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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to __________________
Commission file number: 0-21231
MATRIX BANCORP, INC.
(Exact name of registrant as specified in its charter)
Colorado 84-1233716
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
700 17th Street, Suite 2100
Denver, Colorado 80202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (303) 595-9898
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0001 per share
Preferred Share Purchase Rights
(Title of class)
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of March 12, 2003, 6,491,043 shares of common stock were outstanding.
The aggregate market value of common stock held by non-affiliates of the
registrant, based on the closing sales price of such stock on the NASDAQ
National Market on March 12, 2003, was $17,631,513. For purposes of this
computation, all executive officers, directors and 10% beneficial owners of the
registrant are deemed to be affiliates. Such determination should not be deemed
an admission that such executive officers, directors and 10% beneficial owners
are affiliates.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Company's definitive proxy statement for the Annual
Meeting of Shareholders to be held May 16, 2003 are incorporated by reference
into Part III of this Form 10-K.
TABLE OF CONTENTS Page
PART I
Item 1. Business..............................................................................................3
Item 2. Properties...........................................................................................26
Item 3. Legal Proceedings....................................................................................27
Item 4. Submission of Matters to a Vote of Security Holders..................................................29
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................29
Item 6. Selected Financial Data..............................................................................30
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................32
Item 7A. Quantitative and Qualitative Disclosures about Market Risk...........................................58
Item 8. Financial Statements and Supplementary Data..........................................................58
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.................58
PART III
Item 10. Directors and Executive Officers of the Registrant...................................................59
Item 11. Executive Compensation...............................................................................59
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................................59
Item 13. Certain Relationships and Related Transactions.......................................................59
Item 14. Controls and Procedures..............................................................................59
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................59
PART I
Item 1. Business
Matrix Bancorp, Inc.
General. Matrix Bancorp, Inc. (occasionally referred to in this document,
on a consolidated basis, as "us," "we," the "Company" or similar terms), is a
unitary thrift holding company that, through our subsidiaries, focuses on
traditional banking, mortgage banking, trust and clearing activities, lending
activities and other fee-based services. Our traditional banking activities
include originating and servicing residential, commercial and consumer loans and
providing a broad range of depository services. Our mortgage banking activities
consist of purchasing and selling residential mortgage loans and residential
mortgage servicing rights; offering brokerage, consulting and analytical
services to financial services companies and financial institutions; servicing
residential mortgage portfolios for investors; originating residential
mortgages; and providing real estate management and disposition services. Our
trust and clearing activities focus primarily on offering specialized custody
and clearing services to banks, trust companies, broker-dealers, third party
administrators and investment professionals, as well as the administration of
self-directed individual retirement accounts, qualified business retirement
plans and custodial and directed trust accounts. Our other fee-based services
and lending activities include providing outsourced business services, such as
budgeting, governmental reporting, accounts payable, payroll, facility and
safety management and comprehensive insurance programs to charter schools. We
also offer financing to charter schools for the purchase of school sites and
equipment.
Matrix Bancorp was incorporated in Colorado in June 1993 and was formerly
called "Matrix Capital Corporation." The trading symbol for our common stock on
The Nasdaq National Market is "MTXC."
Sale of Wholesale Production Platform
On February 28, 2003, Matrix Capital Bank and Matrix Financial Services
Corporation entered into a Purchase and Assumption Agreement (the "Purchase
Agreement") to sell substantially all of Matrix Financial's assets associated
with its wholesale mortgage origination platform (the "Platform"). The purchaser
(the "Buyer") is a newly formed corporation whose principals are long-time
participants in the mortgage banking industry. The Company intends for the
foreseeable future to retain Matrix Financial's servicing platform and operate
it in the ordinary course of business. Included in the sale are the wholesale
production offices, the back office personnel that process the loan originations
and a significant portion of the corporate operations and personnel. After the
sale, our remaining operations will primarily consist of our mortgage servicing
platform and a limited amount of corporate personnel and operations.
The following discussion is a summary of the terms of the contemplated
purchase and sale of the Platform and is not intended to be complete. For a more
complete description of the terms of the Purchase Agreement, the reader is
invited to review the Purchase Agreement, which is filed as an exhibit to this
Annual Report on Form 10-K.
The Buyer is not yet licensed to engage in any mortgage banking activities
under state or federal law. It is anticipated that it will take approximately
six months for the Buyer to obtain the necessary licensing. Accordingly, Matrix
Financial, Matrix Bank and the Buyer desired to structure the purchase and sale
in a manner that transferred substantially all the economic risks and benefits
of the operation of the Platform during the Transition Period (defined below) to
the Buyer, while at the same time having Matrix Financial and Matrix Bank
maintain continuous effective control over the operations of the Platform for
regulatory purposes. The Purchase Agreement, therefore, contemplates a
two-staged closing. The first closing (the "Initial Closing Date") occurred on
the date the Purchase Agreement was signed and is the effective date for the
sale of the fixed assets, and the final or second closing (the "Final Closing
Date") will occur six months following the Initial Closing Date. The period of
operation of the Platform in between the Initial Closing Date and the Final
Closing Date is referred to as the "Transition Period."
As Matrix Financial will maintain effective control at all times during
the Transition Period, Matrix Financial will continue to be an operating
subsidiary of Matrix Bank. The Platform will be operated, for accounting
purposes, during the Transition Period as a division of Matrix Financial.
On the Initial Closing Date, the Buyer purchased substantially all of the
tangible personal property and intangible property associated with the Platform.
The Buyer additionally will take the transfer and assignment of certain contract
rights, real property leases and equipment leases from Matrix Financial as soon
as the necessary consents have been obtained.
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The parties intend for the Final Closing Date to occur within six months
after the Initial Closing Date. At that time, the Buyer will purchase any
tangible and intangible personal property of the Platform that is acquired
during the Transition Period in the ordinary course of business or otherwise
inadvertently not purchased on the Initial Closing Date (the "Subsequently
Acquired Assets"), as well as Matrix Financial's loan files, pipeline
applications and sales commitments. Due to the fact that Matrix Financial will
maintain effective control of the operation, the effective sale date for
accounting purposes will be the Final Closing Date.
The purchase price is determined as follows:
o The Asset Payment Amount (as defined in the Agreement), which is
approximately $3.3 million in payment for the tangible and
intangible assets of the Platform as of the Initial Closing Date;
plus
o The Subsequently Acquired Assets Payment Amount (as defined in the
Agreement), which is the book value of the Subsequently Acquired
Assets as of the Final Closing Date; plus
o The Production Premium (as defined in the Agreement), which is
generally 20 basis points times the original principal balance of
all loans originated during the 12 months following the Initial
Closing Date at the Matrix Financial loan production offices
purchased by Buyer. The Production Premium is "floored" at $4.9
million and is "capped" at $9.1 million plus;
o The Aggregate Locked Loan Profitability Amount (as defined in the
Agreement), which pays Matrix Financial one-half of the profit over
a specified threshold amount (the threshold being generally 30 basis
points) on loans that fund after the Initial Closing Date which have
resulted from its locked pipeline as of the Initial Closing Date;
plus or minus
o The Transition Period Gain or Loss (as defined in the Agreement).
The Transition Period Gain or Loss is a mechanism that provides for
an approximation of the accounting for the transaction as if the
entire sale and transfer had occurred on the Initial Closing Date.
For example, if the Platform generates a loss during the first month
of the six-month Transition Period, the Buyer is then required to
fund such loss by paying the loss into an escrow account.
Conversely, if the Platform generates a profit during the first
month of the six-month Transition Period, then Matrix Financial is
required to pay such profit into an escrow account.
On the Initial Closing Date, the Buyer and Matrix Financial established an
escrow account (the "Escrow") with an Escrow Agent to act as a repository for
the escrow amounts described above and certain other payments contemplated by
the Purchase Agreement. On the Initial Closing Date, the Buyer deposited into
the Escrow $3.5 million as an advance against the Production Premium and paid
directly to Matrix Financial one-half of the Asset Payment Amount.
On the Final Closing Date, the Buyer will pay Matrix Financial the
remaining one-half of the Asset Payment Amount and will pay Matrix Financial the
book value of the Subsequently Acquired Assets.
The Production Premium will be paid over the 12 months following the
Initial Closing Date and the Aggregate Locked Loan Profitability Amount will be
paid over the 2 months following the Initial Closing Date. The Company estimates
that the aggregate sales price for the Platform will be between $8.0 million and
$13.0 million.
During the six-month Transition Period, Matrix Financial will lease-back
from the Buyer the tangible and intangible assets that have been transferred to
Buyer, including any contract rights, real property leases and equipment leases.
The operations of the Platform during the six-month Transition Period will
be governed by the terms of an Operating Plan, which is incorporated into the
Purchase Agreement. The Operating Plan requires Matrix Financial to, among other
things, continue to operate the Platform substantially in the manner in which it
currently operates and in conformity with its current policies and procedures.
Any changes to the Operating Plan must be approved in advance by an Executive
Committee consisting of the following three individuals: (a) the President of
Matrix Bank, (b) the President of Matrix Financial, and (c) another individual
selected by the Board of Directors of Matrix Financial. By establishing this
structure, the Company believes it will be able to maintain for regulatory
purposes continuous effective control over the Platform during the six-month
Transition Period.
Currently, Matrix Bank provides a warehouse line for substantially all of
the loans originated by the Platform. As of December 31, 2002, the balance of
the warehouse line was $458.9 million. During the six-month Transition Period,
it is contemplated that Matrix Bank will continue to provide a warehouse line to
the Platform under similar terms that existed prior to the sale. At the end of
the transition period, the Buyer will be required to utilize third party
financings to fund new originations and the warehouse line will be required to
be paid-off within 60 days after the completion of the Transition Period. Once
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the warehouse line is paid-off, Matrix Bank will have a significant amount of
liquidity to re-invest. It is anticipated that the liquidity will be re-invested
in bulk loan portfolios of adjustable rate loans, guaranteed portions of Small
Business Administration ("SBA") loans or mortgaged-backed securities. To the
extent that we are unable to re-invest the liquidity in a timely manner, the net
interest income earned at Matrix Bank will be reduced by the amount of
un-invested funds. During the period that the liquidity is un-invested, Matrix
Bank will use the liquidity to pay down borrowings from the Federal Home Loan
Bank ("FHLB") or brokered certificates of deposit.
For a period of two years from the Initial Closing Date, Matrix Bank has
agreed that neither Matrix Bank nor any of its affiliates will engage in,
directly or indirectly, the single-family retail or wholesale mortgage
origination business in those states in which the acquired division operates or
is located as of the Initial Closing Date. However, this non-compete provision
does not prohibit Matrix Bank or their affiliates from engaging in such business
in order to comply with applicable law, rule, regulation, directive, agreement
or order from the Office of Thrift Supervision ("OTS") or other party where it
is necessary to resolve regulatory or supervisory concerns. Additionally, the
non-compete provision does not apply in the event of a change in control of
Matrix Bank or the Company.
The Purchase Agreement requires Matrix Bank to guarantee Matrix Financial's
obligations under the Purchase Agreement if certain events occur, such as Matrix
Financial's bankruptcy, failure to maintain a minimum net worth, or loss of
voting control of Matrix Financial.
The Subsidiaries
Our core business operations are conducted through the operating
subsidiaries and an investment in a settlement and clearing operation described
below.
Matrix Capital Bank. With offices in New Mexico, Arizona and Colorado,
Matrix Bank serves its local communities by providing a broad range of personal
and business depository services, offering residential loans and providing
consumer and commercial real estate loans, including Small Business
Administration loans. In 2002, Matrix Bank relocated its domicile from Las
Cruces, New Mexico to Denver, Colorado where it offers all of its existing
banking services in the Denver market. In connection with the relocation, a
subsidiary of Matrix Bank, Matrix Tower Holdings, LLC, purchased a high rise
building in downtown Denver, Colorado in June 2002, named Matrix Financial
Center. In addition to Matrix Bank, the Company and several of its subsidiaries
relocated their offices to Matrix Financial Center during 2002. Additional
relocations will be finalized in 2003.
Matrix Bank holds the noninterest-bearing custodial escrow deposits related
to the residential mortgage loan portfolio serviced by Matrix Financial Services
Corporation, the interest-bearing money market accounts administered by Sterling
Trust Company and the deposits resulting from transactions in which Matrix Bank
acts as the clearing bank for clients of Matrix Settlement & Clearance Services,
L.L.C., an equity method investment. These deposits, as well as other
traditional deposits, are used primarily to fund our mortgage origination
activity, as well as bulk purchases of residential mortgage loan portfolios
throughout the United States, a substantial portion of which are serviced for
Matrix Bank by Matrix Financial following their purchase. As of December 31,
2002, Matrix Bank had total assets of $1.6 billion.
Matrix Bank and several of our other subsidiaries have significant
experience in purchasing and originating mortgage loans, have familiarity with
real estate markets throughout the United States and have traditionally had
access to relatively low-cost deposits. We believe that the resulting knowledge
and activities permit Matrix Bank to manage its funding and capital position in
a way that enhances its performance.
Matrix Financial Services Corporation. Matrix Financial, which became a
wholly owned subsidiary of Matrix Bank in August 2000, originates mortgage loans
through its wholesale loan origination network, acquires mortgage servicing
rights on a nationwide basis through purchases in the secondary market and
services the loans underlying the purchased mortgage servicing rights and a
portion of our originated mortgage servicing rights.
As of December 31, 2002, Matrix Financial serviced over 75,000 borrower
accounts representing $5.3 billion in principal balances, excluding $26.6
million in subservicing for companies that are unaffiliated with us. As a
servicer of mortgage loans, Matrix Financial generally is required to establish
custodial escrow accounts for the deposit of borrowers' payments. These
custodial accounts are maintained at Matrix Bank. At December 31, 2002, the
custodial escrow accounts related to our servicing portfolio maintained at
Matrix Bank were $151.8 million.
5
During 2002, Matrix Financial originated $3.7 billion in residential
mortgage loans primarily through its regional wholesale production offices
located in Atlanta, Dallas, Denver, Houston, Jacksonville, Phoenix, Sacramento,
Santa Ana and St. Louis. The mortgage loans originated by Matrix Financial are
typically sold in the secondary market.
Matrix Capital Markets, Inc. Matrix Capital Markets provides brokerage and
consulting services to financial institutions and financial services companies
in the mortgage banking industry. These services include:
o the brokering, acquisition and analysis of loans;
o the brokering and analysis of residential mortgage loan servicing
rights;
o corporate and mortgage loan servicing portfolio valuations, which
includes the "mark-to-market" valuation and analysis required under
Statements of Financial Accounting Standards No. 133 and No. 140;
and
o to a lesser extent, consultation and brokerage services in
connection with mergers and acquisitions of mortgage banking
entities.
Matrix Capital Markets' volume of brokerage activity and the expertise of
its analytics department give us access to a wide array of information relating
to the mortgage banking industry, including emerging market trends, prevailing
market prices, pending regulatory changes and changes in levels of supply and
demand. Consequently, we are often able to identify certain types of mortgage
loans and, to a lesser extent, mortgage loan servicing portfolios that are well
suited to our particular servicing platform, investment objectives and unique
corporate structure.
First Matrix Investment Services Corp. First Matrix, which became a wholly
owned subsidiary of Matrix Capital Markets in October 2001, is registered with
the National Association of Securities Dealers ("NASD") as a fully disclosed
broker-dealer, with its headquarters in Denver, Colorado and branch offices in
Fort Worth, Texas and Memphis, Tennessee. First Matrix offers brokerage service
related to a wide range of investment options for both individual and
institutional investors, including stocks, bonds, mutual funds and fixed income
and debt securities, as well as providing investment banking services focusing
on fixed income products. The Fort Worth office focuses primarily on long-term
investing and retirement planning for individuals. The Denver office assists
primarily financial institutions in managing their investment portfolios. The
Memphis office focuses on the acquisition, brokering and sale of SBA loan pools.
The SBA loans and securities are acquired by Matrix Bank through the brokerage
activities of First Matrix.
Matrix Asset Management Corporation. Matrix Asset Management provides
nationwide real estate management and disposition services on foreclosed
properties owned by financial services companies and financial institutions. In
addition to the unaffiliated clients currently served by Matrix Asset
Management, Matrix Financial utilizes Matrix Asset Management to handle the
disposition of foreclosed real estate for which it is responsible as servicer.
As of December 31, 2002, Matrix Asset Management had approximately 2,071
foreclosed properties under its management.
Matrix Asset Management also provides limited collateral valuation opinions
to clients that are interested in assessing the value of the collateral
underlying mortgage loans, as well as to clients such as Matrix Bank and other
third party mortgage loan buyers evaluating potential bulk purchases of mortgage
loans.
Sterling Trust Company. Sterling Trust, headquartered in Waco, Texas, was
incorporated in 1984 as a Texas non-bank trust company specializing in the
administration of self-directed individual retirement accounts, qualified
business retirement plans and custodial and directed trust accounts. As of
December 31, 2002, Sterling Trust administered approximately 34,300 accounts,
with assets under administration of over $2.0 billion. As of December 31, 2002,
approximately $141.3 million of the $2.0 billion represented money market
deposits held at Matrix Bank.
