10-Q/A 1 homeintl10qa063001.txt AMENDMENT NO. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Mark one) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 1-12655 HomeSide International, Inc. ---------------------------- (Exact name of registrant as specified in its charter) Delaware 59-3387041 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 7301 Baymeadows Way, Jacksonville, FL 32256 ------------------------------------------- (Address of principal executive offices) (Zip Code) (904) 281-3000 -------------- (Registrant's telephone number, including area code) 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_ No __ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at December 6, 2001 ----- ------------------------------ Common stock $0.01 par value 1.724 Shares Class C non-voting common stock $1.00 par value none HOMESIDE INTERNATIONAL, INC. FORM10-Q/A Quarterly Period Ended June 30, 2001 INDEX Page No. -------- PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements (unaudited) (Note A): Consolidated Balance Sheets as of June 30, 2001 and September 30, 2000........................................ 3 Consolidated Statements of Income and Comprehensive Income for the Three and Nine Months Ended June 30, 2001 and June 30, 2000......................................................... 4 Consolidated Statements of Cash Flows for the Three and Nine Months Ended June 30, 2001 and June 30, 2000...................................................................... 5 Notes to Consolidated Financial Statements.................................................................... 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings............................................................................................. 26 Item 6. Exhibits and Reports on Form 8-K.............................................................................. 26 SIGNATURES................................................................................................................. 27

Note A As discussed in Note 2 of the consolidated financial statements of HomeSide International, Inc. (the "Company") included herein, the Company announced on September 4, 2001 the discovery of an incorrect interest rate assumption in the mortgage servicing rights model. As a result, the Company has determined the necessity to restate certain previously reported interim financial statements. The restatement, as presented herein, corrects the effects of the incorrect interest rate assumption on the consolidated financial statements and related notes for the three and nine months ended June 30, 2001. 2 FINANCIAL INFORMATION ITEM 1. Financial Statements HOMESIDE INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in Thousands, Except Share Data) June 30, 2001 September 30, 2000 (Restated) ---------------------- ------------------ ASSETS Cash and cash equivalents ......................................................... $ 281,341 $ 110,737 Mortgage loans held for sale, net ................................................. 1,676,747 1,441,216 Mortgage servicing rights, net .................................................... 4,265,120 4,464,312 Early pool buyout advances ........................................................ 159,104 141,255 Accounts receivable, net .......................................................... 270,536 324,028 Premises and equipment, net ....................................................... 85,084 80,052 Goodwill, net ..................................................................... 585,664 612,018 Other assets ...................................................................... 151,064 93,415 ----------- ----------- Total Assets ...................................................................... $ 7,474,660 $ 7,267,033 =========== =========== LIABILITIES AND STOCKHOLDER'S EQUITY Accounts payable and accrued liabilities .......................................... $ 501,673 $ 587,275 Risk management instruments at fair value, net .................................... 306,091 - Notes payable ..................................................................... 4,009,000 3,235,400 Long-term debt .................................................................... 1,906,055 1,899,772 Deferred income taxes, net ........................................................ 9,095 271,369 ----------- ----------- Total Liabilities ................................................................. 6,731,914 5,993,816 ----------- ----------- Stockholder's Equity: Common stock: Common stock, $0.01 par value, 100 shares authorized and 1 share issued outstanding ................................................................ - - Class C non-voting common stock, $1.00 par value, 195,000 shares authorized, and 0 shares issued and outstanding ............................ - - Additional paid-in capital ........................................................ 1,231,302 1,231,302 (Accumulated deficit) retained earnings ........................................... (493,872) 41,915 Accumulated other comprehensive income ............................................ 5,316 - ----------- ----------- Total Stockholder's Equity ........................................................ 742,746 1,273,217 ----------- ----------- Total Liabilities and Stockholder's Equity ........................................ $ 7,474,660 $ 7,267,033 =========== ===========

The accompanying notes are an integral part of these financial statements. 3 HOMESIDE INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (Dollars in Thousands) For the Three For the Three For the Nine For the Nine Months Ended Months Ended Months Ended Months Ended June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000 (Restated) (Restated) -------------- ------------- ------------- ------------- REVENUES: Mortgage servicing fees $ 224,927 $ 182,542 $ 653,380 $ 539,369 Amortization of mortgage servicing rights (171,797) (97,085) (427,451) (297,272) Valuation provision of mortgage servicing rights 75,280 - (827,090) - Risk management of mortgage servicing rights (525,280) - (17,218) - --------- --------- --------- --------- Net servicing (expense) revenue (396,870) 85,457 (618,379) 242,097 Interest income 32,889 26,329 90,723 92,601 Interest expense (38,672) (44,500) (134,481) (123,087) --------- --------- --------- --------- Net interest expense (5,783) (18,171) (43,758) (30,486) Net mortgage origination revenue 67,723 13,631 129,905 52,540 Other income 4,195 1,505 11,780 3,617 --------- --------- --------- --------- Total (Expenses) Revenues (330,735) 82,422 (520,452) 267,768 EXPENSES: Salaries and employee benefits 38,094 27,905 100,614 83,594 Occupancy and equipment 10,433 7,690 29,640 23,959 Servicing losses on investor-owned loans and foreclosure-related expenses 8,878 9,092 27,077 24,847 Goodwill amortization 8,785 8,974 26,355 26,922 Other expenses 16,881 13,288 51,915 35,963 --------- --------- --------- --------- Total Expenses 83,071 66,949 235,601 195,285 (Loss) income before income taxes, extraordinary item and (413,806) 15,473 (756,053) 72,483 cumulative effect of a change in accounting principle Income tax (benefit) expense (147,845) 8,923 (266,397) 29,483 --------- --------- --------- --------- (Loss) income before extraordinary item and cumulative effect of a change in accounting principle (265,961) 6,550 (489,656) 43,000 Extraordinary item - gain on early extinguishment of 987 - 987 - debt, net of income tax expense of $567 Cumulative effect of a change in accounting for - - 883 - derivative instruments and hedging activities, net of income tax expense of $507 --------- --------- --------- --------- Net (loss) income (264,974) 6,550 (487,786) 43,000 Other comprehensive income, net of tax: Cumulative effect of a change in accounting - - (9,133) - for derivative instruments and hedging activities Net gains on current period cash flow 5,393 - 4,856 - Less: reclassification adjustment for losses - - included in net income 475 9,593 --------- --------- --------- --------- Other comprehensive income 5,868 - 5,316 - --------- --------- --------- --------- Comprehensive (loss) income $(259,106) $ 6,550 $(482,470) $ 43,000 ========= ========= ========= ========= The accompanying notes are an integral part of these financial statements.

4 HOMESIDE INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (Dollars in Thousands) For the For the For the Nine For the Nine Three Months Three Months Months Ended Months Ended Ended Ended June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000 (Restated) (Restated) ------------- ------------- -------------- -------------- CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES AND RISK MANAGEMENT RESULTS: Net (loss) income $ (264,974) $ 6,550 $ (487,786) $ 43,000 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities and risk management results: Amortization of mortgage servicing rights 171,797 97,092 427,451 297,279 Depreciation and amortization 13,694 11,598 38,667 34,627 Cumulative effect of a change in accounting for derivative - - (883) - Instruments and hedging activities, net Change in fair value of net hedged assets (5,758) - (11,269) - Risk management of mortgage servicing rights 525,280 - 17,219 - Valuation provision of mortgage servicing rights (75,280) - 827,090 - Servicing losses on investor-owned loans 1,727 2,407 5,766 7,611 Change in deferred income tax liability (147,275) 8,917 (265,837) 31,529 Origination, purchase and sale of loans held for sale, net of repayments (66,275) (501,879) (228,722) 22,609 Change in accounts receivable 49,846 (88,372) 47,047 (127,669) Change in other assets and accounts payable and accrued liabilities (182,421) 36,644 (55,699) (17,903) ----------- ----------- ----------- ----------- Net cash provided by (used in) by operating activities and risk management results 20,361 (427,043) 313,044 291,083 CASH FLOWS USED IN INVESTING ACTIVITIES: Purchase of premises and equipment, net (6,314) (5,546) (17,999) (18,989) Acquisition of mortgage servicing rights (320,563) (229,255) (1,055,349) (587,429) Net purchase of risk management contracts 26,746 80,567 240,201 (472,272) Net early pool buyout reimbursements (15,496) 30,773 (18,047) 153,953 ----------- ----------- ----------- ----------- Net cash used in investing activities (315,627) (123,461) (851,194) (924,737) CASH FLOWS PROVIDED BY FINANCING ACTIVITIES: Net borrowings from banks 51,500 200,600 150,600 135,800 Net (repayments) issuance of commercial paper 500,000 - 500,000 336,097 Issuance of medium-term notes - 500,000 250,000 500,000 Issuance of notes payable 123,000 - 123,000 - Payment of debt issue costs (444) (1,348) (2,735) (3,720) Repayment of long-term debt (263,950) (250,225) (264,111) (310,669) Dividends paid to the National (24,000) (24,000) (48,000) (48,000) ----------- ----------- ----------- ----------- Net cash provided by financing activities 386,106 425,027 708,754 609,508 Net increase (decrease) in cash and cash equivalents 90,840 (125,477) 170,604 (24,146) Cash and cash equivalents at beginning of period 190,501 304,190 110,737 202,859 ----------- ----------- ----------- ----------- Cash and cash equivalents at end of period $ 281,341 $ 178,713 $ 281,341 $ 178,713 =========== =========== =========== =========== Supplemental disclosure of cash flow information: Interest paid $ 43,914 $ 38,605 $ 153,388 $ 119,133 Income taxes paid - $ 6 $ 23 $ 348 Income taxes refunded $ 4 - $ 18 $ 2,395 Impact of cash flow hedges on other comprehensive income, net $ 5,868 - $ 5,316 - The accompanying notes are an integral part of these financial statements.

