognized as a result of hedge accounting is reversed at the time Accredited sells the mortgage loans. This results in a correspondingly higher or lower gain on sale revenue at such time. The net amount recorded in the consolidated statements of operations is referred to as hedge ineffectiveness.

 

Cash Flow Hedges

 

During the third quarter of 2004, Accredited implemented the use of cash flow hedging on its securitization debt under SFAS No. 133. Pursuant to SFAS No. 133, hedge instruments have been designated as hedging the exposure to variability of cash flows from our securitization debt attributable to interest rate risk. During the third quarter 2005, Accredited implemented the use of cash flow hedging on its variable rate debt in Canada under SFAS No. 133. Pursuant to SFAS No. 133, hedge instruments have been designated as hedging the exposure to variability of cash flows from our variable rate debt in Canada attributable to interest rates. Cash flow hedge accounting requires that the effective portion of the gain or loss in the fair value of a derivative instrument designated as a hedge be reported as a component of other comprehensive income in stockholders’ equity, and recognized into earnings in the period during which the hedged transaction affects earnings pursuant to SFAS No. 133. At the inception of the hedge and on an ongoing basis, Accredited assesses whether the derivatives used in hedging transactions are highly effective in offsetting changes in cash flows of the hedged items. If it is determined that a derivative is not highly effective as a hedge, Accredited would discontinue the application of cash flow hedge accounting prospectively. In the instance cash flow hedge accounting is discontinued, the

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

derivative will continue to be recorded on the balance sheet at its fair value. Any change in the fair value of a derivative no longer qualifying as an effective hedge is recognized in current period earnings. For terminated hedges or hedges that no longer qualify as effective, the effective portion previously recorded remains in other comprehensive income and continues to be amortized or accreted into earnings with the hedged item. The ineffective portion on the derivative instrument is reported in current earnings as a component of interest expense.

 

For derivative financial instruments not designated as hedge instruments, unrealized changes in fair value are recognized in the period in which the changes occur and realized gains and losses are recognized in the period in which such instruments are settled.

 

Provision for Losses

 

Market valuation adjustments have been recorded on certain nonperforming loans, other loans held for sale and real estate owned. These adjustments are based on Accredited’s estimate of probable losses, calculated using loss severity and loss frequency rate assumptions and are based on the value that Accredited could reasonably expect to obtain from a sale, that is, other than in a forced or liquidation sale. Provision for losses on loans held for investment is recorded in an amount sufficient to maintain the allowance for loan losses at a level considered appropriate to cover probable losses on such loans. Provision for losses also includes net losses on real estate owned. Accredited accrues liabilities associated with loans sold which may be required to be repurchased due to breaches of representations and warranties or early payment defaults. Accredited periodically evaluates the estimates used in calculating expected losses and adjustments are reported in earnings. As these estimates are influenced by factors outside of Accredited’s control and as uncertainty is inherent in these estimates, actual amounts charged-off could differ from amounts recorded.

 

Interest Income

 

Interest income is recorded when earned. Interest income represents the interest earned on mortgage loans held for sale and on mortgage loans held for investment. For loans that are 90 days or more delinquent, Accredited reverses income previously recognized but not collected, and ceases to accrue income until all past-due amounts are collected. In addition, Accredited calculates an effective yield based on the carrying amount of our residual interest in off-balance sheet securitizations and Accredited’s then-current estimates of future cash flows and recognizes accretion income, which is included as a component of interest income. Interest income also includes revenue related to our mortgage loans held for investment (on-balance sheet securitizations), contractually designated as servicing income but classified as interest income for accounting purposes.

 

Escrow and Fiduciary Funds

 

Accredited maintains segregated bank accounts in trust for the benefit of investors for payments on securitized loans and mortgage loans serviced for investors. Accredited also maintains bank accounts for the benefit of borrowers’ property tax and hazard insurance premium payments that are escrowed by borrowers. These bank accounts totaled $120.5 million and $101.9 million at September 30, 2005 and December 31, 2004, respectively, and are excluded from Accredited’s assets and liabilities.

 

Income Taxes

 

Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax basis of assets and liabilities and are measured by applying enacted tax rates and laws to

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

taxable years in which such temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established, if necessary, based on management’s determination of the likelihood of realization of deferred tax assets.

 

Real Estate Owned

 

Real estate acquired in settlement of loans generally results when property collateralizing a loan is foreclosed upon or otherwise acquired by Accredited in satisfaction of the loan. Real estate acquired through foreclosure is carried at lower of cost or its fair value less costs to dispose. Fair value is based on the net amount that Accredited could reasonably expect to receive for the asset in a current sale between a willing buyer and a willing seller, that is, other than in a forced or liquidation sale. Adjustments to the carrying value of real estate owned are made through valuation allowances and charge-offs recognized through a charge to earnings. Legal fees and other direct costs incurred after foreclosure are expensed as incurred. At September 30, 2005 and December 31, 2004, real estate owned amounting to $10.6 million and $6.1 million, net of valuation allowances, respectively, was included in prepaid and other assets.

 

Stock-Based Compensation

 

Accredited currently accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of Accredited’s stock at the date of grant over the grant price.

 

SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value.

 

Accredited has adopted the disclosure only provisions of SFAS No. 123. Had compensation cost for Accredited’s stock-based compensation plans been determined based on the fair value at the grant date for options consistent with the provisions of SFAS No. 123, Accredited’s net income would have been reduced to the pro forma amounts in the following table:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2005

    2004

    2005

    2004

 
     (In thousands, except per share amounts)  

Net income, as reported

   $ 41,291     $ 35,877     $ 112,151     $ 92,677  

Add: Stock-based compensation included in reported net income, net of tax

     16       85       190       164  

Deduct: Stock-based employee compensation expense determined using fair value method, net of tax

     (431 )     (491 )     (2,071 )     (1,473 )
    


 


 


 


Pro forma net income

   $ 40,876     $ 35,471     $ 110,270     $ 91,368  
    


 


 


 


Earnings per share:

                                

Basic—as reported

   $ 1.95     $ 1.75     $ 5.34     $ 4.57  
    


 


 


 


Basic—pro forma

   $ 1.93     $ 1.73     $ 5.25     $ 4.50  
    


 


 


 


Diluted—as reported

   $ 1.87     $ 1.66     $ 5.11     $ 4.31  
    


 


 


 


Diluted—pro forma

   $ 1.85     $ 1.64     $ 5.03     $ 4.25  
    


 


 


 


 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The fair value of each option grant and purchase right is estimated as of the date of the grant using the Black-Scholes option-pricing model. The weighted average risk free rate applied is for a period commensurate with the expected life of the options or purchase rights. Accredited’s historical volatility is used for options or purchase rights where there is sufficient history to correspond with the term of the option or purchase right. Where there is insufficient history due to the limited time that Accredited has been a publicly traded company, Accredited’s volatility is calculated as an average of its own volatility and the mean of its closest competitors’ volatility for the respective periods. The underlying assumptions used to estimate the fair values of options and purchase rights granted are as follows:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
         2005    

        2004    

        2005    

        2004    

 

Weighted average risk free rate for options

     3.88 %     2.97 %     3.52 %     2.36 %

Weighted average expected option life

     2.5 yrs       2.7 yrs       2.7 yrs       2.7 yrs  

Expected stock price volatility for options

     46 %     50 %     45 %     54.5 %

Expected dividend yield

     —         —         —         —    

Weighted average fair value of options granted with an exercise price equal to market price on grant date

   $ 14.13     $ 10.22     $ 14.08     $ 12.70  

 

In December 2004, the Financial Accounting Standards Board issued a revision of SFAS No. 123, Accounting for Stock-Based Compensation, which also supersedes APB 25, Accounting for Stock Issued to Employees. The revised standard eliminates the alternative to use Opinion 25’s intrinsic value method of accounting and eliminates the disclosure only provisions of SFAS No. 123. The compliance date for the revised standard was extended by the Securities and Exchange Commission (the “SEC”) in April 2005. The revised standard applies to all awards granted after December 31, 2005 and requires the recognition of compensation expense in the financial statements for all share-based payment transactions subsequent to that date. The revised standard also requires the prospective recognition of compensation expense in the financial statements for all unvested options after January 1, 2006. Adoption of this standard on January 1, 2006 will have a negative impact on our earnings based on the pro forma data in the table above.

 

Comprehensive Income

 

Other comprehensive net income includes unrealized gains and losses that are excluded from the consolidated Statements of Operations and are reported as a separate component in stockholders’ equity. The unrealized gains and losses include unrealized gains and losses on the effective portion of cash flow hedges and foreign currency translation adjustments.

 

Accumulated other comprehensive income for the nine months ended September 30, 2005 is determined as follows:

 

    

(In thousands)

(Unaudited)


 

Balance at December 31, 2004

   $ 2,042  

Net unrealized gains on cash flow hedges, net of taxes of $11,424

     18,247  

Reclassification adjustment into earnings for realized gain on derivatives, net of taxes of $3,985

     (6,044 )

Foreign currency translation adjustments

     1,885  
    


Balance at September 30, 2005

   $ 16,130  
    


 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Comprehensive income is determined as follows:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2005

    2004

    2005

    2004

 
     (In thousands) (Unaudited)  

Net income

   $ 41,291     $ 35,877     $ 112,151     $ 92,677  

Net unrealized gains or losses on cash flow hedges, net of taxes of $8,027, ($1,240), $11,424 and ($1,240) respectively

     13,180       (1,921 )     18,247       (1,921 )

Reclassification adjustment into earnings for realized gain on derivatives, net of taxes of ($1,535), $0, ($3,985) and $0, respectively

     (2,342 )     —         (6,044 )     —    

Foreign currency translation adjustments

     1,615       —         1,885       —    
    


 


 


 


Total comprehensive income

   $ 53,744     $ 33,956     $ 126,239     $ 90,756  
    


 


 


 


 

Segment Reporting

 

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. These segments should engage in business activities and have discrete financial information available, such as revenue, expenses, and assets. While Accredited’s management monitors originations and sales gains by wholesale and retail channels, it does not record any of the actual financial results other than direct expenses by these groups. In addition, the retail originations have generally been less than 10% of total originations over the past five years. Accordingly, Accredited operates in one reportable operating segment.

 

Reclassifications

 

Certain items in the prior year financial statements have been reclassified to conform to the current year presentation. These reclassifications had no effect on reported net income. We have reclassified $2.9 billion of cash used for the origination of mortgage loans from investing activities to operating activities in the cash flow statement for the period ended September 30, 2004 to conform to the September 30, 2005 presentation.

 

Recently Issued Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board issued a revision of SFAS No. 123, Accounting for Stock-Based Compensation, which also supersedes APB 25, Accounting for Stock Issued to Employees. The revised standard eliminates the alternative to use Opinion 25’s intrinsic value method of accounting and eliminates the disclosure only provisions of SFAS No. 123. The compliance date for the revised standard was extended by the Securities and Exchange Commission (the “SEC”) in April 2005. The revised standard applies to all awards granted after December 31, 2005 and requires the recognition of compensation expense in the financial statements for all share-based payment transactions subsequent to that date. The revised standard also requires the prospective recognition of compensation expense in the financial statements for all unvested options after January 1, 2006. Adoption of this standard on January 1, 2006 will have a negative impact on our earnings based on the pro forma data in the table above.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

2. CONCENTRATIONS OF RISK

 

Significant Customers

 

During the three months ended September 30, 2005, Accredited sold $1.0 billion, $0.7 billion and $0.6 billion in loans to three separate investors, which represented 34%, 25% and 19%, respectively, of total loans sold. During the three months ended September 30, 2004, Accredited sold $0.8 billion, $0.6 billion and $0.5 billion in loans to three separate investors, which represented 34%, 25% and 22%, respectively, of total loans sold.

 

During the nine months ended September 30, 2005, Accredited sold $2.0 billion, $1.8 billion and $1.0 billion in loans to three separate investors, which represented 26%, 22% and 13%, respectively, of total loans sold. During the nine months ended September 30, 2004, Accredited sold $1.8 billion and $1.7 billion in loans to two separate investors, which represented 32% and 30%, respectively, of total loans sold.

 

No other sales to individual investors accounted for more than 10% of total loans sold during the three and nine months ended September 30, 2005 and 2004.