ABS School Services, L.L.C. ABS School Services (sometimes referred to
hereafter collectively with its subsidiaries as "ABS") provides outsourced
business services to charter schools. Charter schools are public schools that
are an alternative to traditional public schools. As of December 31, 2002, ABS
provided its services to approximately 142 schools. The primary services offered
include fund accounting, cash management, budgeting, governmental reporting,
payroll and accounts payable. ABS also offers administrative and instructional
leadership and consults with schools and offers assistance in the following
areas: facility and safety management, technology, policy development, grant
administration and comprehensive insurance programs. Additionally, ABS has a
financing division, which offers financing to charter schools for the purchase
of school sites and equipment.
Matrix Settlement & Clearance Services, L.L.C. Matrix Settlement &
Clearance Services is a joint venture in which we own a 45% equity interest.
Matrix Settlement & Clearance Services provides automated clearing of mutual
funds utilizing the National Securities Clearing Corporation's Fund/SERV and
6
Defined Contribution Clearance & Settlement platform for banks, trust companies,
third party administrators and registered investment advisors. Effective January
2, 2002, Matrix Settlement & Clearance Services' wholly owned subsidiary, MSCS
Financial Services, LLC, began operations as a NASD registered broker-dealer.
For the year ended December 31, 2002, Matrix Settlement & Clearance Services had
$7.7 million of revenues and net income of approximately $475,000.
As of December 31, 2002, Matrix Settlement & Clearance Services had 86
clients under contract. These clients administer approximately $13.8 billion in
funds that would be eligible for inclusion in the automated clearing environment
of the National Securities Clearing Corporation. Matrix Settlement & Clearance
Services has developed relationships with several Matrix Bancorp subsidiaries to
assist in the performance of services for its customers. For example, Matrix
Bank, as the National Securities Clearing Corporation member, serves as the
settlement bank for Fund/SERV transactions and provides banking services for
certain Matrix Settlement & Clearance Services customers. This relationship
helps generate low-cost deposits for Matrix Bank. As of December 31, 2002,
Matrix Settlement & Clearance Services' clients had $60.9 million of deposits at
Matrix Bank. In addition, many of Matrix Settlement & Clearance Services'
clients require trust services. As of December 31, 2002, Matrix Bank held in
custody $5.8 billion of assets for clients of Matrix Settlement & Clearance
Services.
Lending Activities
Purchase and Sale of Bulk Loan Portfolios. In addition to our mortgage loan
origination and servicing-related activities, which are discussed under
"Residential Mortgage Loan Origination" and "Mortgage Servicing Activities,"
respectively, we traditionally make bulk purchases of residential mortgage loans
in the secondary market through Matrix Bank. We believe that our structure
provides advantages over our competitors in the purchase of bulk mortgage loan
packages. In particular:
o Matrix Capital Markets, through its networking within the mortgage
banking and financial services industries, is able to refer
companies that are interested in selling mortgage loan portfolios
directly to Matrix Bank. This direct contact reduces the number of
portfolios that must be purchased through competitive bid
situations, thereby reducing the cost associated with the
acquisition of bulk residential mortgage loan portfolios; and
o Matrix Bank's subsidiary, Matrix Financial, provides servicing
advantages that a typical "stand-alone" community bank does not
possess. Matrix Financial acts as a subservicer for a majority of
Matrix Bank's mortgage loan portfolio. Because Matrix Financial
services loans throughout the entire United States, Matrix Bank can
acquire various types of loans secured by property located in any of
the fifty states.
Substantially all of the residential mortgage loans that Matrix Bank
acquires are classified as held for sale. This accounting classification
requires Matrix Bank to carry the loans at the lower of aggregate cost or market
value. The purchased loan portfolios typically include both fixed and adjustable
rate mortgage loans. Although Matrix Bank reviews many loan portfolios for
prospective acquisition, it focuses on acquiring first lien priority loans
secured primarily by one-to-four single-family residential properties with
unpaid principal balances of less than $500,000. To the extent that adjustable
rate loans are available, Matrix Bank generally targets adjustable over fixed
rate portfolios. Due to the accounting treatment required, we believe that the
focus on adjustable rate products is generally expected to reduce the effect of
changing interest rates on the portfolio's market value.
Matrix Bank purchases mortgage loan portfolios from various sellers who
have either originated the loans or acquired the loan portfolios in bulk
purchases. Matrix Bank considers several factors prior to a purchase. Among
other factors, Matrix Bank considers the product type, the current loan balance,
the current interest rate environment, the seasoning of the mortgage loans,
payment histories, geographic location of the underlying collateral, price, the
current liquidity of Matrix Bank and the product mix in its existing mortgage
loan portfolio.
In some cases, the mortgage loan portfolios that Matrix Bank acquires are
purchased at yields that exceed market. Some of the loans in these portfolios
are considered performing loans that have had payment problems in the past or
have had document deficiencies. These types of portfolios afford Matrix Bank
with an opportunity to resell the loans at a higher price if the discount to
market on these portfolios accurately reflects the additional risks associated
with purchasing these types of loans. Loan document deficiencies are identified
in the due diligence process and, to the extent practical, are cured by Matrix
Bank prior to reselling the loans. Matrix Bank also analyzes the payment history
on each mortgage loan portfolio. Many prior problems may be a result of
inefficient servicing or may be attributable to several servicing transfers of
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the loans over a short period of time. Because many considerations may impact
pricing or yield, Matrix Bank prices each loan package based on the specific
underlying loan characteristics.
In the past, Matrix Bank has purchased nonperforming Federal Housing
Administration ("FHA") and Veteran's Administration ("VA") loans from third
party sellers. The Department of Housing and Urban Development ("HUD") generally
guarantees the majority of principal and interest on these nonperforming loans.
These loans are at fixed rates and have a relatively short average life since
the loans are typically liquidated through the foreclosure and subsequent claim
process with HUD. As of December 31, 2002, Matrix Bank owned $26.0 million of
these loans.
Matrix Bank performs due diligence on each mortgage loan portfolio that it
desires to purchase on a bulk basis. These procedures consist of analyzing a
representative sample of the mortgage loans in the portfolio and are typically
performed by Matrix Bank employees, but occasionally are outsourced to third
party contractors. The underwriter takes into account many factors and
statistics in analyzing the sample of mortgage loans in the subject portfolio,
including: the general economic conditions in the geographic area or areas in
which the underlying residential properties are located; the loan-to-value
ratios on the underlying loans; and the payment histories of the borrowers. In
addition, the underwriter attempts to verify that each sample loan conforms to
the standards for loan documentation set by Fannie Mae and Freddie Mac. In cases
where a significant portion of the sample loans contain nonconforming
documentation, Matrix Bank assesses the additional risk involved in purchasing
the loans. This process helps Matrix Bank determine whether the mortgage loan
portfolio meets its investment criteria and, if it does, the range of pricing
that is appropriate.
Matrix Bank continually monitors the secondary market for purchases and
sales of mortgage loan portfolios and typically undertakes a sale of a
particular loan portfolio in an attempt to "match" an anticipated bulk purchase
of a particular mortgage loan portfolio or to generate current period earnings
and cash flow. To the extent that Matrix Bank is unsuccessful in matching its
purchases and sales of mortgage loans, Matrix Bank may have excess capital,
resulting in less leverage and higher capital ratios.
During the year ended December 31, 2002, we made bulk purchases of mortgage
loans of approximately $565.7 million and made bulk sales of approximately
$166.6 million for a net gain on sale of bulk mortgage loans of $3.6 million.
Residential Mortgage Loan Origination. We originate residential mortgage
loans on a wholesale basis through Matrix Financial and on a retail basis
through both Matrix Financial and Matrix Bank. Matrix Financial originated a
total of $3.7 billion in residential mortgage loans for the year ended December
31, 2002. See "Item 1. Business--Sale of Wholesale Production Platform."
Wholesale Originations. Matrix Financial's primary source of mortgage loan
originations is its wholesale division, which historically has originated
mortgage loans through approved independent mortgage loan brokers. These brokers
qualify to participate in Matrix Financial's program through a formal
application process that includes an analysis of the broker's financial
condition and sample loan files, as well as the broker's reputation, general
lending expertise and references. As of December 31, 2002, Matrix Financial had
approved relationships with approximately 1,400 mortgage loan brokers. From
Matrix Financial's offices in Atlanta, Dallas, Denver, Houston, Jacksonville,
Phoenix, Sacramento, Santa Ana and St. Louis, the sales staff solicits mortgage
loan brokers throughout the Southeastern, Western, Midwestern and Rocky Mountain
areas of the United States for mortgage loans that meet Matrix Financial's
criteria.
Mortgage loan brokers act as intermediaries between borrowers and Matrix
Financial in arranging mortgage loans. Matrix Financial, as an approved
seller/servicer for Fannie Mae, Freddie Mac, Ginnie Mae and a multitude of
private investors, provides these brokers access to the secondary market for the
sale of mortgage loans that they otherwise cannot access because they do not
meet the applicable seller/servicer net worth requirements. Matrix Financial
attracts and maintains relationships with mortgage loan brokers by offering a
variety of services and products.
To supplement our product offerings made through our wholesale loan
origination network, we have also historically offered a program tailored to
borrowers who are unable or unwilling to obtain mortgage financing from
conventional mortgage sources. The borrowers who need this type of loan product
often have impaired or unsubstantiated credit histories and/or unverifiable
income and require or seek a high degree of personalized service and swift
response to their loan applications. As a result, these borrowers generally are
not adverse to paying higher interest rates for this loan product type, as
compared to the interest rates charged by conventional lending sources. We have
established classifications with respect to the credit profiles of these
borrowers. The classifications range from Alternative A through D depending upon
a number of factors, including the borrower's credit history and employment
status. During 2002, Matrix Financial originated $177.6 million of Alternative A
8
through D credit residential mortgage loans, the majority of which were sold to
unaffiliated third party investors on a nonrecourse basis. All originations of
Alternative A through lesser quality credit loans are originated under third
party investor guidelines and are generally sold monthly in bulk loan
portfolios. This method of sale generally provides better execution as compared
to selling individual loans.
Following the Final Closing Date, we will not originate mortgage loans on
a wholesale basis. In addition, we have agreed with the Buyer not to compete in
certain respects. See "Item 1. Business--Sale of Wholesale Production Platform."
Retail Originations. Matrix Bank originates residential loans on a retail
basis through its branches in Las Cruces, New Mexico and Sun City, Arizona.
Matrix Bank's lending office in Denver, Colorado, which relocated from
Evergreen, Colorado in 2002, primarily originates residential construction loans
and commercial loans in the local market place. Matrix Bank attempts to convert
the construction loans funded through the Denver office into permanent mortgage
loans. The retail loans originated by Matrix Bank consist of a broad range of
residential loans, at both fixed and adjustable rates, consumer loans and
commercial real estate loans.
We have agreed with the Buyer not to compete in certain respects. We do not
believe, however, that this stipulation will substantially impact the ability of
Matrix Bank to effectively serve its local markets or customers. See "Item 1.
Business--Sale of Wholesale Production Platform."
Matrix Financial has also developed a retention center that focuses on the
solicitation of our servicing portfolio and third-party owned servicing
portfolios for refinancing opportunities. The goal is to identify those
borrowers which are likely to refinance and have them refinance with Matrix
Financial. If the refinanced loan replaces a loan that comprises part of our
servicing portfolio, we have effectively preserved a portion of our servicing
portfolio and the periodic servicing fees resulting therefrom, as the borrower
would have been likely to refinance with an unaffiliated lender if not with us,
which would result in a loss of the servicing income that results from servicing
the loan. Included in the sale of the Platform are the operations of the
retention center. During the Transition Period, and after the Final Closing
Date, the Buyer has agreed to solicit our customers for the refinance of their
mortgage loans. It is contemplated that we will sell the mortgage loans on a
servicing released basis and pay the Buyer an agreed upon fee to originate such
loan. See "Item 1. Business--Sale of Wholesale Production Platform."
Quality Control. We have a loan quality control process designed to ensure
sound lending practices and compliance with Fannie Mae, Freddie Mac, Ginnie Mae
and applicable private investor guidelines. Prior to funding any wholesale or
retail loan, we perform a verbal or written verification of employment as
required by investor programs and utilize a detailed checklist to ensure
accuracy of documentation. In addition, on a monthly basis, we select 10% of all
closed loans for a detailed audit conducted by our own personnel or a third
party service provider. The quality control process entails performing a
complete underwriting review and independent re-verification of all employment
information, tax returns, source of down payment funds, bank accounts and
credit. Furthermore, 10% of the audited loans are chosen for an independent
field review and standard factual credit report. All discovered deficiencies in
these audits are reported to our senior management to determine trends and
additional training needs. We then address and cure all resolvable issues. We
also perform a quality control audit on all early payment defaults, first
payment defaults and 60-day delinquent loans, the findings of which are reported
to the appropriate investor and/or senior management.
Sale of Originated Loans. We generally sell the residential mortgage loans
that we originate. Under ongoing programs established with Fannie Mae, Freddie
Mac and Ginnie Mae, conforming conventional and government loans may be sold on
a cash basis or pooled by us and exchanged for securities guaranteed by Fannie
Mae, Freddie Mac or Ginnie Mae. We then sell these securities to national or
regional broker-dealers. Mortgage loans sold to Fannie Mae, Freddie Mac or
Ginnie Mae are sold on a nonrecourse basis, except for standard representations
and warranties, so that foreclosure losses are generally borne by Fannie Mae,
Freddie Mac or Ginnie Mae and not by us.
We also sell nonconforming and conforming residential mortgage loans on a
nonrecourse basis to other secondary market investors. Nonconforming loans are
typically first lien mortgage loans that do not meet all of the agencies'
underwriting guidelines, and are originated instead for other institutional
investors with whom we have previously negotiated purchase commitments and for
which we occasionally pay a fee.
We sell residential mortgage loans on a servicing-retained or
servicing-released basis. Certain purchasers of mortgage loans require that the
loan be sold to them servicing-released. We sell nonconforming loans on a
9
servicing-released basis and may sell conforming loans on a servicing-retained
or servicing-released basis. See "Item 1. Mortgage Servicing
Activities--Residential Mortgage Loan Servicing."
In connection with our residential mortgage loan originations and sales, we
make customary representations and warranties. Our experience has been that
giving such representations and warranties have not resulted in material
repurchases. However, there can be no assurance that we will not be required to
make a significant repurchase in the future or that losses will not occur in the
future due to the representations and warranties made.
The sale of mortgage loans may generate a gain or loss for us. Gains or
losses result primarily from two factors. First, we may make a loan to a
borrower at a rate resulting in a price that is higher or lower than we would
receive if we had immediately sold the loan in the secondary market. These price
differences occur primarily as a result of competitive pricing conditions in the
primary loan origination market. Second, gains or losses may result from changes
in interest rates that consequently change the market value of the mortgage
loans. The change in the market value of the mortgage loans may occur after the
price commitment is given to the borrower and before the time that the mortgage
loan is sold to the investor. Net gains and losses on originated loans sold are
recorded in loan origination income.
In order to hedge against the interest rate risk resulting from these
timing differences, we historically have committed to sell all closed originated
mortgage loans held for sale and a portion of the mortgage loans that are not
yet closed but for which the interest rate has been established, sometimes
referred to in this document as "pipeline loans." We adjust our net commitment
position daily either by entering into new commitments to sell or by buying back
commitments to sell depending upon our projection of the portion of the pipeline
loans that we expect to close. These projections are based on numerous factors,
including changes in interest rates and general economic trends. The accuracy of
the underlying assumptions bears directly upon the effectiveness of our use of
forward commitments and subsequent profitability. The market value of loans
committed for sale is determined based on the related forward loan sale
commitments. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Sensitive Assets and Liabilities" for
information on our adoption of Statement of Financial Accounting Standards
("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities.
Commercial and Other Lending. We have sought to diversify and enhance the
yield of our loan portfolio by originating commercial and, to a lesser extent,
consumer loans and by offering a full range of lending products to our
customers. The Company offers a variety of commercial loan products, including:
single-family construction loans; commercial real estate loans; business and SBA
loans; and financing to charter schools for the purchase of real estate and
equipment. Matrix Bank's loan production office in Denver, Colorado principally
originates single-family construction and commercial real estate loans. Matrix
Bank's office in Las Cruces, New Mexico also originates a portion of these
loans. ABS performs underwriting and funding of financings for charter schools.
Matrix Bank's small business lending division, headquartered in Denver,
Colorado, offers the following loan products: SBA 7a loans; first trust deed
loans senior to SBA 504 debentures; first trust deed companion loans senior to
SBA 7a loans; and Business and Industry Guaranteed Loans offered through the
United States Department of Agriculture. Matrix Bank has again been awarded
preferred lender status by the SBA in the Colorado market area, and is expecting
first quarter expansion of that designation into New Mexico, Utah, Arizona,
Oregon and Idaho. Matrix Bank has the further potential of expansion of the
designation into Washington and Texas. Preferred lender status allows Matrix
Bank to approve SBA guaranteed loan applications without prior review from the
SBA, thereby accelerating the approval process for small business loan
applications. Preferred lenders also are granted unilateral servicing powers
over the term of those loans. During 2002, Matrix Bank originated $16.2 million
in SBA loans.