5 HOMESIDE INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosed amounts of contingent liabilities at the date of the financial statements. Actual results may differ from those estimates. Operating results for the three- and nine-month periods ended June 30, 2001 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2001. For further information, refer to the consolidated financial statements and footnotes thereto included in the Form 10-K for the fiscal year ended September 30, 2000 of HomeSide International, Inc. See also Note A to the Index to the Form 10-Q/A above. 2. RESTATEMENT As announced on September 4, 2001, the Company discovered an incorrect interest rate assumption in the mortgage servicing rights ("MSR") valuation model which caused the model to under estimate the MSR's sensitivity to movements in interest rates, particularly in a falling rate environment. During the quarter ended December 31, 2000, mortgage rates declined by 58 basis points from 7.88% at September 30, 2000 to 7.30% at December 31, 2000 with substantially all of the rate movement occurring in the second half of the quarter. During the six month period from December 31, 2000 to June 30, 2001, mortgage rates continued to decline an additional 10 basis points to 7.20% at June 30, 2001. Had the valuation model included the correct interest rate assumption, the model would have estimated faster loan prepayment speeds and, as a result, a lower valuation of the mortgage servicing rights asset. The correction of the incorrect interest rate assumption caused the Company to determine that the inception documentation required to apply hedge accounting pursuant to Financial Accounting Standards No. 133, "Accounting for Derivative and Hedging Activities" ( "SFAS 133"), was inadequate to support the characteristics of the hedged item and its exposure to changes in hedged risk. Therefore, the Company concluded that the application of hedge accounting was inappropriate for those derivative instruments previously designed to hedge the exposure to changes in the fair value of the mortgage servicing rights assets. The Company recognized a loss of ($567.7) million to current earnings related to the change in fair value of these derivatives for the three months ended June 30, 2001, and a gain of $66.9 million for the nine months ended June 30, 2001, with no corresponding hedge offset relative to the change in the fair value of the mortgage servicing rights. Consequently, the Company reversed a previously recorded change in value of the mortgage servicing rights due to hedged risk of ($389.0) million to earnings for the three months ended June 30, 2001 and $176.1 million for the nine months ended June 30,2001. Pursuant to the guidance provided under Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140'), the Company subsequently performed an impairment evaluation of the mortgage servicing rights and recognized a decrease in valuation provision of $389.0 million to earnings for the three months ended June 30, 2001, and an additional valuation provision of $497.4 million for the nine months ended June 30, 2001. Accordingly, the consolidated statement of income for the three months ended June 30, 2001, as restated, reflects no net effect to current period earnings. For the nine months ended June 30, 2001, the consolidated statement of income as restated, reflects a pretax net reduction in net servicing (expense) revenue and pretax income of ($321.3) million and a related tax (benefit) of ($117.3) million, for a net reduction in previously reported earnings of $204.0 million. 6 The impact of the correction to the basis of the mortgage servicing rights for the three months ended June 30, 2001, as set forth herein, is as follows: Mortgage Servicing Rights Restatement For the Three Months Ended June 30, 2001 (Dollars in millions) Mortgage servicing Restatement adjustments Restated mortgage rights as to mortgage servicing servicing rights originally reported rights (1) ---------------------------------------------------------------------- Restated Beginning Balance at March 31, 2001 $ 4,041.0 $ - $ 4,041.0 Additions 320.6 - 320.6 Change in value due to hedged risk 389.0 (389.0) - Amortization (171.8) - (171.8) Valuation provision (313.7) 389.0 75.3 ---------------------------------------------------------------------- Ending Balance at June 30, 2001 $ 4,265.1 $ - $ 4,265.1 ====================================================================== ---------- (1) Ending Balance at June 30, 2001 is modified in accordance with the Restated Beginning Balance at March 31, 2001. Refer to Form 10-Q/A filed for the quarterly period ended March 31, 2001 for additional information regarding the Restated Beginning Balance at March 31, 2001.

3. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and cash due from banks and interest-bearing deposits with an original maturity of three months or less. Margin deposits associated with the risk management program for mortgage servicing rights are maintained with counterparties and the Company in accordance with the requirements of International Swap Dealer Agreements. At June 30, 2001, the Company's net margin deposits with counterparties were approximately $176.9 million. At September 30, 2000, the Company's net margin deposits with counterparties totaled approximately $84.0 million. 4. MORTGAGE SERVICING RIGHTS (Restated) The Company capitalizes the rights to service mortgage loans for others as assets, whether the servicing rights are retained upon sales of loan originations or acquired through purchases. Mortgage servicing rights are the rights to receive a portion of the interest coupon and fees collected from the mortgagor for performing specified servicing activities. Mortgage servicing rights are recorded by allocating the total cost of loans originated or acquired between the loan sold and the servicing right retained based on their relative fair values at the date of sale. The value of servicing rights acquired through bulk acquisitions is capitalized at cost. The fair value of mortgage servicing rights is estimated based on discounted future net cash flows using a third party vendor prepayment model which considers portfolio characteristics and assumptions regarding interest rates, delinquency rates, ancillary revenues and other economic factors. The Company continually monitors, updates and revises, as necessary, the major assumptions and modeling techniques used in estimating the fair value of its mortgage servicing rights. Valuation model results are reviewed relative to market prices of similar mortgage servicing assets, if available. The net carrying value of the mortgage servicing rights is amortized in proportion to and over the period of the estimated net servicing revenue. For purposes of evaluating and measuring impairment of mortgage servicing rights, the Company stratifies its portfolio on the basis of the predominant risk characteristics, which include loan type and mortgage rate. Impairment is recognized to earnings through a valuation provision to the extent that the carrying value of an individual stratum exceeds its estimated fair value. As restated, in the three-month period ended June 30, 2001, the Company recognized a $75.3 million increase to earnings through the valuation provision of mortgage servicing rights. As restated, in the nine-month period ended June 30, 2001, the Company recognized a $827.1 million decrease to earnings through the valuation provision of mortgage servicing rights. In the three-month period ended June 30, 2001, the Company previously recognized a $313.7 million decrease to earnings through the valuation provision of mortgage servicing rights as a 7 result of unprecedented refinancing activity and extreme interest rate volatility. During the restatement process (see Note 2), the Company recognized a $389.0 million increase to earnings through the valuation provision of mortgage servicing rights for the three months ended June 30, 2001. The Company recognized an increase in the valuation provision of $497.4 million, a decrease to earnings, resulting in the total valuation provision of $827.1 million for the nine-month period ended June 30, 2001. The change in the balance of mortgage servicing rights was as follows (in thousands): Balance, September 30, 2000 $4,464,312 Additions 1,055,349 Amortization (427,451) Valuation provision (827,090) ----------- Balance, June 30, 2001 $4,265,120 =========== 5. RISK MANAGEMENT AND THE ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES (Restated) The Company has developed risk management programs and processes designed to manage market risk associated with the Company's business activities. As more fully described herein, interest rate risk is a predominant risk that further influences a number of other business risks such as pricing risk, prepayment risk, valuation risk, balance sheet management and funding risk. As part of its risk management programs, the Company utilizes a number of derivative instruments to manage these risks. In June of 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133, as amended, standardizes the accounting for derivative instruments and hedging activities and requires that all derivative instruments be recognized as assets and liabilities at fair value. If certain conditions are met, "hedge accounting" may be applied and the derivative instruments may be specifically designated as: (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment ("fair value hedge"), (b) a hedge of the exposure to variability of cash flows of a recognized asset, liability or forecasted transaction ("cash flow hedge") or (c) a hedge of certain foreign currency exposures. In the case of a qualifying fair value hedge, changes in the value of the derivative instruments that have been highly effective are recognized in current earnings along with the change in value of the designated hedge item. In the case of a qualifying cash flow hedge, changes in the value of the derivative instruments that have been highly effective are recognized in other comprehensive income ("OCI"), until such time that earnings are affected by the cash flows of the underlying hedged item. In either a fair value hedge or a cash flow hedge, net earnings are impacted to the extent the changes in the value of the derivative instruments do not perfectly offset the changes in the value of the hedge items (so called "ineffectiveness"). Derivative instruments that are non-designated or do not meet the relevant hedge accounting criteria are accounted for at fair value with gains and losses recorded to current earnings. The Company is not a party to any foreign currency hedge relationships. Effective with its first fiscal quarter beginning October 1, 2000, the Company adopted SFAS 133 as required. Accordingly, all derivative instruments are recognized on balance sheet at fair value and are either designated as fair value hedges, cash flow hedges, or are non-designated pursuant to the Company's risk management policies. At October 1, 2000, the Company recognized a cumulative-effect transition adjustment of $1.4 million to increase pre-tax income for the effect of the change in accounting principle. Additionally, the Company recognized a pre-tax cumulative-effect transition adjustment to reduce OCI by $14.4 million. The transition adjustments are more fully explained in the following sections along with the risk management activities and hedge accounting results for the three months and nine months ended June 30, 2001. The impact of the accounting for risk management activities pursuant to SFAS 133 is expected to create a level of ongoing volatility in reported financial results. Risk Management of Loan Production Activities Loan production activities include the origination or acquisition of mortgage loans, the warehousing of those loans in inventory and the resale of those loans to investors in the secondary mortgage market. The Company maintains a risk management program to protect and manage interest rate risk and pricing risk associated with its mortgage committed pipeline and mortgage inventory. The Company does not presently originate or acquire loans for investment (portfolio) purposes. 8 Mortgage Pipeline The Company's mortgage committed pipeline includes interest rate lock commitments ("IRLCs" or "commitments") that have been extended to borrowers who have applied for loan funding and meet certain defined credit and underwriting criteria. All of the Company's IRLCs will be classified as held for sale upon funding of the underlying loan. Effective with the adoption of SFAS 133, the Company classifies and accounts for IRLCs as non-designated derivative instruments. Accordingly, IRLCs are recorded at fair value with changes in value recorded to current earnings. Risk management derivative contracts used to economically hedge the IRLCs are also classified and accounted for as non-designated derivatives. In summary, since a derivative instrument cannot hedge another derivative instrument (for accounting purposes) the pipeline is effectively accounted for as a mark-to-market book of business. The fair value of the Company's IRLCs generally approximate zero at inception (the lock-in date) since the Company's practice is to extend loan commitments at market rates of interest and to exclude from its fair value calculation the normal profit margin associated with the future loan execution. The future loan execution involves the sale of the loan and, typically, the retention of the servicing rights. IRLCs have value characteristics that are somewhat analogous to certain option contracts in that the commitments tend to: (i) decrease in value at an accelerating rate as interest rates increase and the probability of the borrower's loan closing increases, and (ii) increase in value at a decelerating rate as interest rates decline and the probability of the borrower's loan closing decreases. The Company manages the interest rate and pricing risks associated with its IRLCs by using mortgage forward delivery contracts, options on mortgage-backed securities and certain treasury instruments. The Company's risk management program employs the use of financial modeling to maintain a high degree of economic correlation between the changes in values of the IRLCs and the related non-designated derivatives. However, due to imprecisions in projecting the timing and rate of loan closings (which are influenced by borrower behavior), some level of economic ineffectiveness can be expected. Following is a summary of the net gains/(losses) recognized on non-designated risk management derivatives related to the pipeline at June 30, 2001 (in thousands): For the three For the nine months ended months ended June 30, 2001 June 30, 2001 ----------------- ------------------ (Losses)/Gains on IRLCs recognized to income $ (6,695) $ 27,181 Gains/(Losses) on mortgage forward delivery contracts 4,766 (18,601) Gains on options contracts 5,715 3,044 -------- -------- Total gains/(losses) recognized to income 10,481 (15,557) Net gains recognized on non-designated derivatives $ 3,786 $ 11,624 ================= ==================