 

Credit Repurchase Risk

 

Accredited’s sales of mortgage loans are subject to standard mortgage industry representations and warranties, material violations of which may require Accredited to repurchase one or more mortgage loans. Additionally, certain whole loan sale contracts include provisions requiring Accredited to repurchase a loan if a borrower fails to make one or more of the first loan payments due on the loan. During the three months ended September 30, 2005 and 2004 loans repurchased totaled $21.3 million and $8.3 million, respectively, and during the nine months ended September 30, 2005 and 2004 loans repurchased totaled $55.3 million and $21.7 million, respectively, pursuant to these provisions. The increase in repurchase activity results primarily from a modification to our typical sales agreement requiring our buyers to notify us promptly of their intent to exercise their repurchase right coupled with a more diligent review of loan payment performance on the part of our buyers. While we are unable to accurately predict the future level of repurchase activity, we expect repurchases to stabilize at current levels. At September 30, 2005 and December 31, 2004, the reserve for potential future repurchase losses totaled $6.8 million and $5.1 million, respectively.

 

Geographic Concentration

 

Properties securing the mortgage loans in Accredited’s servicing portfolio (loans held for sale, loans held for investment and off-balance sheet securitizations), including loans subserviced, are geographically dispersed throughout the United States and, to a much lesser extent, in Canada. At September 30, 2005, 23% and 10% of the unpaid principal balance of mortgage loans in Accredited’s servicing portfolio were secured by properties located in California and Florida, respectively. At September 30, 2004, 33% of the unpaid principal balance of mortgage loans in Accredited’s servicing portfolio were secured by properties located in California. The remaining properties securing mortgage loans serviced did not exceed 10% in any other state at September 30, 2005 and 2004.

 

Loan originations are geographically dispersed throughout the United States and, to a much lesser extent, in Canada. During the three months ended September 30, 2005, 18% and 11% of loans originated were collateralized by properties located in California and Florida, respectively. During the three months ended September 30, 2004, 28% and 7% of loans originated were collateralized by properties located in California and Florida, respectively. During the nine months ended September 30, 2005, 20% and 11% of loans originated were

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

collateralized by properties located in California and Florida, respectively. During the nine months ended September 30, 2004, 29% and 8% of loans originated were collateralized by properties located in California and Florida, respectively. The remaining originations did not exceed 10% in any other state during the three and nine months ended September 30, 2005 and 2004.

 

An overall decline in the economy or the residential real estate market, or the occurrence of a natural disaster that is not covered by standard homeowners’ insurance policies, such as an earthquake, hurricane or wildfire, could decrease the value of mortgaged properties. This, in turn, would increase the risk of delinquency, default or foreclosure on mortgage loans in our portfolio and restrict our ability to originate, sell, or securitize mortgage loans, which would significantly harm our business, financial condition and liquidity. While we have not completed our assessment of potential losses stemming from the recent hurricanes in the southeastern United States, we do not expect the resulting losses to have a material adverse impact on our business, financial condition, liquidity or results of operations.

 

3. MORTGAGE LOANS

 

Mortgage loans held for sale—Mortgage loans held for sale were as follows:

 

     September 30,
2005


   

December 31,

2004


 
     (In thousands)  
     (Unaudited)        

Mortgage loans held for sale—principal balance

   $ 2,370,788     $ 1,805,620  

Basis adjustment for fair value hedge accounting

     882       5  

Net deferred origination costs (fees)

     (1,551 )     1,574  

Market reserve

     (20,734 )     (17,065 )
    


 


Mortgage loans held for sale, net

   $ 2,349,385     $ 1,790,134  
    


 


 

Mortgage loans held for investment—Mortgage loans held for investment were as follows:

 

     September 30,
2005


   

December 31,

2004


 
     (In thousands)  
     (Unaudited)        

Mortgage loans held for investment—principal balance

   $ 5,874,947     $ 4,101,982  

Mortgage loans held for securitization

     810,833       642,451  

Basis adjustment for fair value hedge accounting

     (579 )     12,365  

Net deferred origination fees

     (8,034 )     (5,902 )

Allowance for loan losses

     (95,728 )     (60,138 )
    


 


Mortgage loans held for investment, net

   $ 6,581,439     $ 4,690,758  
    


 


 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Reserves for losses—Activity in the reserves was as follows:

 

    

Balance at

Beginning

of Period


  

Provision

for Losses


  

Chargeoffs,

net


    Transfers

   

Balance at

End of

Period


     (In thousands) (Unaudited)

Three Months Ended September 30,:

                                    

2005:

                                    

Mortgage loans held for sale

   $ 19,119    $ 2,768    $ (1,153 )   $ —       $ 20,734

Mortgage loans held for investment

     84,228      12,694      (1,194 )     —         95,728

Real estate owned

     7,010      2,733      (1,784 )     —         7,959

Reserve for repurchases included in accrued liabilities

     6,328      973      (533 )     —         6,768
    

  

  


 


 

Total

   $ 116,685    $ 19,168    $ (4,664 )   $ —       $ 131,189
    

  

  


 


 

2004:

                                    

Mortgage loans held for sale

   $ 13,699    $ 1,281    $ (608 )   $       $ 14,372

Mortgage loans held for investment

     39,077      11,806      (557 )     (677 )     49,649

Real estate owned

     2,174      853      (1,017 )     677       2,687

Reserve for repurchases included in accrued liabilities

     5,468      476      (180 )     —         5,764
    

  

  


 


 

Total

   $ 60,418    $ 14,416    $ (2,362 )   $ —       $ 72,472
    

  

  


 


 

     Balance at
Beginning
of Period


   Provision
for Losses


   Chargeoffs,
net


    Transfers

    Balance at
End of
Period


     (In thousands) (Unaudited)

Nine Months Ended September 30,:

                                    

2005:

                                    

Mortgage loans held for sale

   $ 17,065    $ 7,111    $ (3,442 )   $ —       $ 20,734

Mortgage loans held for investment

     60,138      38,681      (3,091 )     —         95,728

Real estate owned

     4,405      7,696      (4,142 )     —         7,959

Reserve for repurchases included in accrued liabilities

     5,126      2,977      (1,335 )     —         6,768
    

  

  


 


 

Total

   $ 86,734    $ 56,465    $ (12,010 )   $ —       $ 131,189
    

  

  


 


 

2004:

                                    

Mortgage loans held for sale

   $ 9,698    $ 4,943    $ (1,811 )   $ 1,542     $ 14,372

Mortgage loans held for investment

     21,762      32,497      (1,060 )     (3,550 )     49,649

Real estate owned

     2,328      1,456      (3,105 )     2,008       2,687

Reserve for repurchases included in accrued liabilities

     5,444      812      (492 )     —         5,764
    

  

  


 


 

Total

   $ 39,232    $ 39,708    $ (6,468 )   $ —       $ 72,472
    

  

  


 


 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following tables summarize the historical loss and delinquency amounts for the serviced portfolio, including mortgage loans and real estate owned:

 

     At September 30, 2005

   At December 31, 2004

     Total
Principal
Amount


   Delinquent
Principal
Over 90
Days


   Total
Principal
Amount


   Delinquent
Principal
Over 90
Days


     (In thousands)
     (Unaudited)          

Mortgage loans held for sale(1)

   $ 2,370,788    $ 18,176    $ 1,805,620    $ 18,556

Mortgage loans held for investment

     6,685,780      49,082      4,744,433      22,634

Mortgage loans sold servicing retained

     101,157      8,638      171,002      16,493

Real estate owned

     18,508      18,508      10,526      10,526
    

  

  

  

Total serviced portfolio

   $ 9,176,233    $ 94,404    $ 6,731,581    $ 68,209
    

  

  

  

 

     Credit Losses, net of recoveries

     Three Months Ended
September 30,


   Nine Months Ended
September 30,


         2005    

       2004    

       2005    

       2004    

     (In thousands) (Unaudited)

Mortgage loans held for sale(1)

   $ 1,686    $ 788    $ 4,777    $ 2,303

Mortgage loans held for investment

     1,194      557      3,091      1,060

Real estate owned

     1,784      1,017      4,142      3,105
    

  

  

  

Total

   $ 4,664    $ 2,362    $ 12,010    $ 6,468
    

  

  

  


(1) Includes loans repurchased.

 

4. OTHER RECEIVABLES

 

Other receivables were as follows:

 

    

September 30,

2005


   December 31,
2004


     (In thousands)
     (Unaudited)     

Deposit in derivative margin account

   $ 45,003    $ 15,457

Accrued interest on mortgage loans

     39,340      28,852

Corporate, escrow and servicing advances

     10,365      10,491

Other

     3,718      2,858
    

  

Total

   $ 98,426    $ 57,658
    

  

 

5. DERIVATIVE FINANCIAL INSTRUMENTS

 

Fair Value Hedges

 

Accredited uses hedge accounting in accordance with SFAS No. 133 for certain derivative financial instruments used to hedge its mortgage loans held for sale and mortgage loans held for investment. At September 30, 2005 and December 31, 2004 fair value hedge basis adjustments of $881,940 and $5,000, respectively, are included as an addition to mortgage loans held for sale related to the $1.1 billion and $1.6 billion, respectively, of such loans designated as the hedged assets. Hedge ineffectiveness associated with these

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

fair value hedges of ($57.6 thousand) and $0.3 million was recorded in earnings during the three and nine months ended September 30, 2005, respectively, and is included as an addition to gain on sale of loans in the consolidated statements of operations.

 

At September 30, 2005 and December 31, 2004, fair value hedge basis adjustments of ($0.6 million) and $12.4 million, respectively, are included in loans held for investment. No hedge ineffectiveness associated with these fair value hedges was recorded in earnings during the three and nine months ended September 30, 2005, respectively, as Accredited has discontinued fair value hedge accounting on loans held for investment.

 

Cash Flow Hedges

 

During the third quarter of 2004, Accredited implemented the use of cash flow hedge accounting on its securitization debt under SFAS No. 133. Previously Accredited had been using fair value hedge accounting, but elected to add this alternative method to accommodate elements of the REIT requirements. The net impact on earnings is not expected to be materially different under the two methods. Effective unrealized gains, net of effective unrealized losses, associated with cash flow hedges of $21.2 million, reduced by related tax expense of $8.0 million, were recorded in other comprehensive income during the three months ended September 30, 2005, which is reported as a component of stockholders’ equity. Effective unrealized gains, net of effective unrealized losses, associated with cash flow hedges of $29.7 million, reduced by related tax expense of $11.4 million, were recorded in other comprehensive income during the nine months ended September 30, 2005, which is reported as a component of stockholders’ equity. These contracts settle on various dates ranging from December 2005 to June 2014. A total of $19.5 million in net effective gains before taxes, included in other comprehensive income at September 30, 2005, is expected to be recognized in earnings during the next twelve months. Hedge ineffectiveness associated with cash flow hedges of $1.5 million and $2.0 million was recorded in earnings during the three and nine months ended September 30, 2005, respectively, and is included as a component of interest expense in the consolidated statements of operations.

 

During the third quarter 2005, Accredited implemented the use of cash flow hedge accounting on its variable rate debt in Canada under SFAS No. 133.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Futures Contracts, Options Contracts, Interest Rate Swap and Cap Agreements and Margin Accounts

 

At September 30, 2005 Accredited had outstanding futures contracts, options contracts, interest rate swap agreements and interest rate cap agreements that were designated as hedge instruments. At September 30, 2005 and December 31, 2004, the fair value of the margin account balances required for these derivatives and the futures contracts was $45.0 million and $15.5 million, respectively, and is included in other receivables. At September 30, 2005, the fair value of the options contracts, interest rate swap and cap agreements was $3.9 million, $12.7 million and $0.1 million, respectively, and is included in other assets. At December 31, 2004, the fair value of the options contracts, interest rate swap and cap agreements was $1.0 million, $1.8 million and $0.3 million, respectively. The total net liquidation value at September 30, 2005 and December 31, 2004 of these derivatives and related margin account balances was $61.8 million and $18.6 million, respectively. A gain of $0.3 million and a gain of $2.0 million on derivative instruments not designated for SFAS No. 133 hedge accounting treatment was recorded in interest expense on the statement of operations during the three and nine months ended September 30, 2005, respectively, relating to the gain in value of interest rate cap agreements and interest rate swap agreements. The change in the fair value of derivative financial instruments and the related hedged asset recorded in the statement of operations was as follows:

 

     Interest
Income


    Interest
Expense


    Gain on
Sale


    Other
Income


    Total

 
     (In thousands) (Unaudited)  

Three months ended September 30,

                                        

2005:

                                        

Net unrealized loss

   $ (1,046 )   $ (3,970 )   $ (5,464 )   $ —       $ (10,480 )

Net realized gain

     —         9,372       13,334       —         22,706  
    


 


 


 


 


Total

   $ (1,046 )   $ 5,402     $ 7,870     $ —       $ 12,226  
    


 


 


 


 


2004:

                                        

Net unrealized gain (loss)