Matrix Bank generally limits its commercial lending to income-producing
real estate properties. The repayment of loans collateralized by
income-producing properties depends upon the successful operation of the related
real estate property and also on the credit and net worth of the borrower. Thus,
repayment is subject to the profitable operation of the borrower's business,
conditions in the real estate market, interest rate levels and overall economic
conditions. Loans on income-producing properties must generally meet internal
underwriting guidelines that include: a limit on the loan-to-value ratio of 75%;
a review of the borrower with regard to management talent, integrity, experience
and available financial resources; and, in most instances, a personal guarantee
from the borrower.
Matrix Bank originates loans to builders for the construction of
single-family properties, and to a lesser extent, for the acquisition and
development of improved residential lots. Matrix Bank generally makes these
loans on commitment terms that last from nine to eighteen months and typically
adjust with the prime rate of interest. In many cases, the residential
10
properties have been pre-sold to the homeowner. It is generally considered that
construction lending involves a higher level of risk than secured lending on
existing properties because the properties securing construction loans are
usually more speculative and more difficult to evaluate and monitor.
Matrix Bank originates loans on multi-family residential properties. The
properties generally are in the Denver metropolitan area and are on properties
of between 10 to 50 units. In 2002, Matrix Bank originated approximately $41.4
million of multi-family loans.
In addition to origination, Matrix Bank also buys participations in
commercial real estate loans primarily from banks located in the Colorado
market. The loans that we acquire through participations are underwritten with
the same diligence and standards as though we were originating them directly.
ABS offers financing to charter schools located primarily in Arizona,
Colorado, Missouri, Florida and Texas for the purchase of real estate, modular
space and equipment. The offered financing is generally fully amortizing and
completed on a tax-exempt basis. On occasion, we also provide cash flow loans to
charter schools. As of December 31, 2002, we had a total of $47.3 million loans
outstanding to charter schools. Charter school financing involves inherent risks
such as:
o the loan-to-value ratio for real estate transactions can be as high
as 90% and for furniture, fixtures and equipment and modular space
it is 100%;
o there are no personal guarantees; and
o cash flow to service the financing is derived from the school's
student count. If the school's student count decreases, or is less
than projected, the school's ability to make scheduled payments on
the financing may be impaired.
In addition, Matrix Bank offers a variety of lending products to meet the
specific needs of its customers. These products include fully amortizing secured
installment loans, manufactured housing financing, credit card programs, home
equity loans, business loans and share loans. In addition to the secured
consumer loans, Matrix Bank extends unsecured loans, on a limited basis, to
qualified borrowers based on their financial statements and creditworthiness.
Matrix Bank originates the majority of its consumer lending within the Las
Cruces, New Mexico market area.
Mortgage Servicing Activities
Residential Mortgage Loan Servicing. We conduct our residential mortgage
loan servicing activities exclusively through Matrix Financial including the
residential mortgage loan servicing that Matrix Financial provides as
subservicer for Matrix Bank's servicing portfolio. At December 31, 2002, Matrix
Financial serviced approximately $5.3 billion of mortgage loans, excluding $26.6
million subserviced for companies that are not affiliated with us.
Servicing mortgage loans involves a contractual right to receive a fee for
processing and administering loan payments. This processing involves collecting
monthly mortgage payments on behalf of investors, reporting information to those
investors on a monthly basis and maintaining custodial escrow accounts for the
payment of principal and interest to investors and property taxes and insurance
premiums on behalf of borrowers. These payments are held in custodial escrow
accounts at Matrix Bank. Matrix Bank invests this money in interest-earning
assets with returns that historically have been greater than could be realized
by Matrix Financial using the custodial escrow deposits as compensating balances
to reduce the effective borrowing cost on its warehouse credit facilities.
As compensation for its mortgage servicing activities, Matrix Financial
receives servicing fees, plus any late charges collected from delinquent
borrowers and other fees incidental to the services provided. In the event of
default by the borrower, Matrix Financial receives no servicing fees until the
default is cured. At December 31, 2002, Matrix Financial's annual
weighted-average servicing fee, including ancillary fees, was 0.48%.
Servicing is provided on mortgage loans on a recourse or nonrecourse basis.
Our policy is to accept only a limited number of servicing assets on a recourse
basis. As of December 31, 2002, on the basis of outstanding principal balances,
approximately 1.15% of our owned mortgage servicing contracts involved recourse
servicing. To the extent that servicing is done on a recourse basis, we are
exposed to credit risk with respect to the underlying loan in the event of a
repurchase. Additionally, many of our nonrecourse mortgage servicing contracts
owned require us to advance all or part of the scheduled payments to the owner
of the mortgage loan in the event of a default by the borrower. Many owners of
mortgage loans also require the servicer to advance insurance premiums and tax
payments on schedule even though sufficient escrow funds may not be available.
11
Therefore, we must bear the funding costs associated with making such advances.
If the delinquent loan does not become current, these advances are typically
recovered at the time of the foreclosure sale. Foreclosure expenses, which may
include legal fees or property maintenance, are generally not fully reimbursable
by Fannie Mae, Freddie Mac or Ginnie Mae, for which agencies we provide
significant amounts of mortgage loan servicing. As of December 31, 2002, we had
advanced approximately $11.7 million in funds on behalf of third party
investors. A foreclosure reserve is estimated and included in the consolidated
financial statements. For the VA loans sold and serviced for the Ginnie Mae,
which are sold on a nonrecourse basis, the VA loan guarantees may not cover the
entire principal balance and, in that case, the Company is responsible for the
losses which exceed the VA's guarantee.
Mortgage servicing rights represent a contractual right to service, and not
a beneficial ownership interest in, underlying mortgage loans. Failure to
service the loans in accordance with contract or other applicable requirements
may lead to the termination of the mortgage servicing rights and the loss of
future servicing fees. To date, there have been no terminations of mortgage
servicing rights by any mortgage loan owners because of our failure to service
the loans in accordance with our obligations.
In order to track information on our servicing portfolio, Matrix Financial
utilizes a data processing system provided by Alltel Information Services, Inc.
Because Alltel is one of the largest mortgage banking service bureaus in the
United States, we believe that this system gives Matrix Financial capacity to
support expansion of our residential mortgage loan servicing portfolio.
The following table sets forth certain information regarding the
composition of our mortgage servicing portfolio, excluding loans subserviced for
others, as of the dates indicated:
As of December 31,
---------------------------------------------------
2002 2001 2000
-------------- -------------- ----------------
(In thousands)
FHA insured/VA guaranteed residential........................ $ 2,128,363 $ 2,187,686 $1,608,115
Conventional loans........................................... 3,053,368 3,272,109 3,764,586
Other loans.................................................. 151,896 196,570 145,262
--------------- -------------- ---------------
Total mortgage servicing portfolio...................... $ 5,333,627 $ 5,656,365 $5,517,963
=============== ============== ===============
Fixed rate loans............................................. $ 4,688,672 $ 5,009,501 $4,346,813
Adjustable rate loans........................................ 644,955 646,864 1,171,150
--------------- -------------- ---------------
Total mortgage servicing portfolio...................... $ 5,333,627 $ 5,656,365 $5,517,963
=============== ============== ===============
The following table shows the delinquency statistics for the mortgage loans
serviced by Matrix Financial, excluding loans subserviced for others, as of the
dates presented. Delinquencies and foreclosures for the mortgage loans serviced
by us generally exceed the national average due to high rates of delinquencies
and foreclosures on certain bulk loan and bulk servicing portfolios that we
acquired at a discount.
As of December 31,
-----------------------------------------------------------------------------------------------
2002 2001 2000
------------------------------ -------------------------------- -------------------------------
Number Percentage Number Percentage Number Percentage
of of Servicing of of Servicing of of Servicing
Loans Portfolio Loans Portfolio Loans Portfolio
------------- ---------------- ------------- ----------------- ------------- ----------------
Loans delinquent for:
30-59 days.......... 4,276 5.65% 4,610 5.35% 5,214 5.64%
60-89 days.......... 1,021 1.35 932 1.08 992 1.07
90 days and over.... 647 0.86 616 0.72 530 0.58
------------- -------------- ------------- --------------- ------------- --------------
Total delinquencies. 5,944 7.86% 6,158 7.15% 6,736 7.29%
============= ============== ============= =============== ============= ==============
Foreclosures........ 540 0.71% 757 0.88% 1,027 1.11%
============= ============== ============= =============== ============= ==============
The following table sets forth certain information regarding the number and
aggregate principal balance of the mortgage loans serviced by Matrix Financial,
including both fixed and adjustable rate loans, excluding loans subserviced for
others, at various interest rates:
12
As of December 31,
-----------------------------------------------------------------------------------------------------------
2002 2001 2000
----------------------------------- -------------------------------------------- --------------------------
Percentage Percentage Percentage
--------- ----------- ------------ --------- ----------- ---------------------- ------------ -------------
Number Aggregate of Aggregate Number Aggregate of Aggregate Number Aggregate of Aggregate
of Principal Principal of Principal Principal of Principal Principal
Rate Loans Balance Balance Loans Balance Balance Loans Balance Balance
---- --------- ----------- ------------ --------- ----------- ---------------------- ------------ -------------
(Dollars in thousands)
Less than 7.00%.... 23,345 2,196,944 41.19% 16,024 $ 1,443,862 25.53 % 6,317 $ 474,596 8.60 %
7.00%--7.99%...... 19,043 1,634,054 30.64 23,815 1,895,797 33.52 18,424 1,335,738 24.21
8.00%--8.99%...... 13,424 724,053 13.57 19,002 1,144,290 20.23 27,691 1,801,131 32.64
9.00%--9.99%...... 8,755 349,308 6.55 12,122 542,621 9.59 19,369 1,002,226 18.16
10.00% and over.... 11,080 429,268 8.05 15,192 629,795 11.13 20,603 904,272 16.39
---------- ---------- ----------- ---------- --------- ----------- --------- --------- ----------
Total............ 75,647 5,333,627 100.00% 86,155 $ 5,656,365 100.00 % 92,404 $ 5,517,963 100.00 %
========== ========== =========== ========== ========= =========== ========= ========= ==========
Loan administration fees decrease as the principal balance on the
outstanding loan decreases and as the remaining time to maturity of the loan
shortens. The following table sets forth certain information regarding the
remaining contractual maturity of the mortgage loans serviced by Matrix
Financial, excluding loans subserviced for others, as of the dates shown. The
changes in the remaining maturities as a percentage of unpaid principal between
2002, 2001 and 2000, as reflected below, are the result of acquisitions of
mortgage servicing rights completed during 2001 and 2000.
As of December 31,
------------------------------------------------------------------------------------------------------------------
2002 2001 2000
---------------------------------- --------------------------------------- ---------------------------------------
Percentage Percentage Percentage
Number Percentage Unpaid Unpaid Number Percentage Unpaid Unpaid Number Percentage Unpaid Unpaid
of of Number Principal Principal of of Number Principal Principal of of Number Principal Principal
Maturity Loans of Loans Amount Amount Loans of Loans Amount Amount Loans of Loans Amount Amount
- -------- ------- -------- ---------- --------- ------ --------- --------- ---------- ------ ----------- --------- ----------
(Dollars in thousands)
1--5 years.. 11,647 15.40 % $ 188,463 3.53% 11,539 13.39% $ 169,794 3.00% 19,489 21.09% $ 321,196 5.82%
6--10 years. 8,954 11.84 271,438 5.09 14,711 17.08 442,458 7.82 15,891 17.20 411,152 7.45
11--15 years. 10,728 14.18 662,439 12.42 12,101 14.05 729,162 12.89 14,981 16.21 779,922 14.13
16--20 years. 12,914 17.07 1,042,962 19.56 18,013 20.91 1,428,794 25.26 27,779 30.06 2,505,728 45.41
21--25 years. 1,588 2.10 134,967 2.53 2,219 2.58 246,835 4.36 4,522 4.90 444,679 8.06
More than 25
years 29,816 39.41 3,033,358 56.87 27,572 32.00 2,639,322 46.66 9,742 10.54 1,055,286 19.13
------- -------- ---------- --------- ------ ------- ---------- ------- ------ ------- ---------- -------
Total..... 75,647 100.00 % $5,333,627 100.00% 86,155 100.00% $5,656,365 100.00% 92,404 100.00% $5,517,963 100.00%
======= ======== ========== ========= ====== ======= ========== ======= ====== ======= ========== =======
Our servicing activity is diversified throughout all 50 states with
concentrations at December 31, 2002 in California, Texas, Missouri and Arizona
of approximately 15%, 14%, 15% and 10%, respectively, based on aggregate
outstanding unpaid principal balances of the mortgage loans serviced.
Acquisition of Servicing Rights. Historically, our strategy with respect to
mortgage servicing was to focus on acquiring servicing for which the underlying
mortgage loans tended to be more seasoned and to have higher interest rates,
lower principal balances and higher custodial escrow balances than newly
originated mortgage loans. We believed this strategy allowed us to reduce our
prepayment risk, while allowing us to capture relatively high custodial escrow
balances in relation to the outstanding principal balance. During periods of
declining interest rates, prepayments of mortgage loans usually increase as
homeowners seek to refinance at lower interest rates, resulting in a decrease in
the value of the servicing portfolio. Mortgage loans with higher interest rates
and/or higher principal balances are more likely to result in prepayments since
the cost savings to the borrower from refinancing can be significant. During
2002, existing low interest rates continued to decrease throughout the year. We
did not purchase any servicing in 2002 due to the interest rates prevalent
during the year, the lack of the servicing products available and a decision to
retain a portion of our originated servicing.
The following table shows quarterly and annual average prepayment rate
experience on the mortgage loans serviced by Matrix Financial, excluding loans
subserviced by and for others:
For the Years Ended December 31,
-----------------------------------------------------
2002(1)(4) 2001(2)(4) 2000(3)(4)
---------------- ---------------- ----------------
Quarter ended:
December 31.... 31.03% 24.67% 12.50%
September 30... 23.30 25.13 12.70
June 30........ 19.00 24.63 12.70
March 31....... 21.60 17.13 10.50
---------------- ---------------- ----------------
Annual average.... 23.73% 22.89% 12.10%
================ ================ ================
13
__________
(1) These prepayment rates exclude prepayment experience for mortgage servicing
rights subserviced for us by others of $26.6 million, $600,000, $5.8
million and $34.6 million for the quarters ended December 31, September 30,
June 30, and March 31, 2002, respectively.
(2) These prepayment rates exclude prepayment experience for mortgage servicing
rights subserviced for us by others of $889.0 million, $581.8 million,
$306.9 million and $1.1 billion for the quarters ended December 31,
September 30, June 30, and March 31, 2001, respectively.
(3) These prepayment rates exclude prepayment experience for mortgage servicing
rights subserviced for us by others of $447 million, $0, $16 million and $0
for the quarters ended December 31, September 30, June 30 and March 31,
2000, respectively.
(4) These prepayment rates do not include prepayments that resulted from us
targeting our own servicing portfolio for refinance opportunities.
Historically, we acquired substantially all of our mortgage servicing
rights in the secondary market. The industry expertise of Matrix Capital Markets
and Matrix Financial allows us to capitalize upon inefficiencies in this market
when acquiring mortgage servicing rights. Prior to acquiring mortgage servicing
rights, we analyze a wide range of characteristics of each portfolio considered
for purchase. This analysis includes projecting revenues and expenses and
reviewing geographic distribution, interest rate distribution, loan-to-value
ratios, outstanding balances, delinquency history and other pertinent
statistics. Due diligence is performed either by our employees or a designated
independent contractor on a representative sample of the mortgages involved. The
purchase price is based on the present value of the expected future cash flow,
calculated by using a discount rate, loan prepayment, default rate and other
assumptions that we consider to be appropriate to reflect the risk associated
with the investment. In 2000, we began to retain a portion of the mortgage
servicing rights generated from the origination platform. Throughout 2000 and
for the majority of 2001, we generally retained the servicing on the loans sold
to Ginnie Mae. In the fourth quarter of 2001, we began to retain the servicing
on loans sold to Fannie Mae and Freddie Mac and sold our newly originated Ginnie
Mae servicing. In April through August of 2002, we retained all of the servicing
originated on Fannie Mae and Ginnie Mae loans. Beginning in September of 2002,
we entered into an assignment of trade contract with a national mortgage banker
to sell the majority of our originated servicing. The decision on which
servicing to retain or sell is based on factors including interest rate
environment, secondary market pricing for the servicing, our capital levels and
liquidity. As of December 31, 2002, in terms of unpaid principal amount,
approximately $2.3 billion of the underlying mortgage loans in our servicing
portfolio were from loans originated and sold by Matrix Financial. It is
anticipated that after the sale of the Platform we will continue to sell the
majority of our newly originated servicing. See "Item 1. Business--Sale of
Wholesale Production Platform." Any significant additions to our servicing
portfolio will be done through acquisitions and likely will be portfolios with
characteristics of more seasoning, lower balances and higher escrows. Any future
acquisitions will be based on availability of desired product, our capital
levels, our current investment in mortgage servicing assets and the prevalent
interest rate environment.
Sales of Servicing Rights. We periodically sell our purchased mortgage
servicing portfolios and generally sell a portion of the mortgage servicing
rights on new loans that we originate, as mentioned above. These sales generate
cash at the time of sale but reduce future cash flow and servicing fee income.