Gains/(losses) on interest rate lock commitments represent the change in value of the commitments from the rate-lock inception date to the loan funding date (for those commitments that are funded), or to the current reporting date for those IRLCs that are open at June 30, 2001. The basis of the IRLCs at the loan funding date, representing cumulative gains or losses on the IRLCs, is included as a component of the initial cost basis of the loans. Approximately $1.0 million of the net losses recognized on IRLCs (reported for the three months ended June 30, 2001, above) were applied to the initial basis of the underlying loans funded. The balance of the losses totaling $5.7 million are recognized as open derivative contracts at June 30, 2001 and are recorded at fair value in the consolidated balance sheets. The net gains on non-designated derivatives (related to the pipeline) were included as a component of risk management results in the previously filed Form 10-Q for the quarter ended June 30, 2001. To present an integrated operational perspective, these results were reclassified and are now included in net mortgage origination revenue in the accompanying consolidated statements of income. Mortgage Inventory The Company's mortgage inventory includes closed loans that are held for resale pending completion of normal post-closing review, collateral document preparation and other pooling requirements necessary to consummate the sale and/or securitization. Based on the status of such, as well as historical delivery patterns and investor settlement dates, the Company is able to forecast the amount and timing of loan sales. Approximately $1.4 billion of the Company's loans at June 30, 2001 are conforming loans which have been underwritten pursuant to the requirements of the secondary marketing agencies (FNMA, FHLMC or GNMA as appropriate). The Company's risk management program involves the use of mortgage forward delivery contracts to hedge 100% of its agency-eligible conforming loans as forecasted loan sales. At June 30, 2001, a total of $1.4 billion of mortgage forward delivery contracts were designated as cash flow hedges. At the inception of the hedge, the Company formally documents the relationship between the forward delivery contracts and the forecasted loan sales as well as its risk management objective and strategy for undertaking the hedge transactions. The dollar amount of the forward delivery contracts along with the underlying rate and terms of the contracts are equivalent to the 9 forecasted loan sales that are probable of occurring. Hence, the forward delivery contracts effectively fix the forward sales price and thereby substantially eliminate interest rate and pricing risk to the Company. Mortgage loans held for sale at June 30, 2001 include non-conforming loans aggregating $280.6 million which will be sold to non-agency, private investors. During the three- and nine-month periods ended June 30, 2001, gains of $1.5 million and $1.3 million, respectively, on non-designated mortgage forward delivery contracts maintained as economic hedges of non-conforming loans were recorded to earnings and included as a component of risk management results in the previously filed Form 10-Q for the quarter ended June 30, 2001. To present an integrated operational perspective, these results were reclassified and are now included in net mortgage origination revenue in the accompanying consolidated statements of income. The fair value of risk management hedging relationships at June 30, 2001 is as follows (in thousands): Mortgage Pipeline: IRLCs at period end $ (5,732) Non-designated mortgage forward delivery contracts 4,766 Options on mortgage-backed securities 8,523 --------------------- Total fair value of pipeline derivatives 7,557 Mortgage Inventory: Designated mortgage forward delivery contracts 8,371 Non-designated mortgage forward delivery contracts 1,248 --------------------- Total fair value of derivatives related to inventory 9,619 Net asset recorded for fair value derivatives $ 17,176 =====================

At June 30, 2001, the carrying value of mortgages held for sale approximated fair value. Cumulative gains related to the hedge instruments in the amount of $8.4 million were recorded in OCI at June 30, 2001 and will be reclassified to earnings during the next 90 days, concurrent with the recognition in earnings of the changes in cash flows of the forecasted loan sales. Transition Adjustments and Current Period Activity in OCI As discussed above, the cumulative effect of the adoption of SFAS 133 was to increase pre-tax net income by $1.4 million. This amount relates solely to the mortgage pipeline at October 1, 2000 and represents the net effect of the adjustments necessary to record IRLCs and the related non-designated derivatives at fair value. The pre-tax cumulative-effect transition adjustment to reduce OCI by $14.4 million relates solely to the hedging activities of the mortgage inventory at October 1, 2000. Specifically, this amount represents the cumulative losses (to September 30, 2000) of mortgage forward delivery contracts that were off-balance sheet prior to the adoption of SFAS 133. Such cumulative losses did not exceed cumulative unrealized gains in the designated mortgage inventory at October 1, 2000. Pursuant to the requirements of SFAS 133, cumulative losses in OCI of $14.4 million were reclassified to earnings during the nine-month period ended June 30, 2001, concurrent with the recognition of the gains (or favorable variability in cash flows) of the related forecasted loan sales that were settled. Gains and losses on such hedge relationships related to settled transactions are included as a component of net mortgage origination revenue in the accompanying consolidated statements of income. 10 Activity in OCI related to cash flow hedges of forecasted loan sales is summarized as follows for the nine-months ended June 30, 2001 (in thousands): Tax Before-tax (expense) Net-of-tax Amount or benefit amount ---------------- ---------------- ---------------- Balance at September 30, 2000 $ - $ - $ - Cumulative effect of a change in accounting for hedging activities (14,383) 5,250 (9,133) Net losses on current period cash flow hedges (847) 310 (537) Reclassification of losses to net income 14,361 (5,243) 9,118 ---------------- ---------------- ---------------- Balance at March 31, 2001 $ (869) $ 317 $ (552) Net gains on current period cash flow hedges 8,492 (3,099) 5,393 Reclassification of losses to net income 748 (273) 475 ---------------- ---------------- ---------------- Balance at June 30, 2001 $ 8,371 $ (3,055) $ 5,316 ================ ================ ================

Risk Management of Mortgage Servicing Rights HomeSide utilizes a number of risk management derivative instruments to manage the interest rate risk associated with its mortgage servicing rights. Such instruments include interest rate swaps, swaptions and caps, mortgage forward delivery contracts, options on mortgage-backed securities, and options and futures on exchange traded Treasury and Eurodollar contracts. Given the unique value determinants of mortgage servicing rights, management uses a combination of derivative instruments to construct a hedge portfolio that is intended to provide effective protection of the value of the Company's mortgage servicing rights from interest rate risk. Pursuant to the requirements of SFAS 133, mortgage servicing rights are stratified into portfolios of similar assets based on their price sensitivity such that the mortgage servicing rights in a given portfolio can be expected to respond in a generally proportionate manner to the expected changes in the total value of the designated portfolio. The Company uses vendor provided valuation models to determine the price sensitivity of the mortgage servicing rights for selected rate shock scenarios such that individual portfolios can be established and qualify for hedge designation (hereinafter referred to as the "designated portfolios"). Certain mortgage servicing rights with dissimilar value determinants may fail to meet the Company's price sensitivity criteria and are excluded from the portfolios that are designated for hedging (such portfolios are hereinafter referred to as "non-designated portfolios"). The Company employs statistical correlation techniques, both at the inception of the hedge period and on an ongoing basis, to formally assess its expectation that changes in the value of the derivative contracts are effectively correlated to changes in the value of the hedged asset or liability. Due to an incorrect interest rate assumption in the mortgage servicing rights valuation model (see Note 2), the Company determined that the inception documentation required for hedge accounting pursuant to SFAS 133 for the quarter ended June 30, 2001 was inadequate to support the characteristics of the hedged item and its exposure to changes in hedged risk Therefore, the Company concluded that the application of hedge accounting was inappropriate for those derivative instruments previously designed to hedge the exposure to changes in the fair value of the mortgage servicing rights assets. The Company recognized a loss of ($567.7) million to current earnings related to the change in fair value of these derivatives for the three months ended June 30, 2001, and a gain of $66.9 million for the nine months ended June 30, 2001. No corresponding hedge offset relative to the change in the fair value of the mortgage servicing rights asset was recognized. Consequently, the Company reversed a previously recorded change in value of the mortgage servicing rights due to hedged risk of $389.0 million to current earnings for the three months ended June 30, 2001 and $176.1 million for the nine months ended June 30, 2001. The Company also recorded an additional valuation provision recovery of $389.0 million related to an impairment evaluation of mortgage servicing rights for the three months ended June 30, 2001, and an additional valuation provision of $497.4 million for the nine months ended June 30, 2001. HomeSide's risk management program also employs the use of non-designated derivative contracts that are used to provide a level of economic offset against the value changes attributable to the non-designated portfolios that do not qualify for hedge accounting treatment under SFAS 133. Additionally, the Company is party to certain risk management strategies that are structured to mitigate yield curve risk and to provide a level of economic offset to the time decay (theta). These non-designated derivatives are marked-to-market with changes in value recorded to earnings. During the three months ended June 30, 2001 the company recognized a gain of $50.6 million to current earnings related to the change in fair value of these non-designated derivatives and a loss in the amount of $8.2 million associated with excluded components relating to theta. During the nine months ended June 30, 2001 the company recognized a gain of $10.3 million to current earnings related to the change in fair value of these non-designated derivatives and a loss in the amount of $94.4 million associated with the excluded components relating to theta. Additionally, the fair value of 11 the Company's derivative instruments used in the risk management of mortgage servicing rights is ($347.4) million at June 30, 2001. Risk Management of Corporate Funding To meet its funding requirements, the Company periodically issues fixed-rate, medium-term notes which are converted to floating-rate debt as part of its Corporate funding strategies. As of the three months and nine months ended June 30, 2001, the Company had $750 million of fixed-rate, medium