   $ (1,859 )   $ (204 )   $ 23,834     $ 9     $ 21,780  

Net realized loss

     (886 )     —         (23,012 )     (157 )     (24,055 )
    


 


 


 


 


Total

   $ (2,745 )   $ (204 )   $ 822     $ (148 )   $ (2,275 )
    


 


 


 


 


Nine months ended September 30,

                                        

2005:

                                        

Net unrealized loss

   $ (4,506 )   $ (11,303 )   $ (2,690 )   $ —       $ (18,499 )

Net realized gain

     —         24,665       16,324       46       41,035  
    


 


 


 


 


Total

   $ (4,506 )   $ 13,362     $ 13,634     $ 46     $ 22,536  
    


 


 


 


 


2004:

                                        

Net unrealized gain (loss)

   $ (4,269 )   $ (204 )   $ 18,925     $ 615     $ 15,067  

Net realized loss

     (3,578 )     —         (17,671 )     (617 )     (21,866 )
    


 


 


 


 


Total

   $ (7,847 )   $ (204 )   $ 1,254     $ (2 )   $ (6,799 )
    


 


 


 


 


 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

6. WAREHOUSE CREDIT FACILITIES

 

Outstanding warehouse credit facilities consist of committed credit lines bearing interest based on One-Month LIBOR plus a spread. The spread over LIBOR varies depending on the mortgage asset class being financed. The interest rates (One-Month LIBOR plus the spread) ranged from 3.44% to 7.34% during the nine months ended September 30, 2005. The warehouse credit facilities are collateralized by the mortgage loans held for sale and certain subordinated securitized bonds. The outstanding warehouse credit facilities consisted of the following:

 

     September 30,
2005


  

December 31,

2004


     (In thousands)
     (Unaudited)     

A $660 million warehouse credit facility expiring December 2006

   $ 482,546    $ 266,436

A $500 million warehouse credit facility expiring January 2006

     367,147      376,290

A $600 million warehouse credit facility expiring December 2005

     336,520      210,979

A $600 million warehouse credit facility expiring January 2006

     288,774      371,213

A $300 million warehouse credit facility expiring November 2005

     285,647      269,020

A $650 million warehouse credit facility expiring July 2006

     228,480      277,280

An $85.4 million warehouse credit facility expiring June 2006

     73,179      —  

A $40 million warehouse credit facility expiring November 2006

     12,701      28,826

A $650 million warehouse credit facility expiring January 2006

     —        404,816
    

  

Total warehouse credit facilities

   $ 2,074,994    $ 2,204,860
    

  

 

At September 30, 2005, Accredited was in compliance with all covenant requirements for each of the facilities. Accredited’s warehouse and other credit facilities contain customary covenants including minimum liquidity, profitability and net worth requirements and limitations on other indebtedness. If Accredited fails to comply with any of these covenants or otherwise defaults under a facility, the lender has the right to terminate the facility and require immediate repayment that may require sale of the collateral at less than optimal terms. In addition, if Accredited defaults under one facility, it would generally trigger a default under Accredited’s other facilities.

 

Accredited anticipates that its borrowings will be repaid from net proceeds from the sale of loans and other assets, cash flows from operations, or from refinancing the borrowings. Accredited believes that it can continue to comply with loan covenants and that other alternative sources of credit are available to Accredited to repay maturing loans if anticipated asset sales are not completed by loan due dates.

 

7. ASSET BACKED COMMERCIAL PAPER

 

During the second quarter of 2005, Accredited issued commercial paper in the form of short-term secured liquidity notes (“SLNs”) with initial maturities ranging from one to 180 days and $40.0 million of subordinated notes maturing in five years. In order to issue the debt, Accredited established a special purpose, bankruptcy remote Delaware statutory trust. The trust entered into agreements with third parties who act as back-up liquidity providers. The SLNs bear interest at customary commercial paper market rates, which vary depending on the prevailing market conditions. The capacity of this facility at September 30, 2005, was $1.0 billion of which $985.3 million was outstanding. For the ninety-two days during the quarter this facility was outstanding, the average borrowings outstanding under this facility were $952.0 million, and the weighted average interest rate was approximately 3.82%. The facility is collateralized by mortgage loans held for sale or securitization and certain restricted cash balances.

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

8. SECURITIZATION BOND FINANCING

 

Securitization bond financing consisted of the following:

 

    

September 30,

2005


    December 31,
2004


 
     (In thousands)  
     (Unaudited)        

Series 2002-1 securitization with a stated maturity date of July 25, 2032 and an interest rate of 4.93% for the fixed portion of the bond and One-Month LIBOR plus 0.32% for the variable rate portion of the bond

   $ 32,384     $ 64,644  

Series 2002-2 securitization with a stated maturity date range of January 25, 2033 through February 25, 2033 and an interest rate of 4.48% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.49% to One-Month LIBOR plus 0.50% for the variable rate portions of the bond

     144,256       221,021  

Series 2003-1 securitization with a stated maturity date of June 25, 2033 and an interest rate of 3.58% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.35% to One-Month LIBOR plus 0.38% for the variable rate portions of the bond

     87,282       147,530  

Series 2003-2 securitization with a stated maturity date of October 25, 2033 and an interest rate of 4.23% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.35% to One-Month LIBOR plus 0.37% for the variable rate portions of the bond

     159,373       251,278  

Series 2003-3 securitization with a stated maturity date of January 25, 2034 and an interest rate of 4.46% for the fixed portion of the bond and One-Month LIBOR plus 0.38% for the variable rate portions of the bond

     225,201       342,386  

Series 2004-1 securitization with a stated maturity date of April 25, 2034 and an interest rate of One-Month LIBOR plus 0.30%

     250,116       384,857  

Series 2004-2 securitization with a stated maturity date of July 25, 2034 and an interest rate range of One-Month LIBOR plus 0.29% to One-Month LIBOR plus 0.30%

     422,332       604,229  

Series 2004-3 securitization with a stated maturity date of October 25, 2034 and an interest rate range of 2.90% to 5.25% for the fixed portions of the bond and a range of One-Month LIBOR plus 0.17% to One-Month LIBOR plus 2.50% for the variable rate portions of the bond

     659,606       928,914  

Series 2004-4 securitization with a stated maturity date of January 25, 2035 and an interest rate of 5.25% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.15% to One-Month LIBOR plus 1.80% for the variable rate portions of the bond

     786,716       1,012,214  

Series 2005-1 securitization with a stated maturity date of April 25, 2035 and an interest rate of range of One-Month LIBOR plus 0.10% to One-Month LIBOR plus 2.50%

     770,928       —    

Series 2005-2 securitization with a stated maturity date of July 25, 2035 and an interest rate of range of One-Month LIBOR plus 0.10% to One-Month LIBOR plus 2.50%

     922,428       —    

Series 2005-3 securitization with a stated maturity date of September 25, 2035 and an interest rate of range of One-Month LIBOR plus 0.10% to One-Month LIBOR plus 1.70%

     1,093,492       —    
    


 


       5,554,114       3,957,073  

Unamortized bond discounts

     (3,766 )     (2,958 )
    


 


Total securitization bond financing, net

   $ 5,550,348     $ 3,954,115  
    


 


 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The bonds are collateralized by loans held for investment with an aggregate outstanding principal balance of $5.7 billion and $4.1 billion as of September 30, 2005 and December 31, 2004, respectively. Unamortized debt issuance costs, included in prepaid and other assets, are $18.4 million and $14.1 million at September 30, 2005 and December 31, 2004, respectively.

 

Amounts collected on the mortgage loans are remitted to the respective trustees, who in turn distribute such amounts each month to the bondholders, together with other amounts received related to the mortgage loans, net of fees payable to Accredited, the trustee and the insurer of the bonds. Any remaining funds after payment of fees and distribution of principal and interest is known as excess interest.

 

The securitization agreements require that a certain level of overcollateralization be maintained for the bonds. A portion of the excess interest may be initially distributed as principal to the bondholders to increase the level of overcollateralization. Once a certain level of overcollateralization has been reached, excess interest is no longer distributed as principal to the bondholders, but, rather, is passed through to Accredited. Should the level of overcollateralization fall below a required level, excess interest will again be paid as principal to the bondholders until the required level has been reached.

 

The securitization agreements provide that if delinquencies or losses on the underlying mortgage loans exceed certain maximums, the required levels of credit enhancement would be increased.

 

Due to the potential for prepayments of mortgage loans, the early distribution of principal to the bondholders and the optional clean-up call, the bonds are not necessarily expected to be outstanding through the stated maturity date set forth above.

 

The following table summarizes the expected repayments relating to the securitization bond financing at September 30, 2005 and are based on anticipated receipts of principal and interest on underlying mortgage loan collateral using historical prepayment speeds:

 

    

(In thousands)

(Unaudited)


 

Three months ending December 31, 2005

   $ 446,869  

Years Ending December 31:

        

2006

     2,093,748  

2007

     1,258,389  

2008

     563,024  

2009

     365,390  

2010

     261,614  

Thereafter

     565,080  

Discount

     (3,766 )
    


Total

   $ 5,550,348  
    


 

9. INCOME TAXES

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The tax effects of significant items comprising Accredited’s net deferred tax (liability) asset were as follows:

 

    

September 30,

2005


    December 31,
2004


 
     (In thousands)  
     (Unaudited)        

Deferred tax assets:

                

Loans held for sale

   $ 17,437     $ 13,071  

Market reserve on loans held for sale

     9,757       8,659  

Loan securitizations

     27,248       16,921  

State taxes

     4,720       4,594  

Other reserves and accruals

     6,529       2,491  
    


 


Total deferred tax assets

     65,691       45,736  
    


 


Deferred tax liabilities:

                

Mortgage-related securities

     (10,833 )     (10,161 )

Investment in real estate investment trust

     (48,326 )     —    

Cash flow hedging

     (8,736 )     (1,325 )
    


 


Total deferred tax liabilities

     (67,895 )     (11,486 )
    


 


Net deferred tax asset

   $ —       $ 34,250  
    


 


Net deferred tax liability

   $ (2,204 )   $ —    
    


 


 

The income tax provision consists of the following:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2005

   2004

    2005

   2004

 
     (In thousands) (Unaudited)  

Current:

                              

Federal

   $ 24,057    $ (1,352 )   $ 40,580    $ 50,432  

State

     4,017      (1,748 )     7,595      11,154  
    

  


 

  


Total current provision

     28,074      (3,100 )     48,175      61,586  
    

  


 

  


Deferred:

                              

Federal

     255      20,345       22,472      (742 )

State

     1,188      5,989       6,570      257  
    

  


 

  


Total deferred provision (benefit)

     1,443      26,334       29,042      (485 )
    

  


 

  


Total provision

   $ 29,517    $ 23,234     $ 77,217    $ 61,101  
    

  


 

  


 

The deferred income tax expense resulted from temporary differences in the recognition of revenues and expenses for tax and financial statement purposes.

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following is a reconciliation of the provision computed using the statutory federal income tax rate to the income tax provision reflected in the statements of operations:

 

     Three Months Ended
September 30,


    Nine Months Ended
September 30,


 
     2005

    2004

    2005

    2004

 
     (In thousands) (Unaudited)  

Federal income tax at statutory rate

   $ 25,656     $ 21,095     $ 68,898     $ 54,228  

State income tax, net of federal effects

     3,383       2,756       9,207       7,417  

REIT dividends on preferred stock

     (873 )     —         (2,619 )     —    

Other

     1,351       (617 )     1,731       (544 )
    


 


 


 


Total provision

   $ 29,517     $ 23,234     $ 77,217     $ 61,101  
    


 


 


 


 

Accredited recorded $0.8 million and $2.9 million, during the three months ended September 30, 2005 and 2004, respectively, and $3.7 million and $5.6 million, during the nine months ended September 30, 2005 and 2004, respectively, as a reduction in income taxes payable for corporate tax deductions arising from the sale by employees of common stock they acquired from employee stock plans prior to the fulfillment of the required tax holding periods for such stock. These benefits have been reflected as additional paid in capital in stockholders’ equity.

 

10. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

 

Accounts payable and accrued liabilities were as follows:

 

    

September 30,

2005


   December 31,
2004


     (In thousands)
     (unaudited)     

Accrued liabilities—payroll

   $ 25,042    $ 20,678

Accrued liabilities—general

     26,550      18,401

Reserve for repurchases and premium recapture

     7,521      7,536
    

  

Total

   $ 59,113    $ 46,615
    

  

 

11. MINORITY INTEREST IN SUBSIDIARY

 

In May 2004, AHL formed a subsidiary, Accredited Mortgage Loan REIT Trust (REIT), for the purpose of acquiring, holding and managing real estate assets. All of the outstanding common shares of the REIT are held by AHL, which in turn is a wholly owned subsidiary of AHLHC. The REIT, in 2004, issued Series A Preferred Shares to outside investors in the aggregate amount of $102.3 million. The Series A Preferred Shares bear a dividend of 9.75% annually.