We sold mortgage servicing rights on loans that we originated having an
aggregate principal amount of $681 million during the year ended December 31,
2002. Periodically, we may also sell purchased mortgage servicing rights to
restructure our portfolio or generate revenues. Purchased mortgage servicing
rights were sold during the year ended December 31, 2002 for net gains of
approximately $675,000.
We anticipate that we will sell the majority of our originated mortgage
servicing rights on new loans that we originate. See "Item 1. Business--Sale of
Wholesale Production Platform." We also may sell purchased mortgage servicing
rights. We intend to base decisions regarding future mortgage servicing sales
upon our cash requirements, purchasing opportunities, capital needs, earnings
and the market price for mortgage servicing rights. During a quarter in which we
sell purchased mortgage servicing rights, reported income will tend to be
greater than if we had not made the sale during that quarter. Prices obtained
for mortgage servicing rights vary depending on servicing fee rates, anticipated
prepayment rates, average loan balances, remaining time to maturity, servicing
costs, custodial escrow balances, delinquency and foreclosure experience and
purchasers' required rates of return.
In the ordinary course of selling mortgage servicing rights, consistent
with industry standards, we make certain representations and warranties to
purchasers of mortgage servicing rights. If a borrower defaults and there has
been a breach of representations or warranties and we have no third party
recourse, we may become liable for the unpaid principal and interest on
defaulted loans. In such a case, we may be required to repurchase the mortgage
loan and bear any subsequent loss on the loan. In connection with any purchases
of mortgage servicing rights that we make, we also are exposed to liability to
the extent that an originator or seller of the mortgage servicing rights is
unable to honor its representations and warranties. Historically, we have not
incurred material losses due to breaches of representations and warranties and
we do not anticipate any future material losses due to breaches of
representations and warranties; however, there can be no assurance that we will
not experience such losses.
14
Hedging of Servicing Rights. Our investment in mortgage servicing rights is
exposed to potential impairment in certain interest rate environments. As
previously discussed, the prepayment of mortgage loans increases during periods
of declining interest rates as homeowners seek to refinance their loan to lower
interest rates. If the level of prepayment on segments of our mortgage servicing
portfolio reaches a level higher than we projected for an extended period of
time, the associated basis in the mortgage servicing rights may be impaired. To
mitigate this risk of impairment due to declining interest rates, we initiated a
hedging strategy during 1997 that used a program of exchange-traded futures and
options. Through December 31, 2000, our hedging program qualified for hedge
accounting treatment based on a high degree of statistical correlation and then
current accounting guidance. With the required adoption of the SFAS 133 on
January 1, 2001, we did not attempt to qualify for hedge accounting treatment
due to the requirements in the standard that are necessary to do so. In the
fourth quarter 2002, we elected to reinstate our hedging program to mitigate a
portion of our investment in mortgage servicing rights from further impairment.
This program is identical to the program instituted in 1997. The decision was
based on the historically low interest rates, the continued weakening economy,
the geopolitical environment and the impairment that we incurred to-date. During
the fourth quarter 2002, we hedged approximately $400 million of our servicing
portfolio, or 7.5%. As of December 31, 2002, we removed the hedge and then
reinstated it on January 2, 2003, increasing our hedge portfolio to
approximately $600 million. Although we believe our hedging program would
qualify for hedge accounting, we did not attempt to qualify for hedge accounting
treatment due to the requirements in SFAS 133 that were necessary to do so. The
decision to increase or decrease our hedging coverage will be based on several
factors, including those discussed above, as well as the composition of our
current servicing portfolio.
During 2002, based on a valuation model which incorporates, among other
things, prepayment speeds, we recorded a provision for impairment on our
mortgage servicing rights totaling approximately $14.2 million. Our impairment
reserve as of December 31, 2002 was $14.4 million. The Company is required to
record its investment in mortgage servicing rights at the lower of cost or fair
value. The fair value of mortgage servicing rights is determined based on the
discounted future servicing income stratified based on one or more predominant
risk characteristics of the underlying loans. The Company stratifies its
mortgage servicing rights by product type and investor to reflect the
predominant risks. To determine the fair value of its investment, the Company
uses a valuation model that calculates the present value of discounted future
cash flows. Due to the drop in interest rates, both the actual and anticipated
prepayment speeds used in the valuation model increased causing the fair value
of the servicing to decrease below the carrying basis which resulted in an
impairment. The majority of the impairment related to the servicing rights
retained by the Company on its originations over the last year. Further
decreases in interest rates, or increases in anticipated future prepayment
speeds, may cause additional impairment charges in future years.
Brokerage, Consulting and Outsourcing Services
Brokerage Services. Matrix Capital Markets operates as one of the nation's
leading full-service mortgage servicing and mortgage loan brokers. It is capable
of analyzing, packaging, marketing and closing transactions involving mortgage
servicing and loan portfolios and selected merger and acquisition transactions
for mortgage banking entities. Matrix Capital Markets promotes its services to
all types and sizes of market participants, thereby developing diverse
relationships.
Mortgage servicing rights are sold either on a bulk basis or a flow basis.
In a bulk sale, the seller identifies, packages and sells a portfolio of
mortgage servicing rights to a buyer in a single transaction. In a flow sale,
the seller agrees to sell to a specified buyer from time to time, at a
predetermined price, the mortgage servicing rights originated by the seller that
meet certain criteria. Matrix Capital Markets is capable of helping both buyers
and sellers with respect to bulk and flow sales of mortgage servicing rights.
We believe that the client relationships developed by Matrix Capital
Markets through its national network of contacts with commercial banks, mortgage
companies, savings associations and other institutional investors represent a
significant competitive advantage and form the basis for Matrix Capital Market's
national market presence. These contacts also enable Matrix Capital Markets to
identify prospective clients for our other subsidiaries and make referrals when
appropriate. See "Consulting and Analytic Services" below.
Most institutions that own mortgage servicing rights have found that
careful management of these assets is necessary due to their susceptibility to
interest rate cycles, changing prepayment patterns of mortgage loans and
fluctuating earnings rates achieved on custodial escrow balances. Because
companies must capitalize originated mortgage servicing rights, management of
mortgage servicing assets has become even more critical. These management
15
efforts, combined with interest rate sensitivity of assets and the growth
strategies of market participants, create constantly changing supply and demand
and, therefore, constantly fluctuating price levels in the secondary market for
mortgage servicing rights.
The sale and transfer of mortgage servicing rights occurs in a market that
is inefficient and often requires an intermediary to match buyers and sellers.
Prices are unpublished and closely guarded by market participants, unlike most
other major financial secondary markets. This lack of pricing information
complicates an already difficult process of differentiating between servicing
product types, evaluating regional, economic and socioeconomic trends and
predicting the impact of interest rate movements. Due to its significant
contacts, reputation and market penetration, Matrix Capital Markets has access
to information on the availability of mortgage servicing portfolios, which helps
it bring interested buyers and sellers together. Due to the consolidation that
has taken place in the mortgage banking industry, as well as the low interest
rate environment experienced in 2002 which depressed the value of servicing, the
overall market, including the number of buyers and sellers of servicing, has
decreased. As a result, we have experienced an overall decrease in both the
portfolios brokered and the corresponding revenue. In the current market, we do
not anticipate this trend to reverse.
In addition, Matrix Capital Markets provides brokerage services to buyers
and sellers of all types of loan products. Matrix Capital Markets provides loan
brokerage services to both servicing brokerage clients and non-servicing
brokerage clients.
First Matrix Investment Services is registered with the NASD as a fully
disclosed broker-dealer, headquartered in Denver, Colorado. First Matrix,
incorporated in Texas in 1984, conducts a wide range of general securities
business, including fixed income brokerage, retail brokerage, investment banking
and structured finance services. First Matrix clears all of its transactions
through First Southwest Company based in Dallas, Texas on a fully disclosed
basis.
Fixed Income Trading. First Matrix has traditionally focused its fixed
income business primarily on financial institutions in the Rocky Mountain
Region. First Matrix brokers U.S. government treasury obligations, agencies,
municipal bonds and corporate debt. The majority of its fixed income business is
of an institutional nature, and its clients include banks, savings and loans,
insurance companies, mutual funds, money managers and hedge funds. With the
addition of its SBA group in Memphis, First Matrix has diversified its client
base and its product mix. In its first full year of SBA brokerage activity,
First Matrix was ranked third in SBA guaranteed loan pool securitizations.
First Matrix, acting as agent for Matrix Bank, purchases the guaranteed
portion of SBA 7A loans from bank and non-bank lenders around the country. These
loans are assembled and later pooled into SBA securities which are sold into the
secondary market. These pools are subsequently sold to institutional and
sophisticated investors. This trading strategy enables Matrix Bank to earn
attractive yields on high credit quality assets with reduced exposure to the
traditional risks associated with investing in any fixed income asset.
Retail Brokerage. Retail brokerage services have and will continue to be an
integral part of the First Matrix service platform. The First Matrix focus is to
attract experienced investment professionals with established relationships,
looking to provide their clients with the safety and expanded services provided
by a broker-dealer connected to a well-capitalized, regional bank holding
company. Our brokers have long-standing relationships with a broad range of
retail and small business clients.
Although First Matrix' product mix will focus on fee-based products, it
will continue to offer traditional fixed income and equity investment services
to its retail client base.
Investment Banking / Structured Finance. Historically, the Company has
relied on other financial institutions and the brokerage community to provide
liquidity for many of its assets and the assets of its subsidiaries. In doing
so, the Company and its subsidiaries has paid considerable fees and has relied
on third parties to provide liquidity in assets that individuals in the Company
know intimately and in many cases understand better than the brokerage
community.
First Matrix has hired a small number of professionals who understand the
Company's business lines and have structured its assets at other firms. These
underwriting activities have focused to-date on SBA products, real estate
collateral and chartered school loans originated through the holding company.
All underwriting has been done on a best efforts basis.
Consulting and Analytic Services. Matrix Capital Markets continues to make
significant commitments to its analytics department, which has developed
expertise in helping companies implement and track their "mark-to-market"
valuations and analyses. Matrix Capital Markets has enhanced its existing
valuation models and has created a software program that can be customized to
16
fit its customers' many different needs and unique situations in performing
valuations and analyses. In addition, Matrix Capital Markets has the
infrastructure and management information system capabilities necessary to
undertake the complex analyses required by SFAS 140. Many of the companies
affected by the implementation of SFAS 140 have outsourced this function to a
third party rather than dedicate the resources necessary to develop systems for
and perform their own SFAS 140 valuations.
Because SFAS 140 requires that mortgage servicing portfolios be valued at
the lower of cost or market value, active management of servicing assets has
become a critical component to holders of mortgage servicing rights. Due to the
risk of impairment of mortgage servicing rights as a result of constantly
changing interest rates and prepayment speeds on the underlying mortgage
portfolio, risk management of mortgage servicing rights by holders of mortgage
servicing rights portfolios, which typically takes the form of hedging the
portfolio, has become more prevalent. The SFAS 140 "mark-to-market" analyses
done by Matrix Capital Markets help clients assess which of their portfolios of
mortgage servicing rights are most susceptible to impairment due to interest
rate and prepayment risk.
We believe that the services offered by the analytics department of Matrix
Capital Markets provide us with a competitive advantage in attracting and
retaining clients because we are able to offer financial services companies and
financial institutions a more complete package of services than our competitors.
In addition, Matrix Capital Markets is able to refer clients to Matrix Bank for
bulk loan acquisitions and to Matrix Asset Management for real estate management
and disposition services. The full range of services offered by Matrix Capital
Markets and its affiliates further strengthens Matrix Capital Market's client
relationships.
Real Estate Management and Disposition Services. Matrix Asset Management
provides real estate management and disposition services on foreclosed
properties owned by financial services companies and financial institutions
across the United States. In addition to the unaffiliated clients currently
served by Matrix Asset Management, many of which are also clients of Matrix
Capital Markets, Matrix Financial uses Matrix Asset Management exclusively in
handling the disposition of foreclosed real estate for which it is responsible.
Having Matrix Asset Management, rather than Matrix Financial, provide this
service transforms the disposition process into a revenue generator for us,
since Matrix Asset Management typically collects a referral fee based on the
value of the foreclosed real estate from the real estate broker involved in the
sale transaction. Because Matrix Asset Management typically collects a portion
of its fee from the real estate broker, Matrix Asset Management is able to
provide this disposition service on an outsourced basis at a reduced cost to the
mortgage loan servicer. Matrix Asset Management is able to pass a portion of the
cost of the disposition on to the real estate broker because of the volume it
generates.
In addition, Matrix Asset Management provides limited collateral valuation
opinions to clients who are interested in assessing the value of the underlying
collateral on nonperforming mortgage loans, as well as to clients such as Matrix
Bank and other third party mortgage loan originators and buyers interested in
evaluating potential bulk purchases of mortgage loans.
School Services. In addition to providing financing to charter schools as
mentioned in "Lending Activities--Commercial and Other Lending," ABS also
provides a wide variety of outsourced business and consulting services to
charter schools. The most basic services offered by ABS include fund accounting,
cash management, budgeting, governmental reporting and payroll and accounts
payable processing. Additionally, ABS consults with and offers programs to
charter schools in the following areas:
o facility and safety management;
o technology;
o policy development;
o grant administration; and
o comprehensive insurance coverage.
ABS also provides administrative and instructional leadership to some charter
schools by placing administrators on-site at the charter schools to take a
hands-on approach and work with the schools with regard to curriculum
development, special education and personnel management.
The business services provided by ABS are integral to the financing
division, as these services allow ABS to use their knowledge of the school's
financial condition and the capability of the schools' operators to make
informed decisions in the underwriting of charter school financing. The services
also give ABS a significant advantage in the servicing and ongoing monitoring of
17
the schools, which we believe is imperative to the collection process and the
overall success of our financing efforts.
ABS has begun to expand its services to include more operational control
over individual charter schools, which consists of active oversight of the
day-to-day operations of the charter, including the selection of curriculum. The
expansion of the services applies to both independent charter schools and
charter schools managed by ABS.
Self-Directed Trust, Custody and Clearing Activities
Self-Directed Trust and Custody Services. The Company's trust and custody
activities are provided through Sterling Trust and Matrix Bank.
Sterling Trust provides administrative services for self-directed
individual retirement accounts, qualified business retirement plans and personal
custodial accounts, as well as corporate escrow and paying agent services. In
addition, Sterling Trust offers specialized custody and clearing services to
investment professionals. These services are marketed on a nationwide basis to
the financial services industry, specifically broker-dealers, registered
representatives, financial planners and advisors, tax professionals, insurance
agents and investment product sponsors. The advantage offered by Sterling Trust
is the ability to hold a wide array of publicly traded investments, as well as
nonstandard assets and private placement offerings.
Sterling Trust does not offer financial planning or advising services, nor
does it recommend, sell or solicit any investments. Sterling Trust acts only as
a directed custodian and is not affiliated with any investment. It has always
been Sterling Trust's mission to keep this independence to ensure that high
quality services are offered without any conflicting interests. Sterling Trust
executes no investment transaction without the direction of the account holder
or the account holder's authorized representative.
During 2002, Matrix Bank, through its Denver, Colorado location, expanded
the variety and depth of its trust services, primarily by partnering with Matrix
Settlement & Clearance Services in providing trust and custodial services to
over 50 nationally recognized third party administrators, broker-dealers and
banks. Trust and custodial services range from accepting qualified retirement
plan contributions, facilitating the trading and settlement of plan securities,
making distributions to individual plan participants, to withholding state and
federal taxes and producing annual tax forms.
These services are marketed in conjunction with Matrix Settlement &
Clearance Services on a nationwide-basis to the financial services industry,
specifically, broker-dealers, registered representatives, financial planners and
advisors, tax professionals, insurance agents and investment product sponsors.
The advantage offered by Matrix Bank's trust department is the ability to hold
and report on a wide array of publicly traded investments. Matrix Bank's trust
department acts only as a direct trustee and does not offer financial planning
or advising.
At December 31, 2002, Sterling Trust had 34,300 accounts with assets under
administration of over $2.0 billion, and the trust department of Matrix Bank had
10,800 accounts with assets under administration of over $5.8 billion.
Clearing Services. Matrix Settlement & Clearance Services, our joint
venture, provides automated clearing of mutual funds utilizing the National
Securities Clearing Corporation's Fund/SERV and Defined Contribution Clearance &
Settlement platform for banks, trust companies, third party administrators and
registered investment advisors. In performing services for its customers, Matrix
Settlement & Clearance Services generates low-cost deposits and trust and
custodial fees for the Company. As of December 31, 2002, Matrix Settlement &
Clearance Services had 86 clients under contract with those clients
administering approximately $13.8 billion in funds that would be eligible for
inclusion in the automated clearing environment of the National Securities
Clearing Corporation.
MSCS Financial Services, LLC, a wholly owned subsidiary of Matrix
Settlement & Clearance Services, began operations January 2, 2002 as a NASD
registered broker-dealer.
Through our wholly owned subsidiary, Matrix Advisory Services, LLC, we
continue to develop and plan to offer an Internet-based private wealth
management service through the utilization of proprietary asset allocation
models in 2003 as a complementary business to the clearing operation. The model
was developed and will be supported by a nationally recognized research and
investment firm. The advantage that our service will offer is a turnkey approach
with the automation of the mutual fund clearing.