term notes that had been swapped to floating rates of interest with $750.0 million in notional interest rate swaps. The Company has designated the interest rate swaps as fair value hedges of the change in value of the medium-term notes due to LIBOR interest rates. At the inception of the hedge, the Company formally documents the hedging relationships between the hedge instruments and the hedged items, as well as the risk management objectives and strategy for undertaking the hedge transactions. The medium-term notes are not prepayable and the key terms of the interest rate swaps are equivalent to those of the medium-term notes. Accordingly, the Company expects that changes in the value of the interest rate swaps will offset the changes in the value of the fixed-rate debt attributable to LIBOR interest rates. During the three months and nine months ended June 30, 2001, the value of the interest rate swap contracts (decreased)/increased by $(0.8) million and $24.4 million, respectively, and offset the changes in the fair value of the medium-term notes due to the hedge risk. The fair value of interest rate swap contracts designated as fair value hedges of medium-term notes was $24.2 million at June 30, 2001. Termination of Hedging Relationships The Company employs a number of risk management monitoring procedures to ensure that the designated hedging relationships are demonstrating, and are expected to continue to demonstrate, a high level of effectiveness. Hedge accounting is discontinued on a prospective basis if it is determined that the hedging relationship is no longer effective or expected to be effective in offsetting changes in the fair value or cash flows of the hedge item, or if a forecasted transaction is no longer probable of occurring. Additionally, the Company may elect to dedesignate a hedge relationship during an interim period and redesignate upon the rebalancing of a hedge profile and the corresponding hedge relationship. When hedge accounting is discontinued, the Company continues to carry the derivative instruments at fair value with changes in their value recorded to earnings. However, in the case of a fair value hedge that is discontinued, the carrying amount of the previously hedged asset or liability may not be adjusted for changes in their fair value, except in the case where a decline in fair value creates impairment to the Company. In the case of a cash flow hedge of a forecasted transaction that is no longer probable of occurring, gains and losses that were previously accumulated in other comprehensive income are immediately recognized to earnings. Fair Value of Derivative Instruments Derivative Contracts: The fair value of mortgage forward delivery contracts, options on mortgage-backed securities and exchange traded futures and options on Treasury and Eurodollar contracts are determined based on market quotes. Interest rate swaps, swaptions and caps are determined based on discounted valuation models and are periodically validated against dealer quotes. Interest Rate Lock Commitments Classified as Derivatives: The fair value of interest rate lock commitments is determined using a vendor provided valuation model which references market quotes of the underlying mortgages. The valuation model also considers a number of other key value determinants including the remaining commitment period, the rate of the commitment in relation to current market rates, interest rate volatility and the probability of the loan closing. The probability of the loan closing is estimated based on historical pull-through rates which are stored in matrix detail within the model database by product type for an established set of interest rate shock scenarios. The fair value of the Company's IRLCs generally approximate zero at inception (the lock-in date) since the Company's practice is to extend loan commitments at market rates of interest and to exclude from its fair value calculation the normal profit margin associated with the future loan sale transactions. Other Derivatives: The Company uses certain derivatives to economically hedge the funding activities associated with government loans that are repurchased out of GNMA (Government National Mortgage Association) pools that the Company has previously sold. However, the Company does not designate a hedging relationship for these derivatives for hedge accounting purposes. Accordingly, net gains/(losses) on these derivatives of $0.5 million and $(0.2) million for the three months and nine months ended June 30, 2001, respectively, were recorded to income and included as a component of risk management results in the previously filed Form 10-Q for the quarter ended June 30, 2001. To present an integrated operational perspective, these results were reclassified and are now included as a component of other income in the accompanying consolidated statements of income. 12 6. NOTES PAYABLE Notes payable consist of the following (in thousands): Weighted Average Interest Rate ---------------- ------------- Total Outstanding At Period End During the Period ----------------- ------------- ----------------- June 30, 2001: Money market notes $ 123,000 3.43% 3.43% Commercial paper 2,000,000 4.02% 4.41% National Australia Bank unsecured facility 1,886,000 4.30% 4.37% ---------------------- Total $4,009,000 ====================== September 30, 2000: Commercial Paper $ 1,500,000 6.63% 6.16% National Australia Bank Unsecured Facility 1,735,400 6.70% 6.25% ---------------------- Total $3,235,400 ======================

On June 18, 2001, HomeSide Lending, the Company's wholly-owned operating subsidiary, established a money market note program. As of June 30, 2001, $123.0 million in money market notes were outstanding. Interest is payable at the maturity date of each money market note. The weighted average interest rate on the money market notes during the three-month period ended June 30, 2001 was 3.43%. HomeSide Lending has an established commercial paper program, which is supported by an independent syndicate of banks under a credit facility. On March 19, 2001 this commercial paper program was increased from $1.5 billion to $2.0 billion. The weighted average interest rates on commercial paper outstanding during the three- and nine-month periods ended June 30, 2001 were 4.41% and 5.41%, respectively. On October 16, 2000, HomeSide Lending entered into a $1.5 billion back-up credit facility. This agreement replaces HomeSide Lending's previous bank credit facility and will terminate on October 15, 2002. Borrowings under the credit facility bear interest at rates per annum, based on, at HomeSide's option, (i) the Eurodollar rate plus an applicable margin, (ii) the greater of the federal funds rate plus an applicable margin or the prime rate, (iii) in the case of swingline loans, the federal funds rate plus an applicable margin, or (iv) in the case of competitive bid loans, the lowest competitive Eurodollar or fixed rate submitted by a bidding lender. The primary purpose of this credit facility is to provide liquidity back-up for HomeSide's commercial paper program. The outstanding commercial paper reduces available borrowings under the credit facility. At June 30, 2001, there were no amounts outstanding under the credit facility. In June 1998, HomeSide Lending entered into an unsecured revolving credit facility with the National to provide short-term funding up to $2.0 billion (increased in 1999 to $2.5 billion), subject to limits imposed by the National's regulatory authorities. Borrowings under the credit facility may be overnight or for periods of 7,30,60 or 90 days. For overnight borrowings, the interest rate is determined by the National at the time of the borrowing. For LIBOR - based borrowings, the interest rate is charged at the corresponding LIBOR rate. The weighted average interest rate on outstanding borrowings under this credit facility during the three- and nine-month periods ended June 30, 2001 were 4.37% and 5.51%, respectively. 13 7. LONG-TERM DEBT Medium-term notes As of June 30, 2001, outstanding medium-term notes issued by HomeSide Lending under a $3.568 billion shelf registration statement were as follows (in thousands): Issue Date Outstanding Balance Coupon Rate Maturity Date ---------- ------------------- ----------- ------------- June 30, 1997 $ 200,000 6.88% June 30, 2002 June 30, 1997 40,000 6.82% July 2, 2001 July 1, 1997 15,000 6.86% July 2, 2001 July 31, 1997 200,000 6.75% August 1, 2004 September 15, 1997 45,000 6.77% September 17, 2001 May 22, 1998 225,000 6.20% May 15, 2003 June 9, 2000 215,000 7.07% * June 10, 2002 June 9, 2000 200,000 6.89% * April 9, 2002 June 9, 2000 85,000 7.07% * June 10, 2002 August 1, 2000 75,000 6.97% * August 1, 2002 September 14, 2000 75,000 6.79% * September 16, 2002 September 14, 2000 60,000 6.94% * September 15, 2003 September 14, 2000 25,000 7.00% September 16, 2002 September 15, 2000 100,000 6.79% * September 16, 2002 September 15, 2000 50,000 6.86% * September 16, 2002 December 4, 2000 125,000 6.98% * December 4, 2002 December 4, 2000 75,000 6.98% * December 4, 2002 December 4, 2000 50,000 6.87% * December 4, 2002 --------------------------- Total $1,860,000 =========================== ---------- * Represents initial interest rate for floating rate note

As of June 30, 2001, the outstanding fixed rate medium-term notes of $750.0 million had been effectively converted by interest rate swap agreements to floating-rate notes. During the three months and nine months ended June 30, 2001, the value of the interest rate swap contracts (decreased)/increased by $(0.8) million and $24.4 million, respectively, and offset the changes in the fair value of the medium-term notes due to the hedge risk. The fair value of interest rate swap contracts designated as fair value hedges of medium-term notes was $24.2 million at June 30, 2001. See note 5. The weighted average borrowing rates on medium-term borrowings issued during the three- and nine-month periods ended June 30, 2001, including the effect of the interest rate swap agreements, were 5.75% and 6.32%, respectively. Net proceeds from the issuances were primarily used to reduce the amounts outstanding under the bank credit agreement and fund mortgage servicing rights. Mortgage note payable In connection with the acquisition of BancBoston Mortgage Corporation, HomeSide Lending assumed a mortgage note payable that is due in 2017 and bears interest at a stated rate of 9.5%. HomeSide Lending's main office building is pledged as collateral for the mortgage note payable. The balance of the mortgage payable at June 30, 2001, including the fair value adjustments resulting from the merger with the National, was $21.8 million. 11.25% Notes As of March 31, 2001, the Company had $130.0 million outstanding on a previous issue of 11.25% notes (the "Notes") with a maturity date of May 15, 2003. The balance of the Notes at March 31, 2001, including the fair value adjustment resulting from the merger with the National, was $139.5 million. The Notes were redeemable at the option of the Company, in whole or in part, at any time on or after May 15, 2001, at certain fixed redemption prices. On May 16, 2001 the Company redeemed the 11.25% notes at the redemption price set forth in the Notes. The Company recognized a $1.0 million after tax gain on the early extinguishment of the debt, which is disclosed as an extraordinary item on the accompanying consolidated statements of income. 14 8. SUBSEQUENT EVENTS (Restated) On July 24, 2001, National Australia Bank Limited, the ultimate parent of HomeSide, by and through various intermediate holding companies, entered into a stock subscription agreement with HomeSide in the amount of $150.0 million for the issuance of additional shares of HomeSide common stock. On July 31, 2001, HomeSide and the National amended their unsecured revolving credit facility and changed National's funding limit to $2.42 billion through January 2002, and $1.92 billion thereafter. 9. NEW ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141") which supercedes APB No.16 "Business Combinations" and SFAS 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises". SFAS 141 changes the existing accounting treatment for business combinations to allow only the purchase method. The statement applies to all business combinations initiated after June 30, 2001. The statement also applied to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. Management does not expect the adoption of this statement to have a material impact on the financial statements. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") which supercedes APB Opinion No. 17, Intangible Assets. This statement addresses how intangible assets should be accounted for in financial statements upon their acquisition and also how they should be accounted for after they have been initially recognized in the financial statements. The provisions of this statement are required to be applied starting with fiscal years beginning after December 15, 2001. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not been previously issued. This statement is required to be applied at the beginning of an entity's fiscal year and to be applied to all goodwill and other intangible assets reported in its financial statements at that date. Management is currently evaluating the requirements of this standard and has not yet determined the impact on the financial statements. In July 2001, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 102 ("SAB 102") which expresses certain of the staff's views on the development, documentation and application of a systematic methodology for determining allowances for loan and lease losses in accordance with generally accepted accounting principles. In particular, the guidance focuses on the documentation the staff normally would expect registrants to prepare and maintain in support of their allowances for loan losses. Management believes that it is currently in compliance with the requirements of SAB 102. 10. DIVIDENDS On April 2, 2001 the Company paid dividends to the National in the amount of $24.0 million. On October 23, 2000 the Company paid dividends to the National in the amount of $24.0 million. ITEM 2. Management's Discussion and Analysis of Financial Condition and Results ------------------------------------------------------------------------ of Operations ------------- General HomeSide International, Inc. ("HomeSide" or the "Company"), through its wholly owned operating subsidiary HomeSide Lending, Inc. ("HomeSide Lending"), is one of the largest full service residential mortgage banking companies in the United States. The Company is the successor to HomeSide, Inc. ("HomeSide, Inc. Predecessor"). On February 10, 1998, National Australia Bank, Ltd. (the "National") acquired all outstanding shares of the common stock of HomeSide, Inc. Predecessor and the Company adopted a fiscal year end of September 30 to conform to the fiscal year of the National. HomeSide, Inc. Predecessor was formed through the acquisition of the mortgage banking operations of BankBoston, N.A. ("BBMC Predecessor" to HomeSide, Inc. Predecessor) on March 16, 1996 and subsequently purchased the mortgage banking operations of Barnett Banks, Inc. HomeSide's strategy emphasizes variable cost and diversified mortgage origination, efficient servicing, and risk management. Headquartered in Jacksonville, Florida, HomeSide ranks as the 10th largest originator and the 6th largest servicer in the United States at June 30, 2001, based on data published by Inside Mortgage Finance. 15 HomeSide's strategy has been to continue to expand its core operations through (i) improved economies of scale in servicing; (ii) increased productivity using proprietary technology; and (iii) expanded and diversified variable cost origination channels. In addition, HomeSide has pursued additional portfolio acquisitions and strategic origination relationships with mortgage lenders and other entities that offer similar financial services. Operating results for the three and nine-month periods ended June 30, 2001 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2001. For further information, refer to the consolidated financial statements and footnotes thereto included in the Form 10-K for the fiscal year ended September 30, 2000 of HomeSide Lending, Inc. Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for certain forward-looking statements. This Quarterly Report on Form 10-Q contains forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those identified below, which could cause actual results to differ materially from historical results or those anticipated. The words "believe," "expect," "anticipate," "intend," "estimate" and other expressions which indicate future events and trends identify forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. The following factors could cause actual results to differ materially from historical results or those anticipated: (1) the Company's ability to grow which depends on its ability to obtain additional financing in the future for originating loans, investment in servicing rights, working capital, capital expenditure and general corporate purposes, (2) economic downturns may negatively affect the Company's profitability as the frequency of loan default tends to increase in such environments and (3) changes in interest rates may affect the volume of loan originations and acquisitions, the interest rate spread on loans held for sale, the amount of gain or loss on the sale of loans and the value of the Company's servicing portfolio and hedging relationships. These risks and uncertainties are more fully detailed in the Company's filings with the Securities and Exchange Commission. Loan Production Activities HomeSide participates in several origination channels, including wholesale origination (correspondent, co-issue, and broker) and direct origination (HomeSide Solutions) channels. The direct channels include internet, telemarketing, direct mail, and mortgages related to affinity group and co-branding partnerships. HomeSide also purchases servicing rights in bulk from time to time. HomeSide's strategy is to customarily sell all loans that it originates or purchases while retaining the servicing rights to such loans. This multi-channel production base provides access to and flexibility among production channels in a wide variety of market and economic conditions. By focusing on production channels with a variable cost structure, HomeSide reduces the fixed costs associated with traditional mortgage branch offices. By minimizing the burden of high fixed cost origination overhead, HomeSide is positioned to weather a variety of interest rate environments. The following information regarding loan production activities for HomeSide is presented to aid in understanding the results of operations and financial condition of HomeSide for the three- and nine-month periods ended June 30, 2001 and 2000 (in millions): For the Three For the Three For the Nine For the Nine Months Ended Months Ended Months Ended Months Ended June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000 ----------------- --------------- --------------- ---------------- Correspondent $ 5,487 $ 2,169 $ 11,682 $ 6,448 Co-issue 4,862 1,939 12,393 6,011 Broker 1,379 540 3,159 1,352 ----------------- --------------- --------------- ---------------- Total wholesale 11,728 4,648 27,234 13,811 Direct (HomeSide Solutions) 483 169 989 445 ----------------- --------------- --------------- ---------------- Total production 12,211 4,817 28,223 14,256 Bulk acquisitions - 5,152 15,261 12,176 ----------------- --------------- --------------- ---------------- Total production and Acquisitions $12,211 $9,969 $43,484 $26,432 ================= =============== =============== ================

Total loan production, excluding bulk acquisitions, increased 153% and 98% respectively for the three and nine months ended June 30, 2001 compared to June 30, 2000. The increase was a function of HomeSide's ability to leverage origination alliances, technological enhancements and influences from a more favorable interest rate environment. When interest rates decline, the size of the mortgage origination market increases as home ownership becomes more affordable and as existing mortgagors refinance their loans. For the three- and nine-month periods ended June 30, 2001, refinances were 56% and 46%, respectively, of HomeSide's production volume, compared to 19% and 21%, respectively, for the three and nine month periods ended June 30, 2000. 16 Economies of scale are vital to the long-term viability of mortgage servicing and are increasingly important to remain competitive in the industry. Although HomeSide did not close on any bulk acquisitions during the quarter, the Company continues to pursue growth opportunities through bulk acquisitions of mortgage servicing rights and through its Preferred Partnership program. Preferred partnerships generally include a bulk servicing acquisition and an ongoing mortgage origination flow. HomeSide services loans on a priority basis on behalf of its Preferred Partners and offers the customer mortgage-related products. Preferred Partner relationships contributed 18% of HomeSide's production volume for the nine months ended June 30, 2001. Servicing Portfolio Based on certain industry servicing statistics, management asserts that HomeSide is one of the most efficient mortgage servicers in the industry based on its servicing cost per loan and the number of loans serviced per employee. The servicing operation makes extensive use of state-of-the-art technology, process re-engineering and expense management. With a portfolio size of $187.4 billion, HomeSide services the loans of approximately 2.1 million homeowners from across the United States and is committed to protecting the associated asset value through its risk management strategy. HomeSide's focus on efficient and low cost processes is pursued through the selective use of automation, strategic outsourcing of selected servicing functions and effective control of delinquencies and foreclosures. The following information on the dollar amounts of loans serviced is presented to aid in understanding the results of operations and financial condition of HomeSide for the three- and nine-month periods ended June 30, 2001 and 2000 (in millions): For the Three For the Three For the Nine For the Nine Months Ended Months Ended Months Ended Months Ended June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000 ------------------ ------------------ -- ---------------- -- --------------- Balance at beginning of Period $ 189,408 $ 152,501 $ 173,310 $ 145,552 Additions, net 12,148 9,882 43,376 26,266 Scheduled amortization 1,386 1,079 3,911 3,162 Prepayments 12,546 4,207 24,737 11,009 Foreclosures 214 266 628 816 ------------------ ------------------ ---------------- --------------- Total reductions 14,146 5,552 29,276 14,987 ------------------ ---------------- --------------- ------------------ Balance at end of period $ 187,410 $ 156,831 $ 187,410 $ 156,831 ================== ================== ================ ===============

The number of loans serviced at June 30, 2001 was 2,068,773 compared to 1,772,999 at June 30, 2000. HomeSide's strategy is to grow its mortgage servicing portfolio by concentrating on variable cost loan origination strategies and selective portfolio acquisitions, and as a result, benefit from improved economies of scale. A key to HomeSide's future growth is the capacity provided by its proprietary servicing software. This system allows HomeSide to double the number of loans typically serviced on a single system and is also used by the National to service its growing loan portfolio. Results of Operations (Restated) For the three months ended June 30, 2001 compared to the three months ended June 30, 2000 Summary (Restated) Restated net (loss) income was ($265.0) million for the three months ended June 30, 2001, compared to $6.6 million for the three months ended June 30, 2000. The $271.6 million decrease is primarily due to the impact of the loss caused by the change in value of the derivatives determined to no longer qualify for hedge accounting. Restated total (expenses) revenues for the three months ended June 30, 2001 of ($330.7) million compared to total revenue of $82.4 million for the three months ended June 30, 2000. The $413.1 million decrease was primarily due to the impact of the loss caused by the change in value of the derivatives determined to no longer qualify for hedge accounting. Restated net servicing (expense) revenue resulted in a net expense of ($396.9) million, a decrease of $482.4 million compared to net revenue of $85.5 million for the three months ended June 30, 2000. This change was primarily due to the impact of the loss caused by the change in value of the derivatives determined to no longer qualify for hedge accounting. Net interest expense decreased to ($5.8) million for the three months ended June 30, 2001, compared to ($18.2) million for the three months ended June 30, 2000. This 68% decrease resulted primarily from a decrease in interest rates, widening of the spread between short-term and long-term interest rates and was partially offset by the growth of HomeSide's net assets. Net mortgage origination revenue increased from $13.6 million to $67.7 million primarily due to declining mortgage interest rates, which resulted in increased production volumes and margins. Total expenses increased 24% as a result of higher expenses associated with the increase in production volumes, growth of 17 the servicing portfolio, and higher prepayment activity. Income tax expense decreased as a result of the net loss primarily due to the impact of the loss caused by change in value of the derivatives determined to no longer qualify for hedge accounting. Net Servicing (Expense) Revenue (Restated) The Company incurred a net expense of ($396.9) million for the three months ended June 30, 2001 compared to net revenue of $85.5 million for the three months ended June 30, 2000. Net servicing (expense) revenue is comprised of mortgage servicing fees net of guaranty fees, ancillary servicing revenue, amortization and valuation provision of mortgage servicing rights, and the earnings impact of risk management of the mortgage servicing rights. Mortgage servicing fees increased 23% to $224.9 million for the three months ended June 30, 2001 compared to $182.5 million for the three months ended June 30, 2000, primarily as a result of portfolio growth. The servicing portfolio increased $30.6 billion to $187.4 billion at June 30, 2001 compared to $156.8 billion at June 30, 2000, a 19% increase. The growth in the servicing portfolio was primarily due to the increase in production volumes resulting from declining mortgage rates. HomeSide's weighted average interest