 

The REIT has elected to be taxed as a real estate investment trust and intends to comply with the applicable provisions of the Internal Revenue Code. Accordingly, the REIT will generally not be subject to federal or state income tax to the extent that its distributions to shareholders satisfy the real estate investment trust requirements and certain asset, income and share ownership tests are met.

 

In December 2004, the REIT’s board of trustees declared dividends on common stock of which $50 million was paid in December 2004 and $5 million was paid in January 2005.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In March, June and September of 2005, the REIT’s board of trustees declared a quarterly cash dividend on the preferred shares at the rate of $0.609375 per share to shareholders of record on March 15, June 15 and September 15, which aggregated approximately $7.5 million for the nine months ended September 30, 2005.

 

AHLHC irrevocably and unconditionally agrees to pay in full to the holders of each share of the REIT’s Series A Preferred Shares, as and when due, regardless of any defense, right of set-off or counterclaim which the REIT or Accredited may have or assert: (i) all accrued and unpaid dividends (whether or not declared) payable on the REIT’s Series A Preferred Shares, (ii) the redemption price (including all accrued and unpaid dividends) payable with respect to any of the REIT’s Series A Preferred Shares redeemed by the REIT and (iii) the liquidation preference, if any, payable with respect to any of the REIT’s Series A Preferred Shares. AHLHC’s guarantee is subordinated in right of payment to AHLHC’s indebtedness, on parity with the most senior class of AHLHC’s preferred stock and senior to AHLHC’s common stock. At September 30, 2005, the aggregate redemption value of the total preferred shares outstanding was $102.3 million. Based on total preferred shares outstanding at December 31, 2004, the REIT’s current annual preferred dividend obligation totals $10.0 million.

 

The preferred shares are reported as minority interest in subsidiary in the consolidated balance sheet.

 

12. EARNINGS PER SHARE

 

Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding and the weighted average number of unissued, vested restricted common stock awards for the period. Diluted earnings per share reflects the potential dilution that could occur if net income were divided by the weighted average number of common shares and unissued, vested restricted common stock awards, plus potential common shares from outstanding stock options and unvested restricted stock awards where the effect of those securities is dilutive. The computations for basic and diluted earnings per share are as follows:

 

     Net Income
(numerator)


   Shares
(denominator)


   Per Share
Amount


     (In thousands, except per share amounts) (Unaudited)

Three Months Ended September 30,:

                  

2005:

                  

Basic earnings per share

   $ 41,291    21,217    $ 1.95
                

Effect of dilutive shares:

                  

Stock options

          610       

Restricted stock

          232       
    

  
      

Diluted earnings per share

   $ 41,291    22,059    $ 1.87
    

  
  

Potentially dilutive stock options not included above since they are antidilutive

          317       
           
      

2004:

                  

Basic earnings per share

   $ 35,877    20,470    $ 1.75
                

Effect of dilutive shares:

                  

Stock options

          963       

Restricted stock

          147       
    

  
      

Diluted earnings per share

   $ 35,877    21,580    $ 1.66
    

  
  

Potentially dilutive stock options not included above since they are antidilutive

          173       
           
      

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

     Net Income
(numerator)


   Shares
(denominator)


   Per Share
Amount


     (In thousands, except per share amounts) (Unaudited)

Nine Months Ended September 30,:

                  

2005:

                  

Basic earnings per share

   $ 112,151    21,017    $ 5.34
                

Effect of dilutive shares:

                  

Stock options

          678       

Restricted stock

          237       
    

  
      

Diluted earnings per share

   $ 112,151    21,932    $ 5.11
    

  
  

Potentially dilutive stock options not included above since they are antidilutive

          272       
           
      

2004:

                  

Basic earnings per share

   $ 92,677    20,287    $ 4.57
                

Effect of dilutive shares:

                  

Stock options

          1,071       

Restricted stock

          158       
    

  
      

Diluted earnings per share

   $ 92,677    21,516    $ 4.31
    

  
  

Potentially dilutive stock options not included above since they are antidilutive

          170       
           
      

 

13. COMMITMENTS AND CONTINGENCIES

 

Accredited is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its borrowers. These financial instruments primarily represent commitments to fund loans. These instruments involve, to varying degrees, elements of interest rate risk and credit risk in excess of the amount recognized in the balance sheet. The credit risk is mitigated by Accredited’s evaluation of the creditworthiness of potential mortgage loan borrowers on a case-by-case basis. Accredited does not guarantee interest rates to potential borrowers when an application is received. Interest rates conditionally approved following the initial underwriting of applications are subject to adjustment if any conditions are not satisfied. Accredited commits to originate loans, in many cases dependent on the borrower’s satisfying various terms and conditions. These commitments totaled $812 million as of September 30, 2005.

 

Commitments to sell loans generally have fixed expiration dates or other termination clauses and may require payment of a commitment or a non-delivery fee.

 

Accredited periodically enters into other loan sale commitments. At September 30, 2005 forward loan sale commitments awaiting settlement amounted to $136.4 million.

 

Accredited’s mortgage banking business is subject to the rules and regulations of the Department of Housing and Urban Development (“HUD”) and state regulatory authorities with respect to originating, processing, selling and servicing mortgage loans. Those rules and regulations require, among other things, that Accredited maintain a minimum net worth of $250,000. Accredited is in compliance with these requirements.

 

From time to time, Accredited enters into certain types of contracts that contingently require Accredited to indemnify parties against third party claims and other obligations customarily indemnified in the ordinary course

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

of Accredited’s business. The terms of such obligations vary and, generally, a maximum obligation is not explicitly stated. Therefore, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, Accredited has not been obligated to make significant payments for these obligations and no liabilities have been recorded for these obligations on its balance sheet as of September 30, 2005.

 

AHLHC irrevocably and unconditionally agrees to pay in full to the holders of each share of the REIT’s Series A Preferred Shares: (i) all accrued and unpaid dividends, (ii) the redemption price and (iii) the liquidation preference. See further discussion under Note 11. Minority Interest in Subsidiary.

 

During 2000, Accredited executed its own securitization structured as a sale of $174.7 million of mortgage loans originated or acquired by Accredited. The senior securities were sold to third parties, and Accredited retained a subordinated residual interest. In May 2005, the residual interest was extinguished by Accredited in a clean-up call and the loans were recorded on our books. As of September 30, 2005 we had sold nearly all of the loans received in the clean-up call. Prior to the clean-up call, Accredited’s receipt of such excess cash flows was delayed to the extent that such securitization provides credit enhancement to the senior security holders by requiring the retention in a reserve account and/or the distribution to the senior security holders, as an accelerated amortization of the principal balance of their securities, of certain amounts otherwise payable to Accredited as the residual interest holder.

 

During 2002, 2001 and 2000, Accredited sold to a third-party investor (and former related party) $75.8 million, $299.8 million and $321.0 million, respectively, of mortgage loans originated or acquired by Accredited. At June 30, 2002, the related party had a beneficial ownership interest in Accredited related to a convertible debt facility that existed at that date. Subsequently, all ownership and beneficial ownership interest were sold in connection with our initial public offering in 2003, ceasing the related party relationship. The loans were sold pursuant to three separate commitments, each for a twelve-month period different from the calendar year. Pursuant to the agreement with the investor, Accredited is entitled to receive payments based upon the amount of excess cash flows generated by Accredited’s sold loans under each commitment. The excess cash flows consist of the interest paid by the obligors of Accredited’s sold loans, less the sum of a specified yield payable to the investor, servicing fees and credit losses on Accredited’s sold loans. In general, if credit losses result in a negative excess cash flow, Accredited is obligated to pay the shortfall to the investor; provided, however, that Accredited is not obligated to reimburse the investor for credit losses in excess of 10% of the aggregate outstanding principal balance of the mortgage loans purchased by the investor under each commitment. The aggregate outstanding principal balance of the mortgage loans purchased by the investor totaled $101.2 million at September 30, 2005. Accredited is also entitled to all prepayment penalties collected, as long as the rate of prepayments stay below certain thresholds. Should the thresholds be exceeded, then Accredited must share the prepayment penalties collected with the investor.

 

Legal Matters—In December 2002, AHL was served with a complaint and motion for class certification in a class action lawsuit, Wratchford et al. v. Accredited Home Lenders, Inc., brought in Madison County, Illinois under the Illinois Consumer Fraud and Deceptive Business Practices Act, the consumer protection statutes of the other states in which AHL does business and the common law of unjust enrichment. The complaint alleges that AHL has a practice of misrepresenting and inflating the amount of fees it pays to third parties in connection with the residential mortgage loans that it funds. The plaintiffs claim to represent a nationwide class consisting of others similarly situated, that is, those who paid AHL to pay, or reimburse AHL’s payments of, third-party fees in connection with residential mortgage loans and never received a refund for the difference between what they paid and what was actually paid to the third party. The plaintiffs are seeking to recover damages on behalf of themselves and the class, in addition to pre-judgment interest, post-judgment interest, and any other relief the court may grant. On January 28, 2005, the court issued an order conditionally certifying (1) a class of Illinois

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

residents with respect to the alleged violation of the Illinois Consumer Fraud and Deceptive Business Practices Act who, since November 19, 1997, paid money to AHL for third-party fees in connection with residential mortgage loans and never received a refund of the difference between the amount they paid to AHL and the amount AHL paid to the third party and (2) a nationwide class of claimants with respect to an unjust enrichment cause of action included in the original complaint who, since November 19, 1997 paid money to AHL for third-party fees in connection with residential mortgage loans and never received a refund of the difference between the amount they paid AHL and the amount AHL paid the third party. The court conditioned its order limiting the statutory consumer fraud act claims to claimants in the State of Illinois on the outcome of a case pending before the Illinois Supreme Court in which one of the issues is the propriety of certifying a nationwide class based on the Illinois Consumer Fraud and Deceptive Business Practices Act. That case has now been decided in a manner favorable to AHL’s position, and, in light of this ruling, AHL has filed with the court a motion for reconsideration of the court’s order granting class certification, or in the alternative, the court’s denial of AHL’s request for leave to take an interlocutory appeal of such order. If AHL’s motion for reconsideration is denied, AHL intends to petition the Illinois Supreme Court for a supervisory order reversing the lower court’s class certification decision. There has not yet been a ruling on the merits of either the plaintiffs’ individual claims or the claims of the class, and the ultimate outcome of this matter and the resulting liability, if any, are not presently determinable. AHL intends to continue to vigorously defend this matter and does not believe it will have a material adverse effect on its business.

 

In January 2004, AHL was served with a complaint, Yturralde v. Accredited Home Lenders, Inc., brought in Sacramento County, California. The named plaintiff is a former commissioned loan officer of AHL, and the complaint alleges that AHL violated California and federal law by misclassifying the plaintiff and other non-exempt employees as exempt employees, failing to pay the plaintiff on an hourly basis and for overtime worked, and failing to properly and accurately record and maintain payroll information. The plaintiff seeks to recover, on behalf of himself and all of our other similarly situated current and former employees, lost wages and benefits, general damages, multiple statutory penalties and interest, attorneys’ fees and costs of suit, and also seeks to enjoin further violations of wage and overtime laws and retaliation against employees who complain about such violations. AHL has been served with eleven substantially similar complaints on behalf of certain other former and current employees, which have been consolidated with the Yturralde action. AHL has appealed the court’s denial of its motion to compel arbitration of the consolidated cases, and a resolution of that appeal is not expected before early 2006. In the meantime, discussions are ongoing between the parties regarding potential settlement or mediation of the claims, and AHL has pursued and effected settlements directly with many current and former employees covered by the allegations of the complaints. A motion to certify a class has not yet been filed, and there has been no ruling on the merits of either the plaintiffs’ individual claims or the claims of the putative class. AHL does not believe these matters will have a material adverse effect on its business, but, at the present time, the ultimate outcome of the litigation and the resulting liability, if any, are not determinable.

 

In June 2005, AHL was served with a complaint, Williams et al. v. Accredited Home Lenders, Inc., brought in United States District Court for the Northern District of Georgia. The two named plaintiffs are former commissioned loan officers of AHL, and the complaint alleges that AHL violated federal law by requiring the plaintiffs to work overtime without compensation. The plaintiffs seek to recover, on behalf of themselves and other similarly situated employees, the allegedly unpaid overtime, liquidated damages, attorneys’ fees and costs of suit. A motion to certify a collective class has not yet been filed, and there has been no ruling on the merits of either the plaintiffs’ individual claims or the claims of the putative class, and the ultimate outcome of this matter and the resulting liability, if any, are not presently determinable. AHL intends to vigorously defend this matter and does not believe it will have a material adverse effect on its business.