18
Competition
We compete for the acquisition of mortgage servicing rights and bulk loan
portfolios mainly with mortgage companies, savings associations, commercial
banks and other institutional investors. We believe that we have competed
successfully for the acquisition of mortgage servicing rights and bulk loan
portfolios by relying on the advantages provided by our unique corporate
structure and the secondary market expertise of our employees.
We believe that Matrix Bank's most direct competition for deposits comes
from local financial institutions. Customers distinguish between market
participants based primarily on price and, to a lesser extent, the quality of
customer service and name recognition. Matrix Bank's cost of funds fluctuates
with general market interest rates. During certain interest rate environments,
we expect additional significant competition for deposits from corporate and
governmental debt securities, as well as from money market mutual funds. Matrix
Bank competes for conventional deposits by emphasizing quality of service,
extensive product lines and competitive pricing.
For mortgage loan and mortgage servicing rights, brokerage and consulting,
we compete mainly with other mortgage banking consulting firms and national and
regional investment banking companies. We believe that the customers distinguish
between market participants based primarily on customer service. Matrix Capital
Markets competes for its brokerage and consulting activities by:
o recruiting qualified and experienced sales people;
o developing innovative sales techniques;
o offering superior analytical services;
o providing financing opportunities to its customers through its
affiliation with Matrix Bank; and
o seeking to provide a higher level of service than is furnished by
its competitors.
In originating mortgage loans, Matrix Financial and Matrix Bank have
historically competed mainly with other mortgage companies, finance companies,
savings associations and commercial banks. Customers distinguish among market
participants based primarily on price and, to a lesser extent, the quality of
customer service and name recognition. After the sale of the Platform, we have
agreed with the Buyer not to compete in certain respects. We do not believe,
however, that this stipulation will impact substantially the ability of Matrix
Bank to effectively serve its local markets or customers. See "Item 1.
Business--Sale of Wholesale Production Platform."
Sterling Trust faces considerable competition in all of the services and
products that it offers, mainly from other self-directed trust companies and
broker-dealers. Sterling Trust also faces competition from other trust companies
and trust divisions of financial institutions. Sterling Trust's niche has been,
and will continue to be, providing high quality customer service and servicing
nonstandard retirement products. In an effort to increase market share, Sterling
Trust will endeavor to provide superior service, offer technologically advanced
solutions, expand its marketing efforts, provide competitive pricing and
continue to diversify its product mix.
Matrix Asset Management competes against other companies that specialize
in providing real estate management and disposition services on foreclosed
property. Additionally, clients or potential clients that opt to perform these
services in-house diminish Matrix Asset Management's market.
ABS competes with other outsourcing companies and Educational Management
Organizations, as well as schools that prefer to perform the services offered by
ABS in-house.
Employees
At December 31, 2002, the Company had 902 employees. We believe that our
relations with our employees are good. The Company is not party to any
collective bargaining agreement. We anticipate that the Buyer of the production
platform will hire approximately 346 of our employees, thereby reducing our
employee count to approximately 556 as of the Final Closing Date. See "Item 1.
Business--Sale of Wholesale Production Platform."
19
Regulation and Supervision
Set forth below is a brief description of various laws, regulatory
authorities and associated regulations affecting our operations. The description
of laws and regulations contained in this document does not purport to be
complete and is qualified in its entirety by reference to applicable laws and
regulations.
Any change in applicable laws, regulations or regulatory policies may have
a material effect on our business, operations and prospects.
Matrix Bancorp. We are a unitary savings and loan holding company within
the meaning of the Home Owners' Loan Act. As such, we are subject to OTS
regulation, examination, supervision and reporting requirements. In addition,
the OTS has enforcement authority over us and our savings association and
non-savings association subsidiaries. Among other things, this authority permits
the OTS to restrict or prohibit activities that are determined to be a serious
risk to the financial safety, soundness or stability of our subsidiary savings
institution, Matrix Bank. In addition, Matrix Bank must notify the OTS at least
30 days before making any capital distribution to us.
As a unitary savings and loan holding company that has been in existence
prior to May 4, 1999, we generally are not restricted under existing laws as to
the types of business activities in which we may engage, provided that Matrix
Bank continues to be a "qualified thrift lender" under the Home Owners' Loan
Act. To maintain its status as a qualified thrift lender, Matrix Bank must
maintain a minimum percentage of its assets in qualified thrift investments
unless the Office of Thrift Supervision grants an exception to this requirement.
In general, qualified thrift investments include certain types of residential
mortgage loans and mortgage-backed securities. If we acquire control of another
savings association as a separate subsidiary, we would become a multiple savings
and loan holding company. Multiple savings and loan holding companies may only
engage in those activities permissible for a financial holding company under the
Bank Holding Company Act of 1956, as amended. Generally, financial holding
companies may only engage in activities such as banking, insurance and
securities activities, as well as merchant banking activities under certain
circumstances. In addition, if Matrix Bank fails to maintain its status as a
qualified thrift lender, within one year of Matrix Bank's failure, we would be
required to convert Matrix Bank to a national bank and to register as a bank
holding company under the Bank Holding Company Act of 1956, as amended.
The Change in Bank Control Act, as amended, provides that no person,
acting directly or indirectly or thorough or in concert with one or more other
persons, may acquire control of a savings association unless the Office of
Thrift Supervision has been given 60 days prior written notice. The Home Owners'
Loan Act provides that no company may acquire control of a savings association
without the prior approval of the Office of Thrift Supervision. Any company that
acquires such control becomes a savings and loan holding company subject to
registration, examination and regulation by the Office of Thrift Supervision.
Pursuant to federal regulations, control of a savings association (which
includes its holding company) is conclusively deemed to have been acquired by,
among other things, the acquisition of more than 25% of any class of voting
stock of the association or the ability to control the election of a majority of
the directors of the association. Moreover, control is presumed to have been
acquired, subject to rebuttal, upon the acquisition of more than 10% of any
class of voting stock, but less than 25% of any class of stock of a savings
association, where certain enumerated "control factors" are also present in the
acquisition. The Office of Thrift Supervision may prohibit an acquisition of
control if it would result in a monopoly or substantially lessen competition,
the financial condition of the acquiring person might jeopardize the financial
stability of the association, or the competence, experience or integrity of the
acquiring person indicates that it would not be in the interest of the
depositors or the public to permit the acquisition of control by such person.
Gramm-Leach-Bliley. The Gramm-Leach-Bliley Act of 1999 (otherwise known as
the "Financial Services Modernization Act") eliminated many federal and state
law barriers to affiliations among banks, securities firms, insurance companies
and other financial service providers. The law revised and expanded the Bank
Holding Company Act framework to permit a holding company structure to engage in
a full range of financial activities through a new entity known as a "Financial
Holding Company." "Financial activities" is broadly defined to include not only
banking, insurance and securities activities, but also merchant banking and
additional activities that the Federal Reserve Board, in consultation with the
Secretary of the Treasury, determined to be financial in nature, incidental to
such financial activities, or complementary activities that do not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally.
20
The Financial Services Modernization Act prohibits unitary savings and
loan holding companies formed after May 4, 1999 from engaging in nonfinancial
activities. We are a grandfathered unitary savings and loan holding company. The
Financial Services Modernization Act has not had a material adverse effect on
our operations. However, the Financial Services Modernization Act permits banks,
securities firms and insurance companies to affiliate. This has continued a
trend in the financial services industry toward further consolidation. The
Financial Services Modernization Act could result in an increasing amount of
competition from larger institutions and other types of companies offering
financial products, many of which may have substantially more financial
resources. In addition, the Financial Services Modernization Act may have an
anti-takeover effect because it may tend to limit our attractiveness as an
acquisition candidate to other savings and loan holding companies and financial
holding companies.
The USA Patriot Act was signed into law on October 26, 2001. The USA
Patriot Act gives the federal government new powers to address terrorist threats
through enhanced domestic security measures, expanded surveillance powers,
increased information sharing and broadened anti-money laundering requirements.
The USA Patriot Act also requires the federal banking agencies to take into
consideration the effectiveness of controls designed to combat money laundering
activities in determining whether to approve a merger or other acquisition
application of a member institution. Accordingly, if we engage in a merger or
other acquisition, our controls designed to combat money laundering would be
considered as part of the application process. We do not believe that the USA
Patriot Act will have a material impact on our operations.
Federal Savings Bank Operations. Matrix Bank is subject to extensive
regulation, examination and supervision by the Office of Thrift Supervision, as
its primary federal regulator, and potentially by the Federal Deposit Insurance
Corporation, which insures its deposits up to applicable limits. Such regulation
and supervision:
o establishes a comprehensive framework of activities in which Matrix
Bank can engage;
o limits the types and amounts of investments permissible for Matrix
Bank;
o limits the ability of Matrix Bank to extend credit to any given
borrower;
o significantly limits the transactions in which Matrix Bank may
engage with its affiliates;
o requires Matrix Bank to meet a qualified thrift lender test that
requires Matrix Bank to invest in qualified thrift investments,
which include primarily residential mortgage loans and related
investments;
o places limitations on capital distributions by savings associations
such as Matrix Bank, including cash dividends;
o imposes assessments to the Office of Thrift Supervision to fund its
operations;
o establishes a continuing and affirmative obligation, consistent with
Matrix Bank's safe and sound operation, to help meet the credit
needs of its community, including low and moderate income
neighborhoods;
o requires Matrix Bank to maintain certain noninterest-bearing
reserves against its transaction accounts;
o establishes various capital categories resulting in various levels
of regulatory scrutiny applied to the institutions in a particular
category; and
o establishes standards for safety and soundness.
Matrix Bank must submit annual financial reports audited by independent
auditors to federal regulators. Auditors must receive examination reports,
supervisory agreements and reports of enforcement actions. In addition, an
attestation by the auditor regarding the statements of management relating to
the internal controls must be submitted to the Office of Thrift Supervision. The
audit committees of such institutions must include members with experience in
banking or financial management, must have access to outside counsel and must
not include representatives of large customers. The regulatory structure is
designed primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities. Any change in
these regulations, whether by the Office of Thrift Supervision, the Federal
Deposit Insurance Corporation or Congress, could have a material impact on
Matrix Bank and its operations.
Transactions with Affiliates. Under current federal law, Sections 23A and
23B of the Federal Reserve Act govern transactions between depository
institutions and their affiliates. These provisions are made applicable to
savings associations, such as Matrix Bank, by the Home Owners' Loan Act. In a
holding company context, in general, the parent holding company of a savings
association and any companies that are controlled by the parent holding company
are affiliates of the savings association. However, the Office of Thrift
Supervision has the discretion to treat subsidiaries of savings associations as
affiliates on a case-by-case basis. Section 23A limits the extent to which the
savings association or its subsidiaries may engage in certain transactions with
its affiliates. These transactions include, among other things, the making of
loans or other extensions of credit to an affiliate and the purchase of assets
from an affiliate. Generally, these transactions between the savings association
and any one affiliate cannot exceed 10% of the savings association's capital
21
stock and surplus, and these transactions between the savings institution and
all of its affiliates cannot, in the aggregate, exceed 20% of the savings
institution's capital stock and surplus. Section 23A also establishes specific
collateral requirements for loans or extensions of credit to an affiliate, and
for guarantees or acceptances on letters of credit issued on behalf of an
affiliate. Applicable regulations prohibit a savings association from lending to
any affiliate engaged in activities not permissible for a bank holding company
or acquire the securities of most affiliates. Section 23B requires that
transactions covered by Section 23A and a broad list of other specified
transactions be on terms and under circumstances substantially the same, or no
less favorable to the savings association or its subsidiary, as similar
transactions with non-affiliates. In addition to the restrictions on
transactions with affiliates that Sections 23A and 23B of the Federal Reserve
Act impose on depository institutions, the regulations of the Office of Thrift
Supervision also generally prohibit a savings association from purchasing or
investing in securities issued by an affiliate. Matrix Bank engages in
transactions with its affiliates, which are structured with the intent of
complying with these rules. Sections 23A and 23B have been codified into a new
regulation issued by the Federal Reserve Board which becomes effective on April
1, 2003. The regulation is not expected to materially impact Matrix Bank.
Insurance of Accounts and Regulation by the Federal Deposit Insurance
Corporation. Matrix Bank is a member of the Savings Association Insurance Fund,
which is administered by the Federal Deposit Insurance Corporation. The deposits
of Matrix Bank are insured up to $100,000 per depositor by the Federal Deposit
Insurance Corporation. This insurance is backed by the full faith and credit of
the United States. As insurer, the Federal Deposit Insurance Corporation imposes
deposit insurance assessments and is authorized to conduct examinations of and
to require reporting by institutions insured by the Federal Deposit Insurance
Corporation. It also may prohibit any Federal Deposit Insurance
Corporation-insured institution from engaging in any activity the Federal
Deposit Insurance Corporation determines by regulation or order to pose a
serious risk to the Federal Deposit Insurance Corporation. The Federal Deposit
Insurance Corporation also may initiate enforcement actions against savings
associations and may terminate the deposit insurance if it determines that the
institution has engaged or is engaging in unsafe or unsound practices, or is in
an unsafe or unsound condition.
The Federal Deposit Insurance Corporation's deposit insurance premiums are
assessed through a risk-based system under which all insured depository
institutions are placed into one of nine categories and assessed insurance
premiums based upon their level of capital and supervisory evaluation. Under the
system, institutions classified as well capitalized, as defined below, and
considered healthy pay the lowest premium while institutions that are less than
adequately capitalized, as defined below, and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
depository institutions is made by the Federal Deposit Insurance Corporation for
each semi-annual assessment period.
The Federal Deposit Insurance Corporation is authorized to increase
assessment rates, on a semi-annual basis, if it determines that the reserve
ratio of the Savings Association Insurance Fund will be less than the designated
reserve ratio of 1.25% of the Savings Association Insurance Fund's insured
deposits. In setting these increased assessments, the Federal Deposit Insurance
Corporation must seek to restore the reserve ratio to that designated reserve
level, or such higher reserve ratio as established by the Federal Deposit
Insurance Corporation. The Federal Deposit Insurance Corporation may also impose
special assessments on Savings Association Insurance Fund members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the Federal Deposit Insurance Corporation.
Since January 1, 1997, the premium schedule for insured institutions in
the Bank Insurance Fund and the Savings Association Insurance Fund has ranged
from 0 to 27 basis points. However, Savings Association Insurance Fund and Bank
Insurance Fund insured institutions are required to pay a Financing Corporation
or "FICO" assessment, in order to fund the interest on bonds issued to resolve
thrift failures in the 1980s. For the quarter ended December 31, 2002, the FICO
assessment for both Savings Association Insurance Fund and Bank Insurance Fund
insured institutions was equal to 1.70% for each $100 in domestic deposits
maintained at the institution. These assessment, which will be revised based
upon the level of Savings Association Insurance Fund and Bank Insurance Fund
deposits, will continue until the bonds mature in the year 2017.
Brokered Deposits. Under the Federal Deposit Insurance Corporation
regulations governing brokered deposits, well capitalized associations, such as
Matrix Bank, are not subject to brokered deposit limitations, while adequately
capitalized associations are subject to certain brokered deposit limitations and
undercapitalized associations may not accept brokered deposits. At December 31,
2002, Matrix Bank had $327.3 million of brokered deposits. In the event Matrix
Bank is not permitted to accept brokered deposits in the future, it would have
to find replacement sources of funding. It is possible that such alternatives,
if available, would result in a higher cost of funds.
22
Matrix Bank's Capital Ratios. Federal law requires, among other things,
that federal bank regulatory authorities take "prompt corrective action" with
respect to savings institutions that do not meet minimum capital requirements.
For these purposes, the law establishes five categories: well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized and
critically undercapitalized.
The Office of Thrift Supervision has adopted regulations to implement the
prompt corrective action legislation. An institution is deemed to be:
o "well capitalized" if it has a total risk-based capital ratio of 10%
or greater and a leverage ratio of 5% or greater;
o "adequately capitalized" if it has a total risk-based capital ratio
of 8% or greater, a Tier I risk-based capital ratio of 4% or greater
and generally a leverage ratio of 4% or greater;
o "undercapitalized" if it has a total risk-based capital ratio of
less than 8%, a Tier I risk-based capital ratio of less than 4%, or
generally a leverage ratio of less than 4%;
o "significantly undercapitalized" if it has a total risk-based
capital ratio of less than 6%, a Tier I risk-based capital ratio of
less than 3%, or a leverage ratio of less than 3%; and
o "critically undercapitalized" if it has a ratio of tangible equity
(as defined in the regulations) to total assets that is equal to or
less than 2%.
As of December 31, 2002, Matrix Bank was a "well capitalized" institution.