rates of the mortgage loans in the servicing portfolio for the three-month period were 7.56% and 7.53% at June 30, 2001 and 2000, respectively. The weighted average servicing fee, net of guaranty fees and including ancillary income, for the servicing portfolio was 47.9 basis points for the three months ended June 30, 2001 compared to 47.3 basis points for the three months ended June 30, 2000. Amortization expense increased 77% to $171.8 million for the three months ended June 30, 2001 compared to $97.1 million for the three months ended June 30, 2000. The increase in amortization expense was primarily due to acceleration of projected prepayment speeds associated with declining mortgage interest rates. A decline in mortgage interest rates results in an increase in prepayment estimates used in calculating periodic amortization expense. Because mortgage servicing rights are amortized over the expected period of net service fee revenues, an increase in mortgage prepayment activity typically results in a shorter estimated life of the mortgage servicing assets and, accordingly, higher amortization expense. See Note 4 to the Consolidated Financial Statements. Restated valuation provision of mortgage servicing rights income of $75.3 million for the three months ended June 30, 2001 is primarily due to the reduction in provision for the mortgage servicing rights as described in detail in the Risk Management of Mortgage Servicing Rights below. Restated risk management of mortgage servicing rights (expense) of ($525.3) million is primarily due to the $567.7 million loss on derivatives determined to no longer qualify for hedge accounting , as described in detail in the section on Risk Management of Mortgage Servicing Rights in Note 5, "Risk Management and the Accounting for Derivative Instruments and Hedging Activities". Net Interest Expense Net interest expense is driven by the level of interest rates, the associated spread between short- and long-term interest rates, the rates at which HomeSide is able to borrow, and the growth in net assets. These factors influence the size of the residential mortgage origination market, HomeSide's loan production volumes, the interest income HomeSide earns on its mortgages held for sale and interest paid to its lenders. These factors also influence risk management results that affect funding requirements. Loan refinancing levels are the largest contributor to changes in the size of the mortgage origination market. As interest rates decline, more borrowers refinance their mortgages, resulting in an increase in the mortgage origination market. Higher loan production volumes result in higher average balances of mortgages held for sale and consequently higher levels of the interest income from interest earned on such loans prior to their sale. This higher level of interest income due to increased volume is partially offset by the lower rates earned on the loans. Overall borrowing costs also fluctuate with changes in interest rates. Currently, the interest expense HomeSide pays to finance mortgage loans held for sale and other net assets is generally calculated with reference to short-term interest rates. In addition, because mortgage loans held for sale earn interest based on longer term interest rates, net interest revenue is also influenced by the spread between long-term and short-term interest rates. Net interest expense decreased 68% from ($18.2) million to ($5.8) million for the three months ended June 30, 2001 compared to the three months ended June 30, 2000. The decrease in net interest expense was primarily due to a widening of the spread between short-term and long-term rates partially offset by an increase in net assets due to higher production volumes and servicing portfolio growth. During the three months ended June 30, 2001, the spread between long term average mortgage rates and short term LIBOR rates widened by 85 basis points as compared to the three months ended June 30, 2000. 18 Net Mortgage Origination Revenue Net mortgage origination revenue is comprised of fees earned on the origination of mortgage loans, fees charged to review loan documents for purchased loan production, gains and losses on the sale of loans, and reclassified risk management hedge results. Net mortgage origination revenue was $67.7 million for the three months ended June 30, 2001 compared to $13.6 million for the three months ended June 30, 2000. The increase was primarily due to an increase in production volumes and margins resulting from the factors previously discussed in the loan production activities section. Other Income Other income for the three months ended June 30, 2001 was $4.2 million compared to $1.5 million for the three months ended June 30, 2000. This increase is primarily due to the amortization of the deferred gain resulting from a sale-leaseback transaction involving HomeSide's facility in San Antonio, Texas entered into on October 2, 2000. In accordance with SFAS 98 "Accounting for Leases", HomeSide recognized an immediate gain of $4.5 million and recorded a deferred gain of $7.3 million which is amortized over the life of the lease. Salaries and Employee Benefits Salaries and employee benefits expense was $38.1 million for the three months ended June 30, 2001 compared to $27.9 million for the three months ended June 30, 2000, a 37% increase. The average number of full-time equivalent employees was 2,700 for the three months ended June 30, 2001 compared to 2,365 for the three months ended June 30, 2000. This increase is attributable to higher production volumes resulting in higher commissions, incentives and an increase in temporary and overtime staff. Occupancy and Equipment Expense Occupancy and equipment expense primarily includes rental expense, repairs and maintenance costs, certain computer software expenses and depreciation of HomeSide's premises and equipment. Occupancy and equipment expense for the three months ended June 30, 2001 was $10.4 million compared to $7.7 million for the three months ended June 30, 2000, a 36% increase. The increase is driven by additional leased space and technology related assets in support of growth in the mortgage servicing portfolio. Servicing Losses on Investor-Owned Loans and Foreclosure-Related Expenses Servicing losses on investor-owned loans represent anticipated losses primarily attributable to servicing FHA and VA loans for investors. These amounts include actual losses for the final disposition of loans, non-recoverable foreclosure costs, accrued interest for which payment has been curtailed and estimates for potential losses based on HomeSide's experience as a servicer of government loans. The servicing losses on investor-owned loans and foreclosure-related expenses totaled $8.9 million for the three months ended June 30, 2001 compared to $9.1 million for the three months ended June 30, 2000. The decrease was mainly attributable to a decline in per unit servicing losses for the three-month period. Included in the balance of accounts payable and accrued liabilities at June 30, 2001 is a reserve for estimated servicing losses on investor-owned loans of $16.7 million. The reserve has been established for potential losses related to the mortgage servicing portfolio. Increases to the reserve are charged to earnings as servicing losses on investor-owned loans. The reserve is decreased for actual losses incurred related to the mortgage servicing portfolio. HomeSide's historical loss experience on VA loans generally has been consistent with industry experience. Management believes that HomeSide has an adequate level of reserve based on servicing volume, portfolio composition, credit quality and historical loss rates, as well as estimated future losses. 19 The following table sets forth HomeSide's delinquency and foreclosure experience: Servicing Portfolio Delinquencies (percent by loan count) June 30, 2001 June 30, 2000 -------------------- ------------------- Servicing Portfolio Delinquencies, excluding bankruptcies (at end of period) 30 days 3.08% 2.46% 60 days 0.60% 0.50% 90+ days 0.38% 0.44% -------------------- ------------------- Total past due 4.06% 3.40% ==================== =================== Foreclosures pending 0.65% 0.47% ==================== ===================

Other Expenses Other expenses consist mainly of professional fees, communications expense, advertising and public relations, data processing expenses and certain loan origination expenses. The level of other expenses fluctuates in part based upon the level of HomeSide's mortgage servicing portfolio and loan production volumes. Other expenses were $16.9 million for the three months ended June 30, 2001, compared to $13.3 million for the three months ended June 30, 2000, a 27% increase. The increase was primarily driven by higher production volumes, servicing portfolio growth, and an increase in prepayment activity. Income Tax (Benefit) Expense HomeSide's income tax (benefit) expense was ($147.8) million for the three months ended June 30, 2001 compared to $8.9 million for the three months ended June 30, 2000. The effective income tax rates for the three-month periods ended June 30, 2001 and 2000 were 36% and 58%, respectively. The decrease in the income tax (benefit) expense was due to a net loss resulting from the change in the valuation provision of mortgage servicing rights offset by losses recognized from the change in value of the derivatives determined to no longer qualify for hedge accounting. Results of Operations (Restated) For the nine months ended June 30, 2001 compared to the nine months ended June 30, 2000 Summary (Restated) Restated net (loss) income was ($487.8) million for the nine months ended June 30, 2001, compared to $43.0 million for the nine months ended June 30, 2000. The $530.8 million decrease is primarily due to the impact of the valuation provision for the mortgage servicing rights driven by the acceleration of the projected prepayment speeds associated with declining mortgage interest rates. Restated total (expenses) revenues for the nine months ended June 30, 2001 of ($520.5) million compared to total revenue of $267.8 million for the nine months ended June 30, 2000. The $788.3 million decrease was primarily due to the impact of the valuation provision for the mortgage servicing rights. Restated net servicing (expense) revenue resulted in a net expense of ($618.4) million, a decrease of $860.5 million compared to net revenue of $242.1 million for the nine months ended June 30, 2000. This change was primarily due to the impact of the valuation provision for the mortgage servicing rights. Net interest expense increased to ($43.8) million for the nine months ended June 30, 2001, compared to ($30.5) million for the nine months ended June 30, 2000. This 44% increase resulted primarily from a narrowing of the average period-over-period spread between short-term and long-term interest rates and the growth of HomeSide's assets. Net mortgage origination revenue increased 147% for the nine months ended June 30, 2001 compared to the nine months ended June 30, 2000 primarily due to declining mortgage interest rates which resulted in increased production volume and margins. Total expenses of $235.6 million for the nine months ended June 30, 2001 compared to $195.3 million for the nine months ended June 30, 2000, an increase of 21%, was a result of higher expenses associated with the increase in production volumes, the growth of the servicing portfolio, and higher prepayment activity. Income tax expense decreased as a result of the net loss due to the impact of risk management results (SFAS 133) and provision for mortgage servicing rights recognized in earnings. 20 Net Servicing (Expense) Revenue (Restated) The Company incurred a net expense of ($618.4) million for the nine months ended June 30,2001, compared to net revenue of $242.1 million for the nine months ended June 30, 2000. Net servicing (expense) revenue is comprised of mortgage servicing fees net of guaranty fees, ancillary servicing revenue, amortization and valuation provision of mortgage servicing rights, and the earnings impact of risk management of mortgage servicing rights. Mortgage servicing fees increased 21% to $653.4 million for the nine months ended June 30, 2001 compared to $539.4 million for the nine months ended June 30, 2000, primarily as a result of portfolio growth. HomeSide's weighted average interest rates of the mortgage loans in the servicing portfolio for the nine-month period were 7.59% and 7.53% at June 30, 2001 and 2000, respectively. The weighted average servicing fee, net of guaranty fees and including ancillary income, for the servicing portfolio was 47.2 basis points for the nine months ended June 30, 2001 compared to 47.6 basis points for the nine months ended June 30, 2000. Amortization expense was $427.5 million for the nine months ended June 30, 2001 compared to $297.3 million for the nine months ended June 30, 2000, a 44% increase. The increase in amortization expense was primarily due to the accelerated projected prepayment speeds associated with declining mortgage interest rates. A decrease in mortgage interest rates results in an increase in prepayment estimates used in calculating periodic amortization expense. Because mortgage servicing rights are amortized over the expected period of service fee revenues, an increase in mortgage prepayment activity typically results in a shorter estimated life of the mortgage servicing assets and, accordingly, higher amortization expense. See Note 3 to the Consolidated Financial Statements. Restated valuation provision of mortgage servicing rights of ($827.1) million for the nine months ended June 30, 2001 is primarily due to the impairment of the mortgage servicing rights as described in detail in the Risk Management of Mortgage Servicing Rights below. Restated risk management of mortgage servicing rights (expense) of ($17.2) million for the nine months ended June 30, 2001 is primarily due to the $66.9 million gain on derivatives determined to no longer qualify for hedge accounting offset by the $94.4 million loss associated with the excluded components relating to theta. More detail regarding these items are described in the section on Risk Management of Mortgage Servicing Rights in Note 5, "Risk Management and the Accounting for Derivative Instruments and Hedging Activities". Net Interest Expense Net interest expense is driven by the level of interest rates, the associated spread between short and long-term interest rates, the rates at which HomeSide is able to borrow, and the growth in net assets. These factors influence the size of the residential mortgage origination market. HomeSide's loan production volumes, the interest income HomeSide earns on its mortgages held for sale and interest paid to its lenders. These factors also influence risk management results that affect funding requirements. Loan refinancing levels are the largest contributor to changes in the size of the mortgage origination market. As interest rates decline, more borrowers refinance their mortgages, resulting in an increase in the mortgage origination market. Higher loan production volumes result in higher average balances of mortgages held for sale and consequently higher levels of the interest income from interest earned on such loans prior to their sale. This higher level of interest income due to increased volume is partially offset by the lower rates earned on the loans. Overall borrowing costs also fluctuate with changes in interest rates. Currently, the interest expense HomeSide pays to finance mortgage loans held for sale and other net assets is generally calculated with reference to short-term interest rates. In addition, because mortgage loans held for sale earn interest based on longer term interest rates, the level of net interest revenue is also influenced by the spread between long-term and short-term interest rates. Net interest expense increased 44% from ($30.5) million to ($43.8) million for the nine months ended June 30, 2001 compared to the nine months ended June 30, 2000. The increase in net interest expense was primarily due to a narrowing of the spread between short-term and long-term rates and an increase in net assets due to higher production volumes and servicing portfolio growth. For the nine months ended June 30, 2001, average mortgage rates declined 91 basis points while average short-term LIBOR rates decreased 55 basis points, thereby tightening spreads by 36 basis points as compared to the nine months ended June 30, 2000. Although the decrease in short-term-rates influenced a widening of spreads in the most recent quarter, average spreads for the nine months ended June 30, 2001 were down to 176 basis points versus an average of 212 basis points for the nine months ended June 30, 2000. Net Mortgage Origination Revenue Net mortgage origination revenue is comprised of fees earned on the origination of mortgage loans, fees charged to review loan documents for purchased loan production, gains and losses on the sale of loans, and reclassified risk management hedge results. Net mortgage origination revenue was $129.9 million for the nine months ended June 30, 2001 compared to $52.5 million for the nine months ended June 30, 2000. The increase was primarily due to an increase in 21 production volumes and margins resulting from the factors previously discussed in the loan production activities section. Other Income Other income for the nine months ended June 30, 2001 was $11.8 million compared to $3.6 million for the nine months ended June 30, 2000. This increase primarily resulted from a sale-leaseback transaction involving HomeSide's facility in San Antonio, Texas entered into on October 2, 2000. In accordance with SFAS 98 "Accounting for Leases", HomeSide recognized an immediate gain of $4.5 million and recorded a deferred gain of $7.3 million which is amortized over the life of the lease. Salaries and Employee Benefits Salaries and employee benefits expense was $100.6 million for the nine months ended June 30, 2001 compared to $83.6 million for the nine months ended June 30, 2000, a 20% increase. The average number of full-time equivalent employees was 2,522 for the nine months ended June 30, 2001 compared to 2,463 for the nine months ended June 30, 2000. Occupancy and Equipment Expense Occupancy and equipment expense primarily includes rental expense, repairs and maintenance costs, certain computer software expenses and depreciation of HomeSide's premises and equipment. Occupancy and equipment expense for the nine months ended June 30, 2001 was $29.6 million compared to $24.0 million for the nine months ended June 30, 2000, a 23% increase. The increase is driven by additional leased space and technology related assets in support of growth in the mortgage servicing portfolio. Servicing Losses on Investor-Owned Loans and Foreclosure-Related Expenses Servicing losses on investor-owned loans represent anticipated losses primarily attributable to servicing FHA and VA loans for investors. These amounts include actual losses for the final disposition of loans, non-recoverable foreclosure costs, accrued interest for which payment has been curtailed and estimates for potential losses based on HomeSide's experience as a servicer of government loans. The servicing losses on investor-owned loans and foreclosure-related expenses totaled $27.1 million for the nine months ended June 30, 2001 compared to $24.8 million for the nine months ended June 30, 2000. The increase was primarily attributable to an increase in servicing losses related to the growth of the servicing portfolio. Other Expenses Other expenses consist mainly of professional fees, communications expense, advertising and public relations, data processing expenses and certain loan origination expenses. The level of other expenses fluctuates in part based upon the level of HomeSide's mortgage servicing portfolio and loan production volumes. Other expenses were $51.9 million for the nine months ended June 30, 2001, compared to $36.0 million for the nine months ended June 30, 2000, a 44% increase. The increase is primarily due to an increase in expenses associated with higher production volumes and an increase in prepayment activity. Income Tax (Benefit) Expense (Restated) HomeSide's restated income tax (benefit) expense was ($266.4) million for the nine months ended June 30, 2001 compared to $29.5 million for the nine months ended June 30, 2000. The effective income tax rates for the nine-month periods ended June 30, 2001 and 2000 were 35% and 41%, respectively. The decrease in the income tax (benefit) expense was due to a net loss resulting from the impact of the valuation provision of mortgage servicing rights and losses recognized from the change in value of the derivatives determined to no longer qualify for hedge accounting. Risk Management Activities (Restated) Mortgage banking entities face a broad range of risk that must be proactively managed to achieve success in the industry. The Company has utilized the enterprise-wide risk management structure that has been implemented and proven at the National and its global entities. The structure comprises a common policy framework and a set of controls that are utilized to achieve standardization of risks. Each business function is responsible for using standardized risk assessment templates along with best practices methodology for the identification and quantification of the particular risk it is exposed to and for the implementation of appropriate policies and procedures. 22 The Company's Risk Council, comprising executive and senior management as well as representation from internal audit, is the principal operating risk policy decision making body within the Company. Risk Council's role is to constantly monitor and assess the Company's risk profile in existing and future business operations, and to assist business units in the design and implementation of appropriate risk management policies and strategies. The Risk Council provides direction and oversight for many types of risks such as credit, operations, legislative compliance, e-commerce, business continuity and disaster recovery. Certain of the Company's other major risk areas (e.g. market risk) are more fully discussed below. Risk Management of Market Risk Market risk recognizes the potential change in the value of assets, liabilities and other financial commitments as a result of changes in asset prices along with changes in actual and projected interest rates. HomeSide continues to review and enhance its strategies and underlying policies relating to risk management of market risk based on changes in the market environment. Certain members of the Company's Risk Council also comprise the Company's Asset and Liability Management Committee ("ALCO") which, under delegated authority from the Board, sets policies in relation to the management of market risk, corporate funding and balance sheet management. Representatives of the Company's ALCO report to the National's ALCO concerning risk management and also participate in the National's group ALCO meetings. As more fully discussed in the notes to the financial statements, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", effective October 1, 2000. Accordingly, for the three-month and nine-month periods ended June 30, 2001, all of the Company's risk management derivative instruments are recorded at fair value. Changes in the value of risk management derivative instruments designated as qualifying fair value hedging relationships are recognized in current earnings along with the changes in the value of the qualifying hedged assets or liabilities. Changes in the value of risk management derivative instruments designated as qualifying cash flow hedging relationships of forecasted loan sale transactions are recorded to other comprehensive income ("OCI") and reclassified to earnings concurrent with settlement of the loan sale transactions. The accounting policies relevant to derivative instruments and hedging activities for each of the Company's key risk management areas are more fully discussed in note 5 to the consolidated financial statements. Market Environment During the last nine months, the US market has experienced unprecedented volatility in the interest rate environment. In response to the slowing US economy, the Federal Reserve has lowered interest rates on six occasions resulting in a decline in short-term interest rate of 275 basis points. Despite the sluggish economy, the US housing sector has remained strong. Purchase volumes have been solid and refinancing activities have hit levels not seen since mid-1998. This has resulted in increased production volumes and improved results in the Company's production channels. However, the declining interest rate environment and extensive refinancing activities have resulted in higher prepayment activity adversely impacting the value of the Company's mortgage servicing asset. Continued uncertainties surrounding future monetary policy and the state of the US economy have resulted in significant volatility in interest rate spreads between short and long term rates, placing considerable pressure on the Company's hedge performance. As more fully discussed in note 5 of the financial statements, HomeSide utilizes a combination of derivative instruments to create a hedge portfolio that is intended to provide effective protection of the value of the Company's mortgage servicing rights from interest rate risk. The volatile interest rate environment discussed above has negatively impacted the effectiveness of these derivative instruments. Following is a summary of risk management activities and results for the three months and nine months ended June 30, 2001: Risk Management of Loan Production Activities The Company maintains a risk management program to protect and manage interest rate risk and pricing risk associated with its mortgage commitment pipeline and mortgage inventory. In the normal course of business, the Company extends interest rate lock commitments ("IRLCs" or "commitments") to borrowers who apply for loan funding and meet certain credit and underwriting criteria. IRLCs in the mortgage pipeline expose the Company to interest rate and pricing risk. In a rising rate environment, the aggregate value of the Company's commitments tends to decrease in value and, generally, at an accelerating rate. In a declining rate environment, the value of the Company's commitments tends to increase in value. However, the rate of increase in the value tends to decelerate as the likelihood of the borrower closing on the loan decreases if market rates decline by a meaningful amount versus the borrower's committed rate. As part of its risk management processes, the Company has devoted substantial resources and modeling solutions to enable management to project the expected percent of IRLCs that 23 will ultimately fund under different interest rate scenarios (referred to as "pull-through rates"). The success of the Company's risk management strategies relies on proactive analysis of historical and projected pull-through rates. However, since borrower behavior cannot be perfectly predicted and modeled, an element of economic ineffectiveness can be expected in the Company's pipeline hedging relationships. In the aggregate, the Company's strategy involves the use of a combination of mortgage forward delivery commitments and mortgage options to maintain appropriate risk management coverage related to IRLCs. The Company utilizes mortgage forward delivery contracts to hedge a baseline portion of the Company's pipeline composed of interest rate lock commitments that management believes are probable of closing. Additionally, the Company utilizes options on mortgage securities and certain other products to hedge an element of the pipeline which is considered more uncertain of closing, and for which pull-through rates are likely to be volatile. During the three months and nine months ended June, 2001, the Company's risk management strategy was effective in the declining interest rate environment as the increase in the value of the Company's commitments more than offset the losses in the value of the related risk management derivative instruments. During the three months and nine months ended June 30, 2001, a net gain of approximately $5.2 million and $12.9 million, respectively attributable to pipeline hedging results was recognized to earnings. Pursuant to the requirements of SFAS 133 (which are discussed in note 4 to the Company's consolidated financial statements) interest rate lock commitments and related risk management derivative instruments are accounted for as non-designated derivatives with changes in their values recorded to current earnings. Interest rate lock commitments that are ultimately funded (closed) are classified as loans held for sale and are included in the Company's mortgage inventory. Closed loans in the mortgage inventory are also subject to interest rate and pricing risk. The Company's risk management program involves the use of mortgage forward delivery contracts to hedge 100% of its agency-eligible conforming loans as forecasted loan sales. Pursuant to the terms of SFAS 133, the Company accounts for the forward delivery contracts as cash flow hedges of forecasted loan sales. The forward contracts achieve effective offset against the changes in the value of the loans in that the forward contracts effectively fix the future loan delivery price. At June 30, 2001, gains on forward delivery contracts of $8.4 million were included in other comprehensive income (OCI). Pursuant to the requirements of SFAS 133, the unrealized gains in OCI will be recognized to earnings on the loan settlement dates, as the forecasted loan sales are consummated over the next 90 days. Risk Management of Mortgage Servicing Rights (Restated) Mortgage servicing rights represent the capitalized value of the estimated future net servicing revenues associated with the Company's servicing portfolio. See Note 4 to the Consolidated Financial Statements. The Company maintains a risk management program intended to protect the value of mortgage servicing rights from changes in value due to changes in estimated loan prepayment speeds, which are mainly influenced by changes in interest rates. The value of mortgage servicing rights is extremely sensitive to changes in interest rates since interest rates are the primary driver of actual and projected prepayment rates. As interest rates decline, prepayment rates increase as a result of actual and expected refinancing activities of borrowers. As a result, the value of mortgage servicing rights decreases in value as interest rates decline and, generally, at accelerating rates depending in large measure on the note rates of the underlying loans in relation to market interest rates. The value of the Company's mortgage servicing rights is based on the present value of expected cash flows received over the life of the loan using vendor models which incorporate prepayment estimates to forecast estimated future servicing revenues, servicing costs, ancillary revenues, escrow earnings, credit losses and other expenses. See Note 4 to the Consolidated Financial Statements. The Company's risk management program involves the use of a portfolio of risk management derivative instruments which increase in value as interest rates decline. More specifically, management uses a combination of derivative instruments designed to offset changes in the value of the mortgage servicing rights in different interest rate scenarios. The Company also attempts to manage basis risk, term sector risk, and liquidity risk by diversifying its portfolio with an array of derivative instruments that are approved for use by the Company's ALCO. Accordingly, the hedge portfolio is generally comprised of mortgage products, swap products and treasury products that are structured along various points of the yield curve. The Company continues to review and expand its risk management framework. In view of the volatile market environment, the growth of the Company, and the complexities inherent with risk management of mortgage servicing rights, the Company has made and continues to make investments to enhance systems and control. Since the inception of HomeSide in March of 1996, the Company's hedge strategy has been effective in providing effective offset to changes in the value of its mortgage servicing rights. However, as of the three months ended June 30, 2001, the Company did not qualify for hedge accounting pursuant to the requirements of SFAS 133 (see Note 2). As a result, the Company recognized to current earnings ($567.7) million in (loss) on derivatives determined to no longer qualify for hedge accounting and a $75.3 million reduction in impairment provision for the mortgage servicing rights asset for the three months ended June 30, 2001. For the nine months ended June 30, 2001, the Company recognized to current earnings $66.9 million in gain on derivatives determined to no longer qualify for hedge accounting and a $827.1 million impairment provision for the mortgage servicing rights asset. 24 Risk Management of Corporate Funding As part of its corporate funding and balance sheet management strategies, the Company maintains a desired level of its total borrowings through short-term funding sources. To meet the Company's financing needs, short-term funding is provided through the Company's commercial paper program and its short-term facility with the Parent. Additionally, the Company can alter its weighting in fixed-rate funding by converting medium-term notes to floating rate. During the three-month period ended June 30, 2001, the Company was party to $750 million in interest rate swaps which were effective in converting $750 million of medium-term notes to LIBOR-based funding. As discussed in note 5 to the financial statements, the interest rate swaps were accounted for as fair value hedges of the designated medium-term notes. Liquidity and Capital Resources The Company's principal financing needs are the financing of loan origination activities and the investment in mortgage servicing rights. To meet these needs, the Company currently utilizes funding from its commercial paper program, a credit facility with the National, medium-term notes, money market notes, an independent syndicate of banks, repurchase agreements, and cash flow from operations. HomeSide continues to investigate and pursue alternative and supplementary methods to finance its growing operations through the public and private capital markets. These may include methods designed to expand the Company's financial capacity and reduce its cost of capital. In addition, to facilitate the sale and distribution of certain mortgage products, HomeSide Mortgage Securities, Inc., a wholly owned subsidiary of HomeSide Lending, Inc., may continue to issue mortgage-backed securities. Operations Net cash provided by operations for the quarter ended June 30, 2001 was $20.4 million. Net cash used in operations for the quarter ended June 30, 2000 was $427.0 million. Net cash provided by operating activities for the nine-month periods ended June 30, 2001 and 2000 was $313.0 million and $291.1 million, respectively. Cash provided from servicing fee income, loan sales and principal repayments was offset by cash used for the origination and purchase of mortgage loans held for sale and to pay corporate expenses. Cash flows from loan originations are dependent upon current economic conditions and the level of long-term interest rates. Decreases in long-term interest rates generally result in higher loan refinancing activity, which results in higher cash demands to meet loan production levels. Investing Net cash used in investing activities for the quarters ended June 30, 2001 and 2000 were $315.6 million and $123.5 million, respectively. Net cash used in investing activities for the nine-month periods ended June 30, 2001 and 2000 were $851.2 million and $924.7 million, respectively. Cash used in investing activities was primarily for the purchase of mortgage servicing rights and risk management contracts. Cash was provided by proceeds from risk management contracts and early pool buyout reimbursements. Future uses of cash for investing activities will be dependent on the mortgage origination market and HomeSide's hedging needs. HomeSide is not able to estimate the timing and amount of cash uses for future acquisitions of other mortgage banking entities, if such acquisitions were to occur. Financing Net cash provided by financing activities for the quarters ended June 30, 2001 and 2000 was $386.1 million and $425.0 million, respectively. Net cash provided by financing activities for the nine-month periods ended June 30, 2001 and 2000 were $708.8 million and $609.5 million, respectively. Cash was provided by borrowings from the National and the issuance of medium-term notes, short-term notes, and commercial paper. Cash was used for repayment of borrowings from the National and commercial paper, payment of debt issue costs, payment of dividends to the Parent, and repayment of medium-term notes. HomeSide expects that to the extent cash generated from operations is inadequate to meet its liquidity needs, those needs can be met through financing from its bank credit facility and other facilities which may be entered into from time to time, as well as from the issuance of debt securities in the public markets. Accordingly, HomeSide does not currently anticipate that it will make sales of servicing rights to any significant degree for the purpose of generating cash. Nevertheless, in addition to its cash and mortgage loans held for sale balances, HomeSide's portfolio of mortgage servicing rights provides a potential source of funds to meet liquidity requirements, especially in periods of rising interest rates when loan origination volume slows. Repurchase agreements also provide an alternative to the established funding sources for mortgages held for sale. Future cash needs are highly dependent on future loan production and servicing results, which are influenced by changes in long-term interest rates. 25 Quantitative and Qualitative Market Risk There have been no material changes in the Company's market risk from September 30, 2000. For information regarding the Company's market risk, refer to Form 10-K for the fiscal year ended September 30, 2000 of HomeSide International, Inc. Additionally, the results of HomeSide's risk management programs and the associated accounting for derivative instruments and hedging activities pursuant to SFAS 133, as amended, is more fully described in Note 5 to the Consolidated Financial Statements. PART II - OTHER INFORMATION ITEM 1. Legal Proceedings ----------------- HomeSide is a defendant in a number of legal proceedings arising in the normal course of business. HomeSide, in management's estimation, has recorded adequate reserves in the financial statements for pending litigation. Management, after reviewing all actions and proceedings pending against or involving HomeSide, considers that the aggregate liability or loss, if any, resulting from the final outcome of these proceedings will not have a material effect on the financial position of HomeSide. In recent years, the mortgage banking industry has been subject to class action lawsuits which allege violations of federal and state laws and regulations, including the propriety of collecting and paying various fees and charges. Class action lawsuits may be filed in the future against the mortgage banking industry. ITEM 6. Exhibits and Reports on Form 8-K -------------------------------- (a) No documents are filed as a part of this Report (b) Reports on form 8-K HomeSide filed no reports on Form 8-K during the quarter ended June 30, 2001. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HomeSide International, Inc. ---------------------------- (Registrant) Date: December 6, 2001 By: /s/ Joseph J. Whiteside ---------------------------- Joseph J. Whiteside Chief Executive Officer (Principal Executive Officer) Date: December 6, 2001 By: /s/ Susan Lester --------------------------- Susan Lester Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 27

HOMESIDE INTERNATIONAL INC 10-Q/A