 

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ACCREDITED HOME LENDERS HOLDING CO. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In September 2005, AHL and AHLHC were served with a class action complaint, Phillips v. Accredited Home Lenders Holding Company, et al., brought in the United States District Court, Central District of California. The complaint alleges violations of the Fair Credit Reporting Act in connection with prescreened offers of credit made by AHL. The plaintiff seeks to recover, on behalf of herself and similarly situated individuals, damages, pre-judgment interest, declaratory and injunctive relief, and any other relief the court may grant. A motion to certify a class has not yet been filed, and there has been no ruling on the merits of either the plaintiff’s individual claims or the claims of the putative class. AHL and AHLHC intend to vigorously defend this matter. If, however, a class were to be certified and were to prevail on the merits, the potential liability could have a material adverse effect on Accredited. The ultimate outcome of this matter and the resulting liability, if any, are not presently determinable.

 

Accredited has accrued for loss contingencies with respect to the foregoing matters to the extent it is probable that a liability has been occurred at the date of the consolidated financial statements and the amount of the loss can be reasonably estimated. Management does not deem the amount of such accrual to be material.

 

In addition, because the nature of our business involves the collection of numerous accounts, the validity of liens and compliance with various state and federal lending laws, we are subject to various legal proceedings in the ordinary course of business related to foreclosures, bankruptcies, condemnation and quiet title actions, and alleged statutory and regulatory violations. We are also subject to legal proceedings in the ordinary course of business related to employment matters. We do not believe that the resolution of these lawsuits will have a material adverse effect on our financial position or results of operations.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

BALANCE SHEETS

(Dollars in thousands, except par value amounts)

 

    

September 30,

2005


   December 31,
2004


 
     (unaudited)       
ASSETS                

Cash and cash equivalents

   $ 1,101    $ 4,018  

Mortgage loans held for investment, net of reserves of $87,748 and $54,960, respectively

     5,642,847      4,056,306  

Other receivables

     62,445      29,983  

Prepaid expenses and other assets

     40,024      19,924  

Receivable from parent

     176,765      15,214  
    

  


Total assets

   $ 5,923,182    $ 4,125,445  
    

  


LIABILITIES AND STOCKHOLDERS’ EQUITY                

LIABILITIES:

               

Securitization bond financing

   $ 5,550,348    $ 3,954,115  

Accrued interest payable

     5,541      5,206  
    

  


Total liabilities

     5,555,889      3,959,321  
    

  


STOCKHOLDERS’ EQUITY:

               

Preferred stock, $1.00 par value, authorized 200,000,000 shares; 4,093,678 shares designated, issued and outstanding as 9.75% Series A Perpetual Cumulative Preferred Shares with an aggregate liquidation preference of $102,342 at September 30, 2005 and December 31, 2004

     4,094      4,094  

Common stock, $0.01 par value; authorized 100,000,000 shares; 100,000 shares issued and outstanding

     1      1  

Additional paid-in capital

     231,354      163,287  

Other comprehensive income

     22,040      3,348  

Retained earnings (deficit)

     109,804      (4,606 )
    

  


Total stockholders’ equity

     367,293      166,124  
    

  


Total liabilities and stockholders’ equity

   $ 5,923,182    $ 4,125,445  
    

  


 

The accompanying notes are an integral part of these financial statements.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)(Unaudited)

 

   

Three

Months
Ended
September 30,
2005


   

Three

Months
Ended
September 30,
2004


   

Nine

Months
Ended

September 30,
2005


   

Inception
(May 4,

2004) to
September 30,
2004


 

REVENUES:

                               

Interest income (including $1,151, $20, $1,582 and $20 from parent)

  $ 109,369     $ 30,898     $ 288,957     $ 36,512  

Interest expense

    (52,811 )     (10,732 )     (131,939 )     (12,574 )
   


 


 


 


Net interest income

    56,558       20,166       157,018       23,938  

Provision for losses

    (2,578 )     (2,432 )     (12,624 )     (3,642 )
   


 


 


 


Net interest income after provision

    53,980       17,734       144,394       20,296  

Other income

    502       117       859       118  
   


 


 


 


Total net revenues

    54,482       17,851       145,253       20,414  
   


 


 


 


OPERATING EXPENSES:

                               

Management fee assessed by parent

    6,750       2,317       18,247       2,660  

Direct general and administrative expenses

    51       5       112       5  
   


 


 


 


Total operating expenses

    6,801       2,322       18,359       2,665  
   


 


 


 


Net income

    47,681       15,529       126,894       17,749  

Dividends on preferred stock

    (2,495 )     (1,160 )     (7,484 )     (1,160 )
   


 


 


 


Net income available to common stockholders

  $ 45,186     $ 14,369     $ 119,410     $ 16,589  
   


 


 


 


Basic and diluted earnings per common share

  $ 451.86     $ 143.69     $ 1,194.10     $ 165.89  

Weighted average shares outstanding for basic and diluted

    100       100       100       100  

 

The accompanying notes are an integral part of these financial statements.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

STATEMENTS OF CASH FLOWS

(In thousands)(Unaudited)

 

    

Nine Months

Ended

September 30,

2005


   

Inception

(May 4, 2004) to

September 30,

2004


 

CASH FLOWS FROM OPERATING ACTIVITIES:

                

Net income

   $ 126,894     $ 17,749  

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

                

Amortization of net deferred origination costs (fees) on securitized loans

     (2,388 )     1,402  

Amortization of bond discount

     782       —    

Provision for losses

     12,624       3,642  

Unrealized loss on derivatives

     (6,808 )     —    

Adjustment into earnings for gain on derivatives from other comprehensive income

     (10,023 )     (1,140 )

Changes in operating assets and liabilities:

                

Other receivables

     (32,207 )     (8,904 )

Prepaid expenses and other assets

     32,610       (4,435 )

Accrued interest payable

     335       (35 )
    


 


Net cash provided by operating activities

     121,819       8,279  
    


 


CASH FLOWS FROM INVESTING ACTIVITIES:

                

Principal payments received on mortgage loans held for investment

     1,403,252       91,683  
    


 


Net cash provided by investing activities

     1,403,252       91,683  
    


 


CASH FLOWS FROM FINANCING ACTIVITIES:

                

Proceeds from issuance of securitization bond financing, net of fees

     3,003,173       1,662,568  

Payments on securitization bond financing

     (1,417,245 )     (95,492 )

Payments on temporary credit facilities

     (2,942,626 )     (1,721,052 )

Net payments to parent

     (5,000 )     —    

Capital contributions from parent

     3,000       26,000  

Net increase in receivable from parent

     (161,806 )     —    

Payments of preferred stock dividends

     (7,484 )     (1,160 )

Proceeds from preferred stock offering of the consolidated subsidiary

     —         84,094  
    


 


Net cash used in financing activities

     (1,527,988 )     (45,042 )
    


 


Net (decrease) increase in cash and cash equivalents

     (2,917 )     54,920  

Beginning balance cash and cash equivalents

     4,018       —    
    


 


Ending balance cash and cash equivalents

   $ 1,101     $ 54,920  
    


 


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

                

Cash paid during the period for interest

   $ 144,911     $ 8,440  
    


 


SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

                

Transfer of loans held for investment to real estate owned, net of reserves, included in other assets

   $ 5,538     $ —    
    


 


Detail of assets and liabilities contributed from parent:

                

Mortgage loans, net of reserves, deferred origination costs and fair value basis adjustments for hedge accounting

   $ 3,007,919     $ 2,616,151  

Outstanding balances on warehouse credit facilities

     (2,942,626 )     (2,616,151 )
    


 


Net capital contributions from parent

   $ 65,293     $ —    
    


 


 

The accompanying notes are an integral part of these financial statements.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS

 

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

Accredited Mortgage Loan REIT Trust (the “REIT”) was formed on May 4, 2004 as a Maryland real estate investment trust for the purpose of acquiring, holding and managing real estate assets. All of the outstanding common shares of the REIT are held by Accredited Home Lenders, Inc. (“AHL”), a wholly owned subsidiary of Accredited Home Lenders Holding Co., (“Accredited”).

 

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. The unaudited financial statements presented herein should be read in conjunction with the audited financial statements and related notes thereto included in the REIT’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

The REIT engages in the business of acquiring, holding, financing, and securitizing non-prime mortgage loans secured by residential real estate. Generally, the REIT acquires mortgage assets and assumes related funding obligations from AHL, which are accounted for at AHL’s carrying value, as contributions of capital from AHL. These mortgage assets consist primarily of residential mortgage loans, or interests in these mortgage loans, that have been originated or acquired by AHL. AHL focuses on borrowers who may not meet conforming underwriting guidelines because of higher loan-to-value ratios, the nature or absence of income documentation, limited credit histories, high levels of consumer debt, or past credit difficulties. AHL originates loans primarily based upon the borrower’s willingness and ability to repay the loan and the adequacy of the collateral.

 

AHL also provides operating facilities, administration and loan servicing for the REIT. The REIT is, therefore, economically and operationally dependent on AHL, and, as such, the REIT’s results of operation or financial condition may not be indicative of the conditions that would have existed for its results of operations or financial condition if it had operated as an unaffiliated entity.

 

The REIT has elected to be taxed as a real estate investment trust and to comply with the provisions of the Internal Revenue Code with respect thereto. Accordingly, the REIT will generally not be subject to federal or state income tax to the extent that its distributions to shareholders satisfy the real estate investment trust requirements and certain asset, income and share ownership tests are met.

 

Use of Estimates

 

The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates and assumptions included in our consolidated financial statements relate to the provision for loan losses, hedging policies and income taxes.

 

Cash and Cash Equivalents

 

For purposes of financial statement presentation, the REIT considers all liquid investments with an original maturity of three months or less to be cash equivalents. All liquid assets with an original maturity of three months or less which are not readily available for use, including cash deposits, are classified as restricted cash.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

Mortgage Loans Held for Investment and Securitization Bond Financing

 

Mortgage loans held for investment include loans that the REIT has securitized in structures that require financing treatment. During the three and nine months ended September 30, 2005, the REIT completed one and three securitizations of mortgage loans totaling $1.1 billion and $3.0 billion, respectively, structured as financings under SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilitiesa replacement of FASB Statement No. 125.

 

The securitizations are structured legally as sales, but for accounting purposes are treated as financings under SFAS No. 140. The securitizations do not meet the qualifying special purpose entity criteria under SFAS No. 140 and related interpretations because after the loans are securitized, the securitization trusts may acquire derivatives relating to beneficial interests retained by the REIT and, AHL, as servicer, subject to applicable contractual provisions, has discretion, consistent with prudent mortgage servicing practices, to determine whether to sell or work out any loans securitized through the securitization trusts that become troubled. Accordingly, the loans remain on the balance sheet as “loans held for investment”, retained interests are not created for accounting purposes, and securitization bond financing replaces the warehouse debt originally associated with the loans held for investment. The REIT records interest income on loans held for investment and interest expense on the bonds issued in the securitizations over the life of the securitizations. Deferred debt issuance costs and discounts related to the bonds are amortized on a level yield basis over the estimated life of the bonds.

 

The REIT periodically evaluates the need for or the adequacy of the allowance for loan losses on its mortgage loans held for investment. Provision for loan losses on mortgage loans held for investment is made in an amount sufficient to maintain credit loss allowances at a level considered appropriate to cover probable losses in the portfolio. The REIT defines a loan as non-accruing at the time the loan becomes 90 days or more delinquent under its payment terms. Probable losses are determined based on segmenting the portfolio relating to their contractual delinquency status and applying the REIT’s and AHL’s historical loss experience. The REIT also uses other analytical tools to determine the reasonableness of the allowance for loan losses. Loss estimates are reviewed periodically and adjustments are reported in earnings. As these estimates are influenced by factors outside of the REIT’s control, there is uncertainty inherent in these estimates, making it reasonably possible that they could change. Carrying values are written down to fair value when the loan is foreclosed upon or deemed uncollectible.

 

Derivative Financial Instruments

 

As part of the REIT’s interest rate management process, the REIT uses derivative financial instruments such as Eurodollar futures and options. In connection with some of the securitizations structured as financings, the REIT entered into interest rate cap agreements. In connection with four of the securitizations structured as financings, the REIT entered into interest rate swap agreements. It is not the REIT’s policy to use derivatives to speculate on interest rates. In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted, derivative financial instruments are reported on the balance sheet at fair value.

 

Fair Value Hedges

 

The REIT designates certain derivative financial instruments as hedge instruments under SFAS No. 133, and, at trade date, these instruments and their hedging relationship are identified, designated and documented. The REIT has implemented fair value hedge accounting on its mortgage loans held for investment, whereby certain derivatives are designated as a hedge of the fair value of mortgage loans held for investment. This process includes linking derivatives to specific assets or liabilities on the balance sheet. The REIT also assesses, both at

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

the hedge’s inception and on an ongoing basis, whether the derivatives used in hedge transactions are highly effective in offsetting changes in fair values of hedged items. Changes in the fair value of such derivative instruments and changes in the fair value of the hedged assets, which are determined to be effective, are recorded as a component of interest income in the period of change. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the REIT discontinues hedge accounting. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective hedge, the derivative will continue to be recorded on the balance sheet at its fair value. For terminated hedges or hedges no longer qualifying as effective, the formerly hedged asset will no longer be adjusted for changes in fair value and any previously recorded adjustment to the hedged asset will be included in the carrying basis. These amounts will be included in results of operations at the time of disposition of the asset. Should the hedge prove to be perfectly effective, the current period net impact to earnings would be minimal. Accordingly, the net amount recorded in the statement of operations relating to fair value hedge accounting is referred to as hedge ineffectiveness.

 

Cash Flow Hedges

 

During the third quarter of 2004, the REIT implemented the use of cash flow hedging on its securitization debt under SFAS No. 133. Pursuant to SFAS No. 133 hedge instruments have been designated as hedging the exposure to variability of cash flows from our securitization debt attributable to interest rate risk. Cash flow hedge accounting requires that the effective portion of the gain or loss in the fair value of a derivative instrument designated as a hedge be reported as a component of other comprehensive income in stockholders’ equity, and recognized into earnings in the period during which the hedged transaction affects earnings pursuant to SFAS No. 133. At the inception of the hedge and on an ongoing basis, the REIT assesses whether the derivatives used in hedging transactions are highly effective in offsetting changes in cash flows of the hedged items. When it is determined that a derivative is not highly effective as a hedge, the REIT discontinues cash flow hedge accounting prospectively. In the instance cash flow hedge accounting is discontinued, the derivative will continue to be recorded on the balance sheet at its fair value. Any change in the fair value of a derivative no longer qualifying as an effective hedge is recognized in current period earnings. For terminated hedges or hedges that no longer qualify as effective, the effective portion previously recorded remains in other comprehensive income and continues to be amortized or accreted into earnings with the hedged item. The ineffective portion on the derivative instrument is reported in current earnings as a component of interest expense.

 

For derivative financial instruments not designated as hedge instruments, unrealized changes in fair value are recognized in the period in which the changes occur and realized gains and losses are recognized in the period when such instruments are settled.

 

Provision for Losses

 

Provision for losses on loans held for investment is recorded in an amount sufficient to maintain the allowance for loan losses at a level considered appropriate to cover probable losses on such loans. Market valuation adjustments have been recorded on real estate owned. These adjustments are based on the REIT’s and AHL’s estimate of probable losses, calculated using loss frequency and loss severity rate assumptions and are based on the value that the REIT could reasonably expect to obtain from a sale, that is, other than in a forced or liquidation sale. Provision for losses also includes net losses on real estate owned. The REIT periodically evaluates the estimates used in calculating expected losses and adjustments are reported in earnings. As these estimates are influenced by factors outside of the REIT’s control and as uncertainty is inherent in these estimates, actual amounts charged-off could differ from amounts recorded.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

Interest Income

 

Interest income is recorded when earned. Interest income represents the interest earned on loans held for investment. The REIT does not accrue interest on loans that are 90 days or more delinquent.

 

Income Taxes

 

The REIT has elected to be subject to taxation as a real estate investment trust under the Internal Revenue Code of 1986. As a result, the REIT will generally not be subject to federal or state income tax to the extent that the REIT distributes its earnings to its shareholders and maintains its qualification as a real estate investment trust.

 

Real Estate Owned

 

Real estate acquired in settlement of loans generally results when property collateralizing a loan is foreclosed upon or otherwise acquired by AHL, as our servicer, in satisfaction of the loan. Real estate acquired through foreclosure is carried at fair value less estimated costs to dispose. Fair value is based on the net amount that the REIT could reasonably expect to receive for the asset in a current sale between a willing buyer and a willing seller, that is, other than in a forced or liquidation sale. Adjustments to the carrying value of real estate owned are made through valuation allowances and charge-offs recognized through a charge to earnings. Legal fees and other direct costs incurred after foreclosure are expensed as incurred. At September 30, 2005 and December 31, 2004, real estate owned amounting to $5.8 million and $2.7 million, respectively, net of valuation allowances, is included in other assets.

 

Comprehensive Income

 

Other comprehensive income includes unrealized gains and losses that are excluded from the statement of operations and are reported as a separate component in stockholders’ equity. The unrealized gains and losses include unrealized gains and losses on the effective portion of cash flow hedges.

 

Accumulated other comprehensive income for the nine months ended September 30, 2005 is determined as follows:

 

     (In thousands)
(Unaudited)


 

Balance at December 31, 2004

   $ 3,348  

Net unrealized gains on cash flow hedges

     28,715  

Reclassification adjustment into earnings for realized gain on derivatives

     (10,023 )
    


Balance at September 30, 2005

   $ 22,040  
    


 

Comprehensive income is determined as follows:

 

    

Three Months

Ended

September 30,

2005


   

Three Months

Ended

September 30,

2004


   

Nine Months

Ended

September 30,

2005


   

Inception

(May 4, 2004) to

September 30,

2004


 
     (In thousands) (Unaudited)  

Net income

   $ 47,681     $ 15,529     $ 126,894     $ 17,749  

Net unrealized gains or losses on cash flow hedges

     20,250       (1,728 )     28,715       (1,728 )

Reclassification adjustment into earnings for realized gain on derivatives

     (3,871 )     —         (10,023 )     —    
    


 


 


 


Total comprehensive income

   $ 64,060     $ 13,801     $ 145,586     $ 16,021  
    


 


 


 


 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

2. CONCENTRATIONS OF RISK

 

Geographic Concentration

 

Properties securing mortgage loans held for investment are geographically dispersed throughout the United States. At September 30, 2005, 25% and 11% of the unpaid principal balance of mortgage loans held for investment were secured by properties located in California and Florida, respectively. The remaining properties securing mortgage loans did not exceed 10% in any other state at September 30, 2005.

 

An overall decline in the economy or the residential real estate market, or the occurrence of a natural disaster that is not covered by standard homeowners’ insurance policies, such as an earthquake, hurricane or wildfire, could decrease the value of mortgaged properties. This, in turn, would increase the risk of delinquency, default or foreclosure on mortgage loans in our portfolio. This could restrict our and AHL’s ability to originate, sell, or securitize mortgage loans, and significantly harm our business, financial condition, liquidity and results of operations. While we have not completed our assessment of potential losses stemming from the recent hurricanes in the southeastern United States, we do not expect the resulting losses to have a material adverse impact on our business, financial condition, liquidity or results of operations.

 

3. MORTGAGE LOANS

 

Mortgage loans held for investment—Mortgage loans held for investment were as follows:

 

     September 30,
2005


    December 31,
2004


 
     (In thousands)  
     (Unaudited)        

Loans held for investment—principal balance

   $ 5,734,732     $ 4,101,982  

Basis adjustment for fair value hedge accounting

     2,048       13,741  

Net deferred origination fees

     (6,185 )     (4,457 )

Allowance for loan losses

     (87,748 )     (54,960 )
    


 


Loans held for investment, net

   $ 5,642,847     $ 4,056,306  
    


 


 

Reserves for losses—Activity in the reserves was as follows:

 

   

Balance at

Beginning

of Period


 

Contributions

from Parent


 

Provision

for Losses


 

Chargeoffs,

net


   

Balance at End

of Period


    (In thousands) (Unaudited)

Three Months Ended September 30, 2005:

                               

Mortgage loans held for investment

  $ 78,140   $ 9,685   $ 1,164   $ (1,241 )   $ 87,748

Real estate owned

    2,995     —       1,414     —         4,409
   

 

 

 


 

Total

  $ 81,135   $ 9,685   $ 2,578   $ (1,241 )   $ 92,157
   

 

 

 


 

Three Months Ended September 30, 2004:

                               

Mortgage loans held for investment

  $ 15,658   $ 16,861   $ 2,432   $ (613 )   $ 34,338

Real estate owned

    —       —       —       —         —  
   

 

 

 


 

Total

  $ 15,658   $ 16,861   $ 2,432   $ (613 )   $ 34,338
   

 

 

 


 

Nine Months Ended September 30, 2005:

                               

Mortgage loans held for investment

  $ 54,960   $ 25,682   $ 10,243   $ (3,137 )   $ 87,748

Real estate owned

    2,028     —       2,381     —         4,409
   

 

 

 


 

Total

  $ 56,988   $ 25,682   $ 12,624   $ (3,137 )   $ 92,157
   

 

 

 


 

Inception (May 4, 2004) to September 30, 2004:

                               

Mortgage loans held for investment

  $ —     $ 31,309   $ 3,642   $ (613 )   $ 34,338

Real estate owned

    —       —       —       —         —  
   

 

 

 


 

Total

  $     $ 31,309   $ 3,642   $ (613 )   $ 34,338
   

 

 

 


 

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

The following table summarizes the loss and delinquency amounts for mortgage loans and real estate owned:

 

     At September 30, 2005

   At December 31, 2004

     Total
Principal
Amount


   Delinquent
Principal
Over 90
Days


   Total
Principal
Amount


   Delinquent
Principal
Over 90
Days


     (In thousands)
     (Unaudited)          

Mortgage loans held for investment

   $ 5,734,732    $ 49,082    $ 4,101,982    $ 22,634

Real estate owned

     10,254      10,254      4,716      4,716
    

  

  

  

Total

   $ 5,744,986    $ 59,336    $ 4,106,698    $ 27,350
    

  

  

  

 

     Credit Losses, net of recoveries

    

Three Months

Ended

September 30,

2005


  

Three Months

Ended

September 30,

2004


  

Nine Months

Ended

September 30,

2005


  

Inception
(May 4, 2004) to

September 30,

2004


     (In thousands) (Unaudited)

Mortgage loans held for investment

   $ 1,241    $ 613    $ 3,137    $ 613

Real estate owned

     —        —        —        —  
    

  

  

  

Total

   $ 1,241    $ 613    $ 3,137    $ 613
    

  

  

  

 

4. OTHER RECEIVABLES

 

Other receivables were as follows:

 

    

September 30,

2005


   December 31,
2004


     (In thousands)
     (Unaudited)     

Accrued interest on mortgage loans

   $ 30,502    $ 22,039

Deposit in derivative margin account

     31,943      6,361

Other

     —        1,583
    

  

Total

   $ 62,445    $ 29,983
    

  

 

5. DERIVATIVE FINANCIAL INSTRUMENTS

 

Fair Value Hedges

 

The REIT uses hedge accounting as defined by SFAS No. 133 for certain derivative financial instruments used to hedge its loans held for investment. At September 30, 2005 and December 31, 2004, fair value hedge basis adjustments of $2.0 million and $13.7 million are included as additions to loans held for investment. No hedge ineffectiveness associated with fair value hedges was recorded in earnings during the three or nine months ended September 30, 2005 or for the three months and the period from inception (May 4, 2004) to September 30, 2004, as the REIT has discontinued fair value hedge accounting on loans held for investment.

 

Cash Flow Hedges

 

During the third quarter of 2004, the REIT began utilizing cash flow hedging and implemented the use of cash flow hedge accounting on its securitization debt under SFAS No. 133. Previously, the REIT had been using

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

fair value hedge accounting, but elected to use this alternative method to accommodate elements of the REIT requirements. The net impact on earnings is not expected to be materially different under the two methods. Effective unrealized gains, net of effective unrealized losses, associated with cash flow hedges of $20.3 million and $28.7 million were recorded in other comprehensive income during the three and nine months ended September 30, 2005, respectively, which is reported as a component of stockholders’ equity. These contracts settle on various dates ranging from December 2005 to June 2014. A total of $19.1 million in net effective gains, included in other comprehensive income at September 30, 2005, is expected to be recognized in earnings during the next twelve months. Hedge ineffectiveness associated with cash flow hedges of $1.5 million and $2.0 million was recorded in earnings during the three and nine months ended September 30, 2005, respectively, and is included as a component of interest expense in the statement of operations.

 

Futures Contracts, Options Contracts, Interest Rate Swap and Cap Agreements and Margin Accounts

 

At September 30, 2005 the REIT had outstanding futures contracts, options contracts and interest rate swap agreements that were designated as hedge instruments, as well as interest rate cap agreements. At September 30, 2005 and December 31, 2004, the fair value of the margin account balances required for these derivatives and the futures contracts was $31.9 million and $6.4 million, respectively, and is included in other receivables. At September 30, 2005, the fair value of the options contracts, interest rate swap and cap agreements was $3.9 million, $11.8 million and $0.1 million, respectively, and is included in other assets. At December 31, 2004, the fair value of the options contracts, interest rate swap and cap agreements was $1.0 million, $1.8 million and $0.3 million, respectively. The total net liquidation value at September 30, 2005 and December 31, 2004 of these derivatives and related margin account balances was $47.8 million and $9.5 million, respectively. A gain of $0.3 million and a gain of $2.0 million on derivative instruments not designated for SFAS No. 133 hedge accounting treatment was recorded in interest expense on the statement of operations during the three and nine months ended September 30, 2005, respectively, relating to the gains and losses in value of interest rate cap agreements and interest rate swap agreements.

 

The change in fair value of derivative financial instruments, and the related hedged liability, recorded in the statement of operations was as follows:

 

     Interest
Income


    Interest
Expense


    Total

 
     (In thousands) (Unaudited)  

Three months ended September 30, 2005:

                        

Net unrealized loss

   $ (1,046 )   $ (3,970 )   $ (5,016 )

Net realized gain

     —         9,372       9,372  
    


 


 


Total

   $ (1,046 )   $ 5,402     $ 4,356  
    


 


 


Three months ended September 30, 2004:

                        

Net unrealized gain

   $ 1,588     $ —       $ 1,588  

Net realized loss

     (911 )     —         (911 )
    


 


 


Total

   $ 677     $ —       $ 677  
    


 


 


Nine months ended September 30, 2005:

                        

Net unrealized loss

   $ (4,506 )   $ (11,314 )   $ (15,820 )

Net realized gain

     —         24,659       24,659  
    


 


 


Total

   $ (4,506 )   $ 13,345     $ 8,839  
    


 


 


Inception (May 4, 2004) to September 30, 2004:

                        

Net unrealized gain

   $ 826     $ —       $ 826  

Net realized loss

     (911 )     —         (911 )
    


 


 


Total

   $ (85 )   $ —       $ (85 )
    


 


 


 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

6. TEMPORARY CREDIT FACILITIES

 

In connection with the REIT’s execution of securitization transactions, AHL and the REIT, as several borrowers or sellers, may enter into warehouse transactions with lenders to finance the related mortgage loans that are to be contributed by AHL to the REIT and then subsequently securitized with permanent bond financing. The net proceeds of the securitizations are to be used by AHL or the REIT to repay the warehouse debt and pay other expenses of the securitization.

 

AHL and the REIT, as several sellers, have entered into temporary aggregate warehouse facilities to permit the securitization of mortgage loans. The duration of any one of these facilities is approximately 30 days. Each of the agreements has cross-default and cross-collateralization provisions and AHL provides a guarantee of the REIT’s obligations under the facilities; in addition, the facilities are structured so that the REIT only has monetary responsibilities for a limited period of time prior to a securitization and otherwise does not have any monetary obligations under the facilities (“REIT Transaction”). The facilities are collateralized by performing, aged and delinquent loans and bear interest based on the One-Month LIBOR. Amounts outstanding on the warehouse facilities described above during the nine months ended September 30, 2005 totaled $3.0 billion and represented the amount of loans securitized during that period. There were no outstanding borrowings on any of the temporary warehouse facilities described above at September 30, 2005.

 

AHL and the REIT, as several borrowers or sellers, may enter into or modify additional warehouse facilities during 2005 in a similar manner in contemplation of a securitization.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

7. SECURITIZATION BOND FINANCING

 

The following is a summary of the outstanding securitization bond financing:

 

    

September 30,

2005


    December 31,
2004


 
     (In thousands)  
     (Unaudited)        

Series 2002-1 securitization with a stated maturity date of July 25, 2032 and an interest rate of 4.93% for the fixed portion of the bond and One-Month LIBOR plus 0.32% for the variable rate portion of the bond

   $ 32,384     $ 64,644  

Series 2002-2 securitization with a stated maturity date range of January 25, 2033 through February 25, 2033 and an interest rate of 4.48% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.49% to One-Month LIBOR plus 0.50% for the variable rate portions of the bond

     144,256       221,021  

Series 2003-1 securitization with a stated maturity date of June 25, 2033 and an interest rate of 3.58% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.35% to One-Month LIBOR plus 0.38% for the variable rate portions of the bond

     87,282       147,530  

Series 2003-2 securitization with a stated maturity date of October 25, 2033 and an interest rate of 4.23% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.35% to One-Month LIBOR plus 0.37% for the variable rate portions of the bond

     159,373       251,278  

Series 2003-3 securitization with a stated maturity date of January 25, 2034 and an interest rate of 4.46% for the fixed portion of the bond and One-Month LIBOR plus 0.38% for the variable rate portions of the bond

     225,201       342,386  

Series 2004-1 securitization with a stated maturity date of April 25, 2034 and an interest rate of One-Month LIBOR plus 0.30%

     250,116       384,857  

Series 2004-2 securitization with a stated maturity date of July 25, 2034 and an interest rate range of One-Month LIBOR plus 0.29% to One-Month LIBOR plus 0.30%

     422,332       604,229  

Series 2004-3 securitization with a stated maturity date of October 25, 2034 and an interest rate range of 2.90% to 5.25% for the fixed portions of the bond and a range of One-Month LIBOR plus 0.17% to One-Month LIBOR plus 2.50% for the variable rate portions of the bond

     659,606       928,914  

Series 2004-4 securitization with a stated maturity date of January 25, 2035 and an interest rate of 5.25% for the fixed portion of the bond and a range of One-Month LIBOR plus 0.15% to One-Month LIBOR plus 1.80% for the variable rate portions of the bond

     786,716       1,012,214  

Series 2005-1 securitization with a stated maturity date of April 25, 2035 and an interest rate range of One-Month LIBOR plus 0.10% to One-Month LIBOR plus 2.50%

     770,928       —    

Series 2005-2 securitization with a stated maturity date of July 25, 2035 and an interest rate of range of One-Month LIBOR plus 0.10% to One-Month LIBOR plus 2.50%

     922,428       —    

Series 2005-3 securitization with a stated maturity date of September 25, 2035 and an interest rate of range of One-Month LIBOR plus 0.10% to One-Month LIBOR plus 1.70%

     1,093,492       —    
    


 


       5,554,114       3,957,073  

Unamortized bond discounts

     (3,766 )     (2,958 )
    


 


Total securitization bond financing, net

   $ 5,550,348     $ 3,954,115  
    


 


 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

The bonds are collateralized by loans held for investment with an aggregate outstanding principal balance of $5.7 billion and $4.1 billion as of September 30, 2005 and December 31, 2004, respectively. Unamortized debt issuance costs, included in other assets, are $18.4 million and $14.1 million at September 30, 2005 and December 31, 2004, respectively.

 

Amounts collected on the mortgage loans are remitted to the respective trustees, who in turn distribute such amounts each month to the bondholders, together with other amounts received related to the mortgage loans, net of fees payable to the REIT, the trustee and the insurer of the bonds. Any remaining funds after payment of fees and distribution of principal and interest is known as excess interest.

 

The securitization agreements require that a certain level of overcollateralization be maintained for the bonds. A portion of the excess interest may be initially distributed as principal to the bondholders to increase the level of overcollateralization. Once a certain level of overcollateralization has been reached, excess interest is no longer distributed as principal to the bondholders, but, rather, is passed through to the REIT. Should the level of overcollateralization fall below a required level, excess interest will again be paid as principal to the bondholders until the required level has been reached.

 

The securitization agreements provide that if delinquencies or losses on the underlying mortgage loans exceed certain maximums, the required levels of credit enhancement would be increased.

 

Due to the potential for prepayment of mortgage loans, the early distribution of principal to the bondholders and the optional clean-up call, the bonds are not necessarily expected to be outstanding through the stated maturity date set forth above.

 

The following table summarizes the expected repayments relating to the securitization bond financing at September 30, 2005. Amounts listed as bond payments are based on anticipated receipts of principal and interest on underlying mortgage loan collateral using historical prepayment spreads:

 

     (In thousands)
(Unaudited)


 

Three months ending December 31, 2005

   $ 446,869  

Years Ending December 31:

        

2006

     2,093,748  

2007

     1,258,389  

2008

     563,024  

2009

     365,390  

2010

     261,614  

Thereafter

     565,080  

Unamortized bond discounts

     (3,766 )
    


Total

   $ 5,550,348  
    


 

8. INCOME TAXES AND DISTRIBUTION OF EARNINGS

 

With the filing of its first Federal income tax return on September 9, 2005, the REIT elected to be treated as a real estate investment trust for income tax purposes in accordance with certain provisions of the Internal Revenue Code of 1986. As a result of this election, the REIT will generally not be subject to federal or state income tax to the extent that it distributes its earnings to its shareholders and maintains its qualification as a real estate investment trust. Currently the REIT plans to distribute substantially all of its taxable income to common and preferred shareholders.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

The following is a reconciliation of the income tax provision computed using the statutory federal income tax rate to the income tax provision reflected in the statement of operations:

 

    

Three Months
Ended

September 30,
2005


   

Three Months
Ended

September 30,
2004


   

Nine Months
Ended

September 30,
2005


   

Inception

(May 4, 2004) to

September 30,
2004


 
     (In thousands) (Unaudited)  

Federal income tax at statutory rate

   $ 16,688     $ 3,529     $ 44,413     $ 4,325  

Preferred stock dividends at statutory rate

     (873 )     (406 )     (2,619 )     (406 )

Common stock dividends paid deduction

     (15,815 )     (3,123 )     (41,794 )     (3,919 )
    


 


 


 


Total provision

   $ —       $ —       $ —       $ —    
    


 


 


 


 

9. PREFERRED STOCK

 

The Board of Trustees, or a duly authorized committee thereof, may issue up to 200,000,000 shares of preferred stock from time to time in one or more classes or series. In addition, the Board of Trustees, or duly authorized committee thereof, may fix the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption.

 

9.75% Series A Perpetual Cumulative Preferred Shares

 

The Board of Trustees and a duly authorized committee thereof has classified and designated 4,093,678 preferred shares as Series A Preferred Shares. At September 30, 2005 and December 31, 2004, there were 4,093,678 preferred shares issued and outstanding.

 

In March, June and September of 2005, the REIT’s board of trustees declared a quarterly cash dividend on the Preferred Shares at the rate of $0.609375 per share to shareholders of record on March 15, June 15 and September 15, which aggregated $7.5 million for the nine months ended September 30, 2005.

 

The Series A Preferred Shares contain covenants requiring the REIT to maintain a total shareholders’ equity balance and total loans held for investment of at least $50.0 million and $2.0 billion, respectively, commencing on December 31, 2004 and at the end of each quarter thereafter. In addition, commencing with each of the four quarters ending December 31, 2005, the REIT is also required to maintain cumulative unencumbered cash flow (as defined in the agreement) greater than or equal to six times the cumulative preferred dividends required in those four quarters. If the REIT is not in compliance with any of these covenants, no dividends can be declared on the REIT’s common shares until it is in compliance with all covenants as of the end of two successive quarters. As of September 30, 2005, the REIT was in compliance with the covenants applicable to date in 2005.

 

Accredited irrevocably and unconditionally agrees to pay in full to the holders of each share of the REIT’s Series A Preferred Shares, as and when due, regardless of any defense, right of set-off or counterclaim which the REIT or Accredited may have or assert: (i) all accrued and unpaid dividends (whether or not declared) payable on the REIT’s Series A Preferred Shares; (ii) the redemption price (including all accrued and unpaid dividends) payable with respect to any of the REIT’s Series A Preferred Shares redeemed by the REIT and (iii) the liquidation preference, if any, payable with respect to any of the REIT’s Series A Preferred Shares. Accredited’s guarantee is subordinated in right of payment to Accredited’s indebtedness, on parity with the most senior class of Accredited’s preferred stock and senior to Accredited’s common stock.

 

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ACCREDITED MORTGAGE LOAN REIT TRUST

 

NOTES TO UNAUDITED FINANCIAL STATEMENTS—(Continued)

 

10. RECEIVABLE FROM PARENT AND ADMINISTRATION AND SERVICING AGREEMENT WITH PARENT

 

The REIT has an administration and servicing agreement with its parent company, AHL, whereby AHL provides loan servicing, treasury, accounting, tax and other administrative services for the REIT in exchange for a management fee equal to 0.5% per year on the outstanding principal balance of the loans serviced, plus miscellaneous fee income collected from mortgagors including late payment charges, assumption fees and similar items. Under this agreement, either party agrees to pay interest on the net average balance payable to the other party at an annual rate equal to the Six-Month LIBOR plus 1.0%. Management fee expense and interest income under this agreement totaled $6.8 million and $1.2 million, respectively for the three months ended September 30, 2005, and $18.2 million and $1.6 million for the nine months ended September 30, 2005. At September 30, 2005 and December 31, 2004, the net receivable from parent was $176.8 million and $15.2 million, respectively. During the 3rd quarter AHL borrowed approximately $150 million from the REIT and used those funds to pay down its warehouse line debt. It is anticipated that the majority of the advance outstanding at September 30, 2005 will be repaid before the current fiscal year end.

 

44


Table of Contents

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

 

The following discussion should be reviewed in conjunction with our consolidated financial statements and the related notes and other financial information appearing elsewhere in this report. In addition to historical information, the following discussion and other parts of this document contain forward-looking information that involves risks and uncertainties. Please refer to the section entitled “Forward-Looking Statements” on page 3 of this Form 10-Q. Our actual results could differ materially from those anticipated by such forward-looking information due to factors discussed under the section entitled “Risk Factors That May Affect Future Results” and elsewhere in this report.

 

General

 

Accredited is a mortgage banking company that originates, finances, securitizes, services and sells non-prime mortgage loans secured by residential real estate throughout the United States, and, to a lesser extent, in Canada. We focus on borrowers who may not meet conforming underwriting guidelines because of higher loan-to-value ratios, the nature or absence of income documentation, limited credit histories, high levels of consumer debt, or past credit difficulties. We originate our loans primarily through independent mortgage brokers and, to a lesser extent, through our direct sales force in our retail offices. We primarily sell our loans in whole loan sales or we securitize our loans.

 

On May 4, 2004, we formed a Maryland real estate investment trust, Accredited Mortgage Loan REIT Trust (the “REIT”), for the purpose of acquiring, holding and managing real estate assets. All of the outstanding common shares of beneficial interest of the REIT are held by Accredited Home Lenders, Inc., which in turn is a wholly owned subsidiary of Accredited Home Lenders Holding Co. The REIT has elected to be taxed as a real estate investment trust and to comply with the provisions of the Internal Revenue Code with respect thereto. Accordingly, the REIT will generally not be subject to federal or state income tax to the extent that it timely distributes its taxable income to its shareholders and satisfies the real estate investment trust requirements and certain asset, income and share ownership tests are met.

 

Revenue Model

 

Our operations generate revenues in three ways:

 

    Interest income. We have two primary components to our interest income. We generate interest income over the life of the loan on the loans we have securitized in structures that require financing treatment. This interest is partially offset by the interest we pay on the bonds that we issue to fund these loans. We also generate interest income on loans held for sale and for securitization from the time we originate the loan until the time we sell or securitize the loan. This interest income is partially offset by our borrowing costs under our warehouse credit facilities used to finance these loans.

 

    Gain on sale of loans. We generate gain on sale of loans by selling the loans we originate for a premium.

 

    Loan servicing income. Our loan servicing income represents all contractual and ancillary servicing revenue for loans that Accredited services for others, net of servicing costs and amortization of mortgage servicing rights.

 

Our revenues also include net gain or loss on mortgage-related securities and derivatives, on our loans held for sale, and some of our loans held for investment, which reflect changes in the value of these instruments based on market conditions.

 

While we currently generate the majority of our earnings and cash flows from whole loan sales, we intend to increase the percentage of our earnings and cash flows received from securitizations whereby we retain an interest in the mortgage loans that we have sold. These transactions will continue to be legally structured as sales,

 

45


Table of Contents

but for accounting purposes are structured as a financing under SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a replacement of FASB Statement No. 125. This “portfolio-based” accounting more closely matches the recognition of income with the actual receipt of cash payments. Also, such securitization structures are consistent with our strategy to predominantly generate cash-based earnings.

 

We anticipate that our results of operations may fluctuate on a quarterly and annual basis. The timing and degree of fluctuation will depend upon several factors, including competition, economic slowdowns and increased interest rates in addition to those discussed under “Risk Factors That May Affect Future Results.” Although we have experienced growth in recent years, we cannot assure you that we will be able to sustain revenue growth or maintain profitability on a quarterly or annual basis or that our growth will be consistent with predictions or forecasts.

 

Results Of Operations

 

Three Months Ended September 30, 2005 Compared to the Three Months Ended September 30, 2004

 

Executive Summary

 

    Net income was $41.3 million for the three months ended September 30, 2005, or $1.87 per diluted share, an increase of 15.1% from $35.9 million, or $1.66 per diluted share in 2004.

 

    The increase in net income was primarily driven by a 31.4% increase in net interest income after provision and a 9.8% increase in gain on whole loan sales. Whole loan sales of $3.0 billion during the three months ended September 30, 2005, resulted in gains recorded of $85.6 million, representing an average premium of 3.07% in 2005, versus 3.5% for the same period in 2004.

 

    Mortgage loan origination volume increased 39.7% from $3.2 billion for the three months ended September 30, 2004 to $4.5 billion in 2005, and our serviced loans increased 49.4% from $6.1 billion at September 30, 2004 to $9.2 billion at September 30, 2005. This was primarily due to the company’s quarterly securitization program and an increase in the loans held for disposition.

 

    Origination costs net of points and fees declined to 1.57% during the three months ended September 30, 2005 from 1.92% during the same period in 2004.

 

    Revenue from net interest income after provision increased from 36.3% of total net revenues for the three months ended September 30, 2004 to 39.8% in 2005 reflecting the growth in net interest income after provision of 31.4% which outpaced our growth in gain on sale of loans of 9.8%.

 

46


Table of Contents

Net Revenues

 

Net revenues and key indicators that affect our net revenues are as follows for the three months ended September 30:

 

     2005

    2004

    Increase

   % Change

 
     (Dollars in thousands)  

Interest income(1)

   $ 164,147     $ 97,493     $ 66,654    68.4 %

Interest expense(2)

     (84,571 )     (37,114 )     47,457    127.9 %
    


 


 

      

Net interest income

     79,576       60,379       19,197    31.8 %

Provision for losses

     (19,168 )     (14,416 )     4,752    33.0 %
    


 


 

      

Net interest income after provision

     60,408       45,963       14,445    31.4 %

Gain on sale of loans

     85,644       77,993       7,651    9.8 %

Loan servicing income

     3,243       1,996       1,247    62.5 %

Other income

     2,461       690       1,771    256.7 %
    


 


 

      

Total net revenues

   $ 151,756     $ 126,642     $ 25,114    19.8 %
    


 


 

      

Net interest income after provision as percentage of net revenues

     39.8 %     36.3 %             

Gain on sale of loans as a percentage of net revenues

     56.4 %     61.6 %             

Mortgage loan originations

   $ 4,492,719     $ 3,216,959     $ 1,275,760    39.7 %

Whole loan sales

   $ 2,979,088     $ 2,300,907     $ 678,181    29.5 %

Mortgage loans securitized

   $ 1,120,042     $ 1,011,032     $ 109,010    10.8 %

Average inventory of mortgage loans

   $ 8,495,639     $ 5,283,913     $ 3,211,726    60.8 %

Annualized interest income as a percentage of average inventory of mortgage loans (Yield)

     7.73 %     7.38 %             

Average outstanding borrowings

   $ 8,131,966     $ 5,069,220     $ 3,062,746    60.4 %

(1) Interest income includes prepayment penalty income, gains and losses from hedging activities and contractually designated servicing income on our balance sheet securitizations treated as interest income for accounting purposes.
(2) Interest expense includes gains and losses from hedging activities and amortization of debt issuance costs.

 

Interest Income. Interest income increased 68.4% during the three months ended September 30, 2005 from the comparable period in 2004 reflecting the 60.8% increase in our average inventory of mortgage loans during the period and an increase in the total yield on our average inventory of mortgage loans outstanding during the three months ended September 30, 2005 when compared to the same period in 2004. The increase in our average inventory of mortgage loans is due to higher loan origination volume during the three months ended September 30, 2005. The increase in our average yield primarily reflects the increase in pricing of loan originations over the past year.

 

Interest Expense. The increase in interest expense during the three months ended September 30, 2005 of 127.9% reflects an increase in our average outstanding borrowings, which increased from $5.1 billion during the three months ended September 30, 2004 to $8.1 billion during the same period in 2005, or 60.4%. The increase in interest expense also resulted from a net increase in our average borrowing rates, which increased from 3.13% on our warehouse lines during the three months ended September 30, 2004 to 4.57% during the same period in 2005 and from 2.77% in 2004 on our securitization debt to 3.93% during the same period in 2005.

 

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Table of Contents

The components of our net interest margin are as follows for the three months ended September 30:

 

     2005

    2004

 
     Interest
Income
(Expense)


    Average
Balance
Outstanding


   Average
Rate


    Interest
Income
(Expense)


    Average
Balance
Outstanding


   Average
Rate


 
     (Dollars in thousands)  

Warehouse:

                                          

Interest income

   $ 58,506     $ 3,115,998    7.51 %   $ 42,734     $ 2,357,879    7.25 %

Interest expense

     (33,543 )     2,935,474    (4.57 )     (17,481 )     2,236,885    (3.13 )
    


        

 


        

Spread

     24,963            2.94 %     25,253            4.12 %
    


        

 


        

Securitizations:

                                          

Interest income

     105,641       5,379,641    7.85 %     54,758       2,926,034    7.49 %

Interest expense

     (51,028 )     5,196,492    (3.93 )     (19,634 )     2,832,335    (2.77 )
    


        

 


        

Spread

     54,613            3.92 %     35,124            4.72 %
    


        

 


        

Net interest margin

   $ 79,576     $ 8,495,639    3.75 %   $ 60,377     $ 5,283,913    4.57 %
    


        

 


        

 

The net interest spread for our warehouse loans declined from 4.12% during the three months ended September 30, 2004 to 2.94% for the comparable period in 2005. This is due to the One-Month LIBOR, which our borrowing costs are indexed to, increasing by more than the average mortgage coupon rate earned on our loan portfolio. This effect was partially offset by a reduction in the spread of the borrowing costs over One-Month LIBOR charged by the warehouse credit facilities, as well as a reduction in the borrowing costs due to the formation of a special purpose entity which issues commercial paper to finance a portion of the loan portfolio held for sale and securitization. The lower growth in coupon rate relative to borrowing costs reflects increased competition from other lenders combined with a flattening of the yield curve. This trend may continue if the yield curve continues to flatten, as suggested by the current forward rates, or if competitive pressures increase.

 

The net interest spread for our securitized loans declined from 4.72% during the three months ended September 30, 2004 to 3.92% for the comparable period in 2005. The decline reflects higher cost of borrowings due to market interest rates increasing, and a greater mix of variable rate bonds to fixed rate bonds in 2005. The spread may continue to decline if short-term rates increase further, as suggested by the forward curve.

 

Provision for Losses. The provision for losses is comprised of the following for the three months ended September 30:

 

     2005

    2004

    Increase
(Decrease)


   % Change

 
     (Dollars in thousands)  

Current period provision for:

                             

Mortgage loans held for sale

   $ 2,768     $ 1,281     $ 1,487    116.1 %

Mortgage loans held for investment

     12,694       11,806       888    7.5 %

Repurchases and real estate owned

     3,706       1,329       2,377    178.9 %
    


 


 

      

Total provision for losses

   $ 19,168     $ 14,416     $ 4,752    33.0 %
    


 


 

      

Reserve balance at period end:

                             

Mortgage loans held for sale

   $ 20,734     $ 14,372     $ 6,362    44.3 %

Mortgage loans held for investment

     95,728       49,649       46,079    92.8 %
    


 


 

      

Total reserve balance on mortgage loans

   $ 116,462     $ 64,021     $ 52,441    81.9 %
    


 


 

      

Principal balance at period end:

                             

Mortgage loans held for sale

   $ 2,370,788     $ 1,853,673     $ 517,115    27.9 %

Mortgage loans held for investment

     6,685,780       4,083,987       2,601,793    63.7 %
    


 


 

      

Total principal balance at period end

   $ 9,056,568     $ 5,937,660     $ 3,118,908    52.5 %