"Undercapitalized" institutions must adhere to growth, capital
distribution and dividend and other limitations and are required to submit a
capital restoration plan with the Office of Thrift Supervision within 45 days
after an association receives notice of such undercapitalization. A savings
institution's compliance with its capital restoration plan is required to be
guaranteed by any company that controls the "undercapitalized" institution in an
amount equal to the lesser of 5% of total assets when deemed "undercapitalized"
or the amount necessary to achieve the status of "adequately capitalized." If an
"undercapitalized" savings institution fails to submit an acceptable plan, it is
treated as if it is "significantly undercapitalized." "Significantly
undercapitalized" institutions must comply with one or more of a number of
additional restrictions, including an order by the Office of Thrift Supervision
to sell sufficient voting stock to become "adequately capitalized," requirements
to reduce total assets and cease receipt of deposits from correspondent banks or
dismiss directors or officers, and restriction on interest rates paid on
deposits, compensation of executive officers and capital distributions to the
parent holding company. "Critically undercapitalized" institutions must comply
with additional sanctions, including, subject to a narrow exception, the
appointment of a receiver or conservator within 270 days after it obtains this
status.
The following table indicates Matrix Bank's regulatory capital ratios:
As of
December 31, 2002
------------------------------------
Core Risk-Based
Capital Capital
------------------ -----------------
(Dollars in thousands)
Shareholder's equity/GAAP capital............................................. 100,716 $ 100,716
Disallowed assets............................................................. 6,341 6,341
Unrealized gain on available for sale securities.............................. (26) (26)
Additional capital items:
General valuation allowances............................................. - 6,083
Residual interests - (65)
------------------ -----------------
Regulatory capital as reported to the Office of Thrift Supervision............ 94,349 100,367
Minimum capital requirement as reported to the Office of Thrift Supervision... 64,602 69,680
------------------ -----------------
Regulatory capital--excess..................................................... 29,747 30,687
================== =================
Capital ratios................................................................ 5.84 11.52
Well capitalized requirement.................................................. 5.00 10.00
Federal Home Loan Bank System. Matrix Bank is a member of the Federal Home
Loan Bank ("FHLB") system, which consists of 12 regional FHLBs. The FHLB
provides a central credit facility primarily for member associations and
administers the home financing credit function of savings associations. The FHLB
23
advances must be secured by specified types of collateral and may only be
obtained for the purpose of providing funds for residential housing finance. The
FHLB funds its operations primarily from proceeds derived from the sale of
consolidated obligations of the FHLB system. Matrix Bank, as a member of the
FHLB system, must acquire and hold shares of capital stock in its regional FHLB
in an amount equal to the greater of 1% of the aggregate principal amount of its
unpaid residential mortgage loans and similar obligations at the beginning of
each year, 0.3% of total assets, or 5% of its advances ("borrowings") from the
FHLB. Prior to relocating its domicile, Matrix Bank was a member of the FHLB of
Dallas. Effective March 25, 2002, Matrix Bank is a member of the FHLB of Topeka.
Matrix Bank was in compliance with the requirement discussed with an investment
in FHLB of Dallas and Topeka stock at December 31, 2002 totaling $30.4 million.
Federal Reserve System. The Federal Reserve Board regulations require all
depository institutions to maintain noninterest-earning reserves at specified
levels against their transaction accounts (primarily NOW and regular checking
accounts). At December 31, 2002, Matrix Bank was in compliance with the Federal
Reserve Board's reserve requirements. Savings associations, such as Matrix Bank,
are authorized to borrow from the Federal Reserve Bank "discount window," but
the Federal Reserve Board regulations require institutions to exhaust other
reasonable alternative sources of funds, including FHLB borrowings, before
borrowing from the Federal Reserve Bank.
Mortgage Banking Operations. Our mortgage banking operations are conducted
through Matrix Financial. The rules and regulations applicable to our mortgage
banking operations establish underwriting guidelines that, among other things,
include anti-discrimination provisions, require provisions for inspections,
appraisals and credit reports on prospective borrowers and fix maximum loan
amounts. Moreover, we are required annually to submit audited financial
statements to the HUD, Fannie Mae, Freddie Mac and Ginnie Mae, and each
regulatory entity maintains its own financial guidelines for determining net
worth and eligibility requirements. Our operations are also subject to
examination by the HUD, Fannie Mae, Freddie Mac and Ginnie Mae at any time to
assure compliance with the applicable regulations, policies and procedures.
Mortgage loan origination activities are subject to, among other laws, the Equal
Credit Opportunity Act, the Federal Truth-in-Lending Act and the Real Estate
Settlement Procedures Act of 1974, and the regulations promulgated under these
laws that prohibit discrimination and require the disclosure of certain basic
information to mortgagors concerning credit terms and settlement costs.
Moreover, the Office of Thrift Supervision, as primary regulatory authority over
Matrix Bank (the parent of Matrix Financial), examines our mortgage banking
operations as well.
Regulation of Sterling Trust Company. Sterling Trust provides custodial
services and directed, non-discretionary trustee services. Sterling Trust was
chartered under the laws of the State of Texas, and as a Texas trust company is
subject to supervision, regulation and examination by the Texas Department of
Banking. Under applicable law, a Texas trust company, such as Sterling Trust, is
subject to virtually all provisions of the Texas Banking Act as if the trust
company were a state chartered bank. The activities of a Texas trust company are
limited by applicable law generally to acting as a trustee, executor,
administrator, guardian or agent for the performance of any lawful act, and to
lend and accumulate money when authorized under applicable law. In addition, a
Texas trust company with capital of $1 million or more, such as Sterling Trust,
has the power to:
o purchase, sell, discount and negotiate notes, drafts, checks and
other evidences of indebtedness;
o purchase and sell securities;
o issue subordinated debentures and promissory notes; and
o exercise powers incidental to the enumerated powers of Texas trust
companies as set forth in the Texas Banking Act.
A Texas trust company, such as Sterling Trust, is generally prohibited
from accepting demand or time deposits if not insured by the Federal Deposit
Insurance Corporation.
Limitation on Capital Distributions. The Texas Finance Code prohibits a
Texas trust company from reducing its outstanding capital and certified surplus
through redemption or other capital distribution without the prior written
approval of the Texas Banking Commissioner. Moreover, Sterling Trust anticipates
that it will not pay cash dividends during 2003.
Investments. A Texas trust company is generally obligated to maintain an
amount equal to 40% of its capital and surplus in investments that are readily
marketable and that can be converted into cash within four business days. So
long as it complies with those requirements, a Texas trust company generally is
permitted to invest its corporate assets in any investment otherwise permitted
by law. Generally, a Texas trust company cannot invest an amount in excess of
15% of its capital and certified surplus in the securities of a single issuer.
24
Branching. The Texas Finance Code permits a Texas trust company to
establish and maintain branch offices at any location within the state if it
first obtains written approval of the Texas Banking Commissioner.
Transactions with Related Parties. The Texas Finance Code prohibits the
sale or lease of an asset of a Texas trust company, or the purchase or lease of
an asset by a Texas trust company, where the transaction involves an officer,
director, principal shareholder or affiliate, unless the transaction is approved
by a disinterested majority of the board of directors or the written approval of
the Texas Banking Commissioner is first obtained. In no event, however, may a
Texas trust company lease real property in a transaction involving an officer,
director, principal shareholder or affiliate without the prior approval of the
Texas Banking Commissioner.
Enforcement. Under applicable provisions of the Texas Finance Code, the
Texas Banking Commissioner has the power to issue enforcement actions against a
Texas trust company or any officer, employee or director of a Texas trust
company. In addition, in certain circumstances, the Texas Banking Commissioner
may remove a present or former officer, director or employee of a Texas trust
company from office or employment, and may prohibit a shareholder or other
persons participating in the affairs of a Texas trust company from such
participation. The Texas Banking Commissioner has the authority to assess civil
penalties of up to $500 per day against a Texas trust company (penalties against
individuals may be higher) for violations of a cease and desist, removal or
prohibition order. The Texas Banking Commissioner may also refer violations of a
cease and desist order to the attorney general for enforcement by injunction.
The Texas Banking Commissioner may pursue an order of supervision or
conservatorship if:
o The Texas Banking Commissioner determines that the Texas trust
company is in a hazardous condition and that the continuation of
business would be hazardous to the public or to the shareholders or
creditors of the Texas trust company,
o The Texas Banking Commissioner determines that the Texas trust
company has exceeded its powers,
o The Texas trust company has violated the law, or
o The Texas trust company gives written consent to supervision or
conservatorship.
The Texas Banking Commissioner also has the authority to pursue the
appointment of an independent receiver for a Texas trust company.
Capital Requirements. Applicable law generally requires a Texas trust
company to have and maintain minimum restricted capital of at least $1 million.
Sterling Trust was in compliance with the requirement at December 31, 2002.
A Texas trust company may not have at anytime outstanding liabilities in
an amount that exceeds five times its capital stock and surplus, except that
with the approval of the Texas Banking Commissioner, a Texas trust company may
have outstanding liabilities in an amount that does not exceed ten times its
capital stock and surplus. The Texas Banking Commissioner may require additional
capital of a Texas trust company if the Texas Banking Commissioner determines it
necessary to protect the safety and soundness of such company. If the Texas
Banking Commissioner were to do so, or in the event Sterling Trust fails to
maintain capital of at least $1 million, there is no assurance that Sterling
Trust would be able to restore its capital or meet such additional requirements.
In either case, the Texas Banking Commissioner could pursue various enforcement
actions, such as appointing either a conservator or a receiver for Sterling
Trust. Currently, however, Sterling Trust is in compliance with all capital
requirements under Texas law.
Regulation of First Matrix Investment Services Corp. First Matrix
Investment Services Corp. is a registered broker-dealer subsidiary that is
subject to the Securities and Exchange Commission's net capital rule, Rule
15c3-1, promulgated under the Securities Exchange Act of 1934. The net capital
rule is designed to measure the general financial condition and liquidity of a
broker-dealer. Net capital generally is the net worth of a broker or dealer
(assets minus liabilities), less deductions for certain types of assets. If a
firm fails to maintain the required net capital, it may be subject to suspension
or revocation of registration by the Securities and Exchange Commission and
suspension or expulsion by the NASD, and could ultimately lead to the firm's
liquidation. The net capital rule also limits the ability of broker-dealers to
transfer large amounts of capital to parent companies and other affiliates. At
December 31, 2002, First Matrix was in compliance with these requirements with
net capital of $285,000, which was $247,000 in excess of its required net
capital of $38,000.
The foregoing is an attempt to summarize some of the relevant laws, rules
and regulations governing unitary savings and loan holding companies and savings
institutions but does not purport to be a complete summary of all applicable
laws, rules and regulations governing such financial institutions.
25
Item 2. Properties
We believe that all of our present facilities are adequate for our current
needs and that additional space is available for future expansion on acceptable
terms. The following table sets forth certain information concerning the real
estate that we own or lease:
Monthly Rent
or Mortgage
Location Square Feet/Acres Owned/Leased Occupant Payment
- ---------------------- ------------------- ---------------------------------- ---------------------------- ----------------
Denver, CO...........(1) 182,623 Owned Matrix Bancorp and various N/A
of its subsidiaries (1)
Denver, CO........... 8,007 Leased through April 30, 2003 Matrix Bancorp and Matrix $ 14,413
Asset Management
Phoenix, AZ..........(5) 62,771 Leased through February 28, 2007 Matrix Financial, Matrix $ 64,278
Bank, ABS and Matrix
Bancorp
Memphis, TN.......... 3,305 Leased month to month First Matrix and Matrix $ 5,619
Capital Markets
Las Cruces, NM....... 1,800 Owned Matrix Bank N/A
Las Cruces, NM.......(2) 30,000 Owned Matrix Bank N/A
Sun City, AZ......... 3,000 Owned Matrix Bank N/A
Atlanta, GA..........(4) 4,129 Leased through August 31, 2003 Matrix Financial $ 7,167
Chicago, IL.......... 1,658 Leased through April 30, 2003 Matrix Financial $ 2,895
Clayton, MO.......... 6,718 Leased through June 30, 2003 Matrix Financial $ 14,275
Dallas, TX...........(4) 6,205 Subleased through May 31, 2004 Matrix Financial $ 11,376
Houston, TX..........(4) 4,011 Leased through October 31, 2003 Matrix Financial $ 5,682
Jacksonville, FL.....(4) 5,250 Leased through December 31, 2005 Matrix Financial $ 7,438
Phoenix, AZ..........(4) 5,500 Leased through June 30, 2005 Matrix Financial $ 8,938
Phoenix, AZ.......... 17,241 Leased through August 31, 2007 Matrix Financial $ 8,365
Sacramento, CA.......(4) 4,202 Leased through December 31, 2003 Matrix Financial $ 7,774
Santa Ana, CA........(4) 8,851 Leased through August 31, 2003 Matrix Financial $ 14,037
Waco, TX............. 11,294 Leased through June 30, 2006 Sterling Trust $ 13,553
Waco, TX.............(3) 928 Leased through June 30, 2003 Sterling Trust $ 1,021
Fort Worth, TX....... 1,148 Leased through November 30, 2004 First Matrix $ 1,579
Cottonwood, AZ....... 1,879 Owned ABS N/A
Deerfield Beach, FL.. 500 Leased month to month ABS $ 863
Flagstaff, AZ........ 10,000 and Owned ABS N/A
1.107 Acres
Gilbert, AZ.......... 1.98 Acres Owned ABS N/A
Gilbert, AZ.......... 10,456 Owned ABS N/A
Glendale, AZ......... 12.892 Acres Owned ABS N/A
Houston, TX.......... 71,437 Owned ABS N/A
Mesa, AZ............. 7616 Owned ABS N/A
Phoenix, AZ.......... 9,150 Owned ABS N/A
Phoenix, AZ.......... 5 Acres Owned ABS N/A
Phoenix, AZ.......... 6.729 Acres Owned ABS N/A
Phoenix, AZ.......... 22,920 Owned ABS N/A
Phoenix, AZ.......... 10,000 Owned ABS N/A
Phoenix, AZ.......... 7,200 Owned ABS N/A
Phoenix, AZ.......... 10,000 Owned ABS N/A
Port Charlotte, FL... 10,200 Owned ABS N/A
St. Louis, MO........ 6,144 Leased through June 30, 2012 ABS $ 12,500
St. Louis, MO........ 5,500 Owned ABS N/A
St. Louis, MO........ 42,000 Owned ABS N/A
Snow Flake, AZ....... 2,850 Owned ABS N/A
__________
(1) Of this 182,623 square feet, approximately 58,167 square feet are leased to
the Company and certain of its subsidiaries. Approximately 4,432 square
feet of this leased property will be assigned to the Buyer of the sale of
the production platform. See "Item 1. Business--Sale of Wholesale
Production Platform." Substantially all of the remaining space is rented to
unaffiliated third parties at market prices.
(2) Of this 30,000 square feet, approximately 10,100 square feet serve as the
branch for Matrix Bank. Substantially all of the remaining space is rented
to unaffiliated third parties at market prices.
(3) Management is reviewing options concerning renewal of the lease at its
expiration.
(4) These properties will be assigned to the Buyer of the production platform.
See "Item 1. Business--Sale of Wholesale Production Platform."
(5) Of this 62,771 square feet, approximately 26,950 square feet will be
subleased to the Buyer of the production platform. See "Item 1.
Business--Sale of Wholesale Production Platform."
26
Item 3. Legal Proceedings
General. We are from time to time party to various litigation matters, in
most cases, involving ordinary and routine claims incidental to our business.
With respect to all pending litigation matters, our ultimate legal and financial
responsibility, if any, cannot be estimated with certainty. Therefore, no
accrual for loss has been made as of December 31, 2002. However, the outcome
with respect to one or more of these matters, if adverse, is reasonably likely
to have a material, adverse impact on the consolidated financial position,
results of operations or cash flows of the Company.
Matrix Bancorp. In early 1999, the Company and Matrix Bank instituted an
arbitration action with the American Arbitration Association in Phoenix, Arizona
against Fidelity National Financial, Inc. The arbitration action arose out of an
alleged breach by Fidelity of a Merger Termination Agreement entered into
between the Company and Fidelity in connection with the termination of their
proposed merger. The arbitration panel has ruled that the entire Merger
Termination Agreement was unenforceable. The Company and Matrix Bank filed an
appeal of the arbitration panel's decision in federal district court in Phoenix,
Arizona, which has been denied. In October 2001, Fidelity initiated a second
arbitration to determine the validity of a release given in connection with the
Merger Termination Agreement. Matrix Bancorp contested that the releases were
valid and, in the alternative, made a counterclaim against Fidelity demanding
restitutional damages for the value of the releases if they were determined
valid. The arbitration panel has held the releases to be valid and enforceable
and has denied the Company's claim for restitutional damages. Fidelity has filed
a motion with the arbitration panel requesting that it be awarded its attorney
fees, and the panel has awarded Fidelity approximately $500,000. The Company
anticipates an appeal of the findings of the arbitration panel.
Matrix Bancorp, The Vintage Group, Inc., Vintage Delaware Holdings, Inc.,
Matrix Bank, and Guy A. Gibson, currently a director of Matrix Bancorp, Richard
V. Schmitz, currently Co-Chief Executive Officer and Chairman of the Board of
Matrix Bancorp, and D. Mark Spencer, currently the President, Co-Chief Executive
Officer and a director of Matrix Bancorp, have been named defendants in an
action filed in November 2000 styled Roderick Adderley, et al. v. Guy A. Gibson,
et al. pending in the District Court of Tarrant County, Texas, seeking to impose
joint and several liability on these defendants for the judgment against
Sterling Trust in Roderick Adderley, et al. v. Advance Financial Services, Inc.,
et al. ("Adderley I") See "Sterling Trust" below. The plaintiffs have asserted
various theories of liability, including control person theories of liability
under the Texas Securities Act and fraudulent transfer theories of liability.
The defendants believe they have adequate defenses and intend to vigorously
defend this action. The parties have agreed to abate the action pending the
outcome of Adderley I. See "Sterling Trust." The ultimate legal and financial
liability of the Company, if any, in this matter cannot be estimated with
certainty at this time.
Matrix Bank. A former customer of Matrix Bank is a debtor in a Chapter 11
proceeding under the Bankruptcy Code styled In re Apponline.com, Inc. and Island
Mortgage Network, Inc. pending in the United States Bankruptcy Court for the
Eastern District of New York. Prior to the bankruptcy filing, Matrix Bank had
provided the customer, Island Mortgage Network, Inc., with a purchase/repurchase
facility under which Matrix Bank purchased residential mortgage loans from
Island Mortgage, with Island Mortgage having the right or obligation to
repurchase such mortgage loans within a specified period of time. Several other
financial institutions had provided Island Mortgage with warehouse financing or
additional purchase/repurchase facilities. The total value of the loans Matrix
Bank purchased from Island Mortgage that are subject to the bankruptcy is
approximately $12.5 million in original principal amount (the "Purchased
Loans"). The principals of Island Mortgage were indicted for fraud in connection
with financial improprieties committed by Island Mortgage.
Various third parties have instituted lawsuits, adversary proceedings or
competing bankruptcy claims against Matrix Bank claiming an equitable interest
in approximately eighteen of the Purchased Loans (approximately $2.3 million in
original principal amount). These third parties consist primarily of title
companies, closing attorneys and other closing agents that provided settlement
funds in connection with the funding of a borrower's mortgage loan, in many
cases, we believe in violation of various "good funds" laws, which typically
require a closing agent to wait for receipt of "good funds" prior to
disbursement of settlement funds on the origination of a loan. After providing
settlement funds, these closing agents discovered that Island Mortgage had
either provided company checks with insufficient funds or had inappropriately
placed a stop payment on the checks. To date, Matrix Bank has reached tentative
agreements with several claimants to settle claims asserted against loans
purchased from Island Mortgage upon terms satisfactory to Matrix Bank.
Additionally, certain parties in the chain of title to property securing
approximately $2.7 million of loans, including sellers and prior lien holders,
are seeking to void or rescind their transactions on the theory that they never
received consideration. Matrix Bank has reached tentative agreements to settle
several claims arising from these loans and has been engaged in discussions with
several additional claimants to resolve as many of these claims as possible on
terms satisfactory to Matrix Bank, the trustee and the Bankruptcy Court.
27
The trustee for Island Mortgage recently completed his "due diligence"
review of the loans Matrix Bank purchased from Island Mortgage at issue in the
bankruptcy and confirmed that Matrix Bank's interests are "perfected" in all but
17 of the loans. The trustee filed three adversary actions seeking to avoid
Matrix Bank's interests in those 17 loans. Matrix Bank believes that it will
prevail in demonstrating to the Bankruptcy Court that Matrix Bank is the
rightful owner of each of the 17 loans subject to the adversary actions filed by
the trustee and that the interests of Matrix Bank are superior to any claim
possessed by the trustee with respect to those loans.
The trustee also initiated an adversary action against Matrix Bank seeking
to recover as an avoidable preference $6.1 million Island Mortgage paid to
Matrix Bank. Matrix Bank believes that it will successfully demonstrate to the
Bankruptcy Court that the $6.1 million the trustee seeks to recover was purchase
money belonging to Matrix Bank returned by Island Mortgage for loans that did
not close and were not sold to Matrix Bank.
Matrix Bank believes it has adequate defenses and intends to vigorously
defend the actions discussed in the previous five paragraphs. The ultimate legal
and financial liability of the Company, if any, in any of these matters cannot
be estimated with certainty at this time.
Additionally, Matrix Bank has initiated an adversary claim against the
State Bank of Long Island ("State Bank"). State Bank was the depository bank for
Island Mortgage, and Matrix Bank believes that State Bank bears liability for
any loss sustained by Matrix Bank as a result of the fraud perpetrated by Island
Mortgage. Matrix Bank also believes that any loss it may sustain as a result of
its dealings with Island Mortgage are insured. Matrix Bank cannot accurately
assess at this time whether and to what extent it will receive compensation from
any source for any loss it may incur as a result of its relationship with Island
Mortgage.
Matrix Financial. Matrix Financial has been named a defendant in an
arbitration claim pending before the American Arbitration Association in Denver,
Colorado. The claim was filed on May 22, 2002 by a former employee, who was
terminated in early 2002. The claimant claims that he was not terminated "for
cause," as specified in his employment agreement and has made claims for, among
other things, breach of good faith and fair dealing, breach of his employment
agreement, back pay and other economic loss, violation of the Colorado wage act
and attorneys' fees and costs. Matrix Financial believes it has meritorious
defenses to this claim and intends to defend the matter vigorously.
Sterling Trust. Sterling Trust has been named a defendant in an action
filed July 1999 styled Roderick Adderley, et al. v. Advanced Financial Services,
Inc., et al. that was tried in Tarrant County, Texas district court in the
spring of 2000. The jury returned a verdict adverse to Sterling Trust with
respect to two of 12 theories of liability posed by the plaintiffs, and the
court has signed a judgment for certain of the plaintiffs in the amount of
approximately $6.4 million. Sterling Trust has filed an appeal of this judgment
and believes it has meritorious points of appeal. It intends to vigorously
prosecute the appeal of this action. The ultimate resolution of this appeal
could result in a loss of up to $6.4 million plus post-judgment interest and
additional attorneys' fees. The ultimate legal and financial liability, if any,
of Sterling Trust cannot be estimated with certainty at this time.
Sterling Trust was named a defendant in several putative class action
lawsuits instituted in November 2000 by one law firm in Pennsylvania. The styles
of such lawsuits are as follows: Douglas Wheeler, et al. v. Pacific Air
Transport, et al.; Paul C. Jared, et al. v. South Mountain Resort and Spa, Inc.,
et al.; Lawrence Rehrig, et al. v. Caffe Diva, et al.; Merrill B. Christman, et
al. v. Millennium 2100, Inc., et al.; David M. Veneziale, et al. v. Sun
Broadcasting Systems, Inc., et al.; and Don Glazer, et al. v. Technical Support
Servs., Inc., et al. All of such lawsuits were originally filed in the United
States District Court for the Western District of Pennsylvania. On April 26,
2001, the District Court for the Western District of Pennsylvania ordered that
all of such cases be transferred to the United States District Court for the
Western District of Texas so that Sterling Trust could properly present its
motion to compel arbitration. Sterling Trust filed separate motions to compel
arbitration in these actions, all of which were granted. Each of the six
plaintiffs timely filed arbitration demands with the American Arbitration
Association. The demands seek damages and allege Sterling Trust breached
fiduciary duties and was negligent in administrating each claimant's
self-directed individual retirement account holding a nine-month promissory
note. Sterling Trust believes it has meritorious defenses and is defending the
matters vigorously.
Sterling Trust has been named a defendant in an action filed in August
2002 styled Charles W. and Wanda Davis v. Lionel Sanchez, et al. that was filed
in the Second Judicial District Court in the County of Bernalillo, State of New
Mexico. The plaintiffs have claims they were defrauded in connection with their
investment of approximately $200,000 through their self-directed IRA held by
Sterling Trust. Sterling Trust has filed a motion to compel arbitration based
28
upon the account agreements entered into by the plaintiffs. Sterling Trust
believes it has meritorious defenses to the claims and intends to defend the
matter vigorously.
Sterling Trust has been named a defendant in an action filed in July 2001
in Department 68, Superior Court for the County of San Diego, State of
California styled Robert Heyenga, et al. v. Brian D. Gibbs, et al. The
plaintiffs have alleged various theories of liability against Sterling Trust
relating to their investments of an indeterminable amount in Legend Financial
Group, Inc. through their self-directed IRAs held by Sterling Trust. Sterling
Trust believes it has meritorious defenses to the claims and intends to defend
the matter vigorously.
Sterling Trust has been named in an arbitration action filed in July 2002
styled David M. Albert, William H. Craven, Charles Savall & Leonid Shapiro v.
Sterling Trust Company that is pending before the Judicial Arbiter Group of
Denver, Colorado. The plaintiffs have alleged breach of contract against
Sterling Trust relating to their investments of approximately $850,000 in
Advisors Capital Investments through their self-directed IRAs held by Sterling
Trust. In January 2003, this action was settled and the matter has been closed.
Sterling Trust has been named a defendant in an action filed in December
2001 styled Heraclio A. Munoz, et al. v. Sterling Trust Company that is pending
in Superior Court of the State of California. The complaint seeks class action
status, requests unspecified damages and alleges negligent misrepresentation,
breach of fiduciary duty and breach of written contract on the part of Sterling
Trust. On December 10, 2002, the court denied Sterling Trust's motion to compel
arbitration. Sterling Trust believes it has meritorious defenses and is
defending the matter vigorously.
In addition, Sterling Trust has been the subject of numerous lawsuits and
arbitration proceedings in which customers and, in some cases, persons who are
not customers allege various theories of liability against the Company for
losses suffered by these claimants in connection with their failed investments
in several enterprises. To the extent that Sterling Trust has had any
relationship with any of such claimants, it has been solely as custodian of such
claimants self-directed IRAs pursuant to contracts that specify the limited
nature of Sterling Trust's obligations. We believe Sterling Trust has in each
case acted in accordance with its obligations under the contracts and/or as
otherwise imposed by law. We further believe that the ultimate outcome of each
of these cases will not be material to the consolidated financial position and
results of operations of Company; but, there can be no assurances that there
will not be an adverse outcome in any one or more of these cases or that any
such adverse outcome will not have a material adverse effect on the consolidated
financial position and results of operations of the Company.
ABS School Services. ABS has been named a defendant in an action filed in
the Superior Court of Arizona, Maricopa County on June 3, 2002 by a former
employee. The former employee claims that she is entitled to approximately
$450,000 in commissions owed to her at the time of termination of her
employment. She has also made claims under the Arizona wage act and for an award
of her attorneys' fees. ABS believes it has meritorious defenses to this claim
and intends to defend the matter vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2002.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock, $0.0001 par value, is traded on The Nasdaq National
Market under the symbol "MTXC." The following table sets forth the high and low
sales prices for our common stock on The Nasdaq National Market for the periods
indicated.
Market Price
---------------------------
Quarter Ended: High Low
------------ ------------
December 31, 2002................. $ 9.920 $ 7.400
September 30, 2002................ 11.690 9.500
June 30, 2002..................... 13.500 10.800
March 31, 2002 ................... 11.750 10.100
December 31, 2001................. $ 11.400 $ 9.960
September 30, 2001................ 11.420 9.810
June 30, 2001 .................... 11.750 8.600
March 31, 2001.................... 9.375 6.938
29
On March 12, 2003, the closing price of our common stock was $8.02 per
share. Also, as of that date, the approximate number of holders of record of our
common stock was 41. This number does not include beneficial owners who hold
their shares in a depository trust in "street" name.
In May 2000, we announced the adoption of a Common Stock Repurchase
Program under which we were authorized to repurchase up to $3 million of our
common stock. In June 2002, the Board of Directors of the Company authorized the
repurchase of up to an additional $2.5 million of common stock, bringing the
total authorization to-date under the repurchase program to $5.5 million of
common stock. Under the program, we have repurchased a total of 389,560 shares
through December 31, 2002, for a total purchase price of approximately $3.2
million. No executive officer or director participated in this repurchase. Our
ability to repurchase stock is further limited due to various provisions in
Matrix Bancorp's debt instruments, the most restrictive of which is our bank
stock loan. Under the bank stock loan, Matrix Bancorp is allowed to make certain
restricted payments, which includes repurchases of stock and payments of
dividends to shareholders, in an amount of up to $3 million plus 25% of the
Company's cumulative consolidated net income for fiscal quarters beginning with
the quarter ending March 31, 2001. Although we have no present plans to do so,
we may seek in the future authorization from the Board of Directors of Matrix
Bancorp to repurchase additional shares of our Common Stock under the Common
Stock Repurchase Program. Any such additional authorization will be consistent
with the restrictions and limitations under our debt covenants, including those
of the bank stock loan described above.
We have not paid any dividends on our equity for the last three fiscal
years. Any future determination as to dividend policy will be made at the
discretion of the Board of Directors of the Company and will depend on a number
of factors, including our future earnings, capital requirements, financial
condition and future prospects and such other factors the Board of Directors may
deem relevant. Our ability to pay dividends is restricted by the same provisions
that restrict our ability to repurchase our stock, as described in the
immediately preceding paragraph. Additionally, Matrix Bancorp is prohibited from
paying dividends on its common stock if the scheduled payments on our junior
subordinated debentures and trust preferred securities have not been made. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources" and Note 10 to the consolidated
financial statements included elsewhere in this document. In addition, the
ability of Sterling Trust and Matrix Bank to pay dividends to Matrix Bancorp may
be restricted due to certain regulatory requirements. See "Item 1.
Business--Regulation and Supervision."
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL AND OPERATING INFORMATION
OF MATRIX BANCORP, INC.
The following selected consolidated financial data and operating
information of Matrix Bancorp, Inc. and subsidiaries should be read in
conjunction with the consolidated financial statements and notes thereto and
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations," each of which is included elsewhere in this document.
30
As of and for the
Year Ended December 31,
----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------- ------------- -------------- ------------
(Dollars in thousands, except per share data)
Statement of Operations Data
Net interest income before provision for
loan and valuation losses................ $ 49,199 $ 40,510 $ 29,785 $ 29,463 $ 24,190
Provision for loan and valuation losses.... 2,821 2,980 4,235 3,180 4,607
------------ ------------- ------------ -------------- ------------
Net interest income after provision for
loan and valuation losses................ 46,378 37,530 25,550 26,283 19,583
------------ ------------- ------------ -------------- ------------
Noninterest income:
Loan administration...................... 32,243 30,113 23,850 23,686 17,411
Brokerage................................ 8,105 4,815 8,119 6,156 7,054
Trust services......................... 5,345 4,036 4,923 4,840 4,169
Real estate disposition services....... 4,153 2,572 3,677 3,659 2,036
Gain on sale of loans and securities..... 521 1,475 982 3,247 3,108
Gain on sale of mortgage servicing rights 675 167 2,634 363 803
Loan origination......................... 35,829 34,933 7,587 6,218 5,677
School services.......................... 4,616 5,427 4,240 2,813 46
Other.................................... 5,923 7,618 2,780 9,378 6,441
------------ ------------- ------------ -------------- ------------
Total noninterest income............... 97,410 91,156 58,792 60,360 46,745
Noninterest expense........................ 152,057 115,899 77,841 69,586 52,939
------------ ------------- ------------ -------------- ------------
(Loss) income before income taxes(8)....... (8,269) 12,787 6,501 17,057 13,389
Income tax (benefit) expense............... (4,317) 4,275 2,243 6,278 4,876
------------ ------------- ------------ -------------- ------------
Net (loss) income.......................... $ (3,952) $ 8,512 $ 4,258 $ 10,779 $ 8,513
============ ============= ============ ============== ============
Net (loss)income per share assuming
dilution(1) ............................... $ (0.61) $ 1.30 $ 0.63 $ 1.58 1.24
Weighted average common shares assuming
dilution................................... 6,462,272 6,560,454 6,748,857 6,833,546 6,881,890
Balance Sheet Data
Total assets............................... $ 1,701,597 $ 1,646,940 $ 1,418,773 $ 1,283,746 $ 1,012,155
Securities................................. 29,073 6,963 66,616 -- --
Total loans, net........................... 1,393,817 1,340,700 1,095,045 1,103,515 848,448
Mortgage servicing rights, net............. 63,200 78,712 71,529 63,479 57,662
Deposits(2)................................ 933,957 866,235 602,669 562,194 490,516
Custodial escrow balances.................. 151,790 129,665 77,647 94,206 96,824
Federal Home Loan Bank borrowings.......... 385,785 303,361 519,433 405,000 168,000
Borrowed money............................. 125,903 222,032 124,503 142,101 178,789
Total shareholders' equity................. 66,936 71,312 64,023 60,497 49,354
Operating Ratios and Other Selected Data
Return on average assets(3)................ (0.24)% 0.54% 0.32% 1.02% 1.02%
Return on average equity(3)................ (5.57) 12.82 6.79 19.79 18.92
Average equity to average assets(3)........ 4.35 4.18 4.75 5.16 5.41
Net interest margin(3)(4).................. 3.53 2.87 2.51 3.25 3.37
Operating efficiency ratio(5).............. 87.23 71.12 76.76 59.21 59.74
Total amount of loans purchased............ $ 1,127,632 $ 97,486 $ 204,922 $ 701,952 $ 678,150
Balance of owned servicing portfolio (end
of period)................................. 5,333,627 5,656,365 5,517,963 5,889,715 5,357,729
Trust assets under administration (end of
period) ................................... 7,876,329 6,017,085 3,847,038 2,545,060 2,089,562
Wholesale loan origination volume.......... 3,720,868 3,612,477 512,541 443,363 574,963
Ratios of Earnings to Fixed Charges(6)
Including interest on deposits............. 0.84x 1.19x 1.09x 1.38x 1.36x
Excluding interest on deposits............. 0.71x 1.40x 1.15x 1.75x 1.64x
Loan Performance Ratios and Data
Allowance for loan and valuation losses.... $ 9,343 $ 9,338 $ 8,581 $ 6,354 $ 3,710
Nonperforming loans(7) .................... 30,818 37,251 28,516 25,641 13,209
Nonperforming loans/total loans(7) ........ 2.20% 2.76% 2.54% 2.31% 1.55%
Nonperforming assets/total assets(7) ...... 2.30 2.77 2.20 2.06 1.40
Net loan charge-offs/average loans(3) ..... 0.25 0.17 0.18 0.06 0.38
Allowance for loan and valuation losses/
total loans ........................... 0.67 0.69 0.76 0.57 0.44
Allowance for loan and valuation losses/
nonperforming loans .................... 30.32 25.07 30.09 24.78 28.09
__________
(1) Net (loss) income per common share assuming dilution is based on the
weighted average number of common shares outstanding during each period
and the dilutive effect, if any, of stock options and warrants
outstanding. There are no other dilutive securities.
(2) Beginning in February 1998, Matrix Bank began accepting brokered deposits.
At December 31, 2002, 2001, 2000 and 1999, the total balance of brokered
deposits was $327.3 million, $303.0 million, $203.6 million and $221.5
million, respectively.
(3) Calculations are based on average daily balances where available and
monthly averages otherwise.
(4) Net interest margin has been calculated by dividing net interest income
before loan and valuation loss provision by average interest-earning
assets.
(5) The operating efficiency ratio has been calculated by dividing noninterest
expense, excluding amortization of mortgage servicing rights, by operating
income. Operating income is equal to net interest income before provision
for loan and valuation losses plus noninterest income.
(6) For purposes of calculating the ratio of earnings to fixed charges,
earnings consist of income before taxes plus interest and rent expense.
Fixed charges consist of interest and rent expense.
(7) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Asset and Liability Management--Nonperforming
Assets" for a discussion of the level of nonperforming loans.
(8) Income before income taxes for the year ended December 31, 2001 is shown
net of a $360,000 cumulative effect of a change in accounting principle.
31
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following management's discussion and analysis of the
financial condition and results of operations in conjunction with the preceding
"Selected Consolidated Financial and Operating Information." Additionally, our
consolidated financial statements and the notes thereto, as well as other data
included in this document, should be read and analyzed in combination with the
analysis below.
General
Matrix Bancorp was formed in June 1993 when the founding shareholders of
Matrix Financial and United Financial, now known as Matrix Capital Markets, two
of our subsidiaries, exchanged all of their outstanding capital stock for shares
of our stock in a series of transactions that were each accounted for as a
pooling of interests. In September 1993, we acquired Dona Ana Savings and Loan
Association, FSB, which was subsequently renamed Matrix Capital Bank. The
acquisition was accounted for using the purchase method of accounting. We formed
Matrix Asset Management, formerly United Special Services, in June 1995 and
United Capital Markets in December 1996. In February 1997, we acquired The
Vintage Group (whose primary subsidiary is Sterling Trust) in a pooling of
interests and, accordingly, no goodwill was recorded and our consolidated
financial statements for the prior periods were restated. Additionally, we
acquired ABS in March 1999. The acquisition was accounted for using the purchase
method of accounting. We entered into our joint venture, Matrix Settlement &
Clearance Services, in September of 1999. On August 1, 2000, we sold the stock
of United Capital Markets to one of the officers of that company. On August 1,
2000, Matrix Financial, our mortgage banking operation, became an operating
subsidiary of Matrix Bank. On October 31, 2001, First Matrix, our broker-dealer
operation, became an operating subsidiary of Matrix Capital Markets.
The principal components of our revenues consist of:
o net interest income recorded by Matrix Bank, Matrix Financial and
ABS School Services;
o loan origination fees generated by Matrix Financial and, to a lesser
extent, Matrix Bank;
o brokerage and consulting fees generated by Matrix Capital Markets
and First Matrix;
o disposition services fees generated by Matrix Asset Management;
o gains on sales of mortgage loans and mortgage servicing rights
generated by Matrix Bank and Matrix Financial;
o loan administration fees generated by Matrix Financial;
o trust service fees generated by Sterling Trust; and
o school service fees generated by ABS.
Our results of operations are influenced by changes in interest rates and
the effect of these changes on our interest margins, the volume of loan
originations, mortgage loan prepayments and the value of mortgage servicing
portfolios. Our fee-based businesses are effected to a lesser extent by interest
rates and more by competition and general market conditions.
Sale of Wholesale Production Platform
In February 2003, we entered into an agreement to sell our wholesale mortgage
origination platform at Matrix Financial. See "Item 1. Business--Sale of
Wholesale Production Platform." As of the Initial Sale Date and during the
Transition Period, due to our continuing involvement, we will continue to
account for the operations of the Platform. The effective sale date for
accounting purposes will be the Final Sale Date which is anticipated to be
approximately six months after the Initial Closing Date. We were concerned that
over an extended period of time we would find it difficult to compete in the
highly competitive industry that generally operates on high volume and low
margins. Based on the size of our wholesale production platform, we were
required to commit a significant percentage of our capital to a line of business
that is fairly cyclical and the earnings were difficult for us to estimate. The
decision to sell the platform will allow us to reduce our operational risks and
costs associated with the origination platform. We intend to reinvest the
liquidity that will be created from the sale into predominately adjustable rate
loans, SBA loans and potentially mortgage-backed securities. To the extent that
we are not able to reinvest the liquidity in a timely manner, we will experience
a decrease in our net interest income. Initially, the liquidity will be used to
pay down borrowings from the FHLB or brokered certificates of deposit.
Comparison of Results of Operations for Fiscal Years 2002 and 2001
Net Income (Loss). A net loss of $(4.0) million for the fiscal year 2002
was recognized, a $12.5 million decrease to the net income of $8.5 million for
fiscal year 2001. On a basic and diluted per share basis, net loss was $(0.61)
32
for the fiscal year 2002 as compared to net income of $1.30 per diluted share
for fiscal year 2001. The decreases in net income, earnings per share and return
on average equity were caused primarily by $14.2 million, net pre-tax, non-cash
impairment charges against the value of the mortgage servicing rights and
related advances, $1.0 million write-off of goodwill balances at ABS and a
$700,000 loss on subleasing of office space. For a further discussion of the
goodwill write-off, see "--Recent Accounting Pronouncements" regarding SFAS No.
142, "Goodwill and Other Intangible Assets."
Net Interest Income. Net interest income before provision for loan and
valuation losses increased $8.7 million to $49.2 million for fiscal year 2002 as
compared to $40.5 million for fiscal year 2001. Our net interest margin
increased 66 basis points (equivalent to 0.0066 percentage points) to 3.53% for
the year ended December 31, 2002 from 2.87% for the year ended December 31,
2001, and interest rate spread increased to 3.19% for the year ended December
31, 2002 from 2.32% for the year ended December 31, 2001. The increase in net
interest income before provision for loan valuation losses was primarily due to
a 184 basis point decrease in the cost of our interest-bearing liabilities,
driven by decreases in interest rates, which have significantly impacted the
rates paid by Matrix Bank for FHLB borrowings and certificates of deposit. The
cost of FHLB borrowings decreased 173 basis points to 2.89% for the year ended
December 31, 2002 as compared to 4.62% for the year ended December 31, 2001. The
cost of certificates of deposit decreased 233 basis points to 3.65 % for the
year ended December 31, 2002 as compared to 5.98% for the year ended December
31, 2001. The interest rate on short-term borrowings fluctuates with the federal
funds rate, which remain at 40-year lows. The decrease in our cost of
interest-bearing liabilities was partially offset by a decrease in the yield
earned on our average loan portfolio to 6.65% for the year ended December 31,
2002 as compared to 7.62% for the year ended December 31, 2001. The increase was
also due to a $64.0 million increase in our average noninterest-bearing deposits
between the two comparable years, offset by a slight decrease in our average
interest-earning assets to $1.40 billion for the year ended December 31, 2002 as
compared to $1.41 billion for the year ended December 31, 2001. For a tabular
presentation of the changes in net interest income due to changes in volume of
interest-earning assets and changes in interest rates, see "Analysis of Changes
in Net Interest Income Due to Changes in Interest Rates and Volumes."
Provision for Loan and Valuation Losses. The provision for loan and
valuation losses decreased $200,000, or 5.3%, to $2.8 million for fiscal year
2002 as compared to $3.0 million for fiscal year 2001. This decrease was
attributable to lower levels of reserves recorded at Matrix Bank and Matrix
Financial due to improvements in nonaccrual loans, offset by higher levels of
reserves recorded at ABS due to higher loan losses versus levels in 2001. For a
discussion of the components of the allowance for loan losses, see "Asset and
Liability Management--Analysis of Allowance for Loan and Valuation Losses." For
a discussion on the allowance as it relates to nonperforming assets, see "Asset
and Liability Management--Nonperforming Assets."
Loan Administration. Loan administration income represents service fees
earned from servicing loans for various investors, which are based on a
contractual percentage of the outstanding principal balance plus late fees and
other ancillary charges, as well as gains on sales of repurchased FHA and VA
loans. Loan administration fees increased $2.1 million to $32.2 million for
fiscal year 2002 as compared to $30.1 million for fiscal year 2001. The increase
includes gains on sale of previously repurchased FHA and VA loans from our
mortgage servicing rights portfolio of $5.0 for the year ended December 31, 2002
as compared to $1.8 million for the year ended December 31, 2001. Gains on sale
of previously repurchased FHA and VA loans relate to delinquent loans which are
purchased out of loan pools of which Matrix Financial acts as servicer and then
re-sells into the secondary market. Loan service fees are also affected by
factors that include the size of our residential mortgage loan servicing
portfolio, the servicing spread, the timing of payment collections and the
amount of ancillary fees received. Our mortgage loan servicing portfolio
increased slightly to an average balance of $5.7 billion for fiscal year 2002 as
compared to an average balance of $5.5 billion for fiscal year 2001. There was a
decrease in the average service fee (including all ancillary income) to 0.48%
for the year ended December 31, 2002 as compared to 0.51% for the year ended
December 31, 2001, excluding the gain noted above, and fiscal 2001 excludes a
$550,000 transition adjustment, as well as $275,000 of subservicing income from
a portfolio sold in 2001 not transferred until 2002. The decrease in the service
fees was due to Matrix Financial's decision in the third quarter of 2002 to
begin to sell the majority of its newly originated servicing under an assignment
of trade contract. In the near term, Matrix Financial anticipates it will
continue to sell the majority of its newly originated servicing. As a result,
Matrix Financial anticipates loan administration fees to decrease as its
servicing portfolio decreases through normal prepayments. See "Item 1.
Business--Sale of Wholesale Production Platform."
Loan Origination. Loan origination income includes all mortgage loan fees,
secondary marketing activity on new loan originations and servicing release
premiums on new originations sold, net of origination costs. Loan origination
income increased slightly to $35.8 million for fiscal year 2002 as compared to
$35.3 million for fiscal year 2001. The consistency in loan origination income
resulted from a combination of an increase in our wholesale origination to $3.8
billion for the year ended December 31, 2002 as compared to $3.6 billion for the
year ended December 31, 2001; an increase in sales of our wholesale production
33
to $3.9 billion for the year ended December 31, 2002 as compared to $3.2 billion
for the year ended December 31, 2001; offset by the effects of a decrease in net
income spread to 63.1 basis points for the year ended December 31, 2002 as
compared to 71.9 basis points for the year ended December 31, 2001. The decrease
in the net income spread is a result of the ineffectiveness in the loan
origination hedging program primarily during the year ended December 31, 2002.
The Company closed fewer loans than anticipated, and thus had committed to sell
more loans than originated. The Company therefore incurred costs on the extra
hedge coverage. The higher than anticipated hedge ineffectiveness was primarily
due to the level of refinancing on which it is more difficult to predict the
probability of closure. Included in prior year income was $1.2 million from the
gain on sale of guaranteed portions of newly originated or purchased SBA loans
as compared to $300,000 in the current year. See "Item 1. Business--Sale of
Wholesale Production Platform."
Brokerage Fees. Brokerage fees represent income earned from brokerage and
consulting services performed pertaining to mortgage servicing rights, as well
as brokerage income earned from whole loan activities, retail and fixed income
activities, and SBA trading fees. Brokerage fees increased $3.3 million, or
68.3%, to $8.1 million for fiscal year 2002 as compared to $4.8 million for
fiscal year 2001. This increase was the result of strong performance in whole
loan brokerage activities, where fees increased to $5.9 million for the year
ended December 31, 2002 as compared to $1.9 million for the year ended December
31, 2001, as well as revenues generated as a result of the focus by First Matrix
on the acquisition, pooling and selling of SBA loans and securities where
revenue increased to $1.7 million for the year ended December 31, 2002 as
compared to $100,000 for the year ended December 31, 2001 when the SBA activity
began.
Trust Services. Trust service fees increased $1.3 million, or 32.4%, to
$5.3 million for fiscal year 2002 as compared to $4.0 million for fiscal year
2001. During 2002, the trust department at Matrix Bank began its operations. The
increase is due to an increase in total trust accounts under administration at
Sterling Trust and Matrix Bank of 45,097 accounts at December 31, 2002 from
41,329 accounts at December 31, 2001 and total fiduciary assets under
administration which increased to $7.9 billion at December 31, 2002 from $6.0
billion at December 31, 2001. Much of the growth was driven by business referred
to us by Matrix Settlement & Clearance Services.
Real Estate Disposition Services. Real estate disposition services
represents fees earned by Matrix Asset Management for real estate management and
disposition services provided on foreclosed properties owned by third party
financial services companies and financial institutions. Real estate disposition
service income increased $1.6 million, or 61.5%, between the fiscal years 2002
and 2001 to $4.2 million. The increase was due to the increase in the number of
properties closed during the year, which increased 58.1%, to 2,283 from 1,444 in
2001. Additionally, the increase is due to new clients obtained as a result of
prior marketing efforts. Properties under management were 2,071 at December 31,
2002 as compared to 1,146 at December 31, 2001.
Gain on Sale of Loans and Securities. Gain on sale of loans and securities
decreased $1.0 million to $500,000 for fiscal year 2002 as compared to $1.5
million for fiscal year 2001. Gains on sale can fluctuate significantly from
year to year based on a variety of factors, such as the current interest rate
environment, the supply and mix of loan or securities portfolios available in
the market, and as market conditions dictate, the particular loan portfolios we
elect to sell.
Gain on Sale of Mortgage Servicing Rights. Gain on sale of mortgage
servicing rights increased $500,000 to approximately $700,000 for fiscal year
2002 as compared to $200,000 for fiscal year 2001. The increased gain was
despite a decrease in terms of aggregate outstanding principal balances of
mortgage loans underlying such mortgage servicing rights which we sold being
$681.0 million in purchased mortgage servicing rights during fiscal year 2002 as
compared to $1.7 billion during fiscal year 2001. Gains from the sale of
mortgage servicing rights can fluctuate significantly from year to year based on
the market value of our servicing portfolio, the particular servicing portfolios
we elect to sell and the availability of similar portfolios in the market. Due
to our position in and knowledge of the market, and as market conditions
dictate, we anticipate selling additional servicing rights to decrease our
overall investment.
School Services. School services income represents fees earned by ABS for
outsourced business and consulting services provided primarily to charter
schools. School services income decreased $800,000, or 14.9%, to $4.6 million
for fiscal year 2002 as compared to $5.4 million for fiscal year 2001. This
decrease was primarily due to a decrease in the rates paid by our core business
service clients, which stood at 142 schools at December 31, 2002. During the
first six months of 2002, in an effort to increase our client base and fee
income on a national basis, ABS incurred significant costs for personnel and
marketing efforts. Ultimately, ABS was not able to attract the amount of new
contracts that it had targeted for the new school year, which begins in July of
each year. As a result of the lower than projected revenue, management has
elected to focus on expense reductions and client retention rather than
significant expansion. We do not anticipate a significant increase in revenue
34
for the coming year. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Comparison of Results of Operations for
Fiscal Years 2002 and 2001-Noninterest Expense" for discussion of goodwill
write-off.
Other Income. Other income decreased $1.7 million, or 22.3%, to $5.9
million for fiscal year 2002 as compared to $7.6 million for fiscal year 2001.
The 2001 fiscal year income included $3.4 million pre-tax gain on sale of assets
generated due to the condemnation of real estate held by Matrix Bank in Denver,
Colorado, which was going to be used for relocation of Matrix Bank's domicile.
The City and County of Denver condenmed the property in October 2001. A similar
gain was not present in 2002. Other income typcially includes service and ATM
fees, rental income, structured finance trading activities, along with other
miscellaneous items.
Noninterest Expense. Noninterest expense increased $36.2 million, or 31.2%,
to $152.1 million for fiscal year 2002 as compared to $115.9 million for fiscal
year 2001. This increase was primarily due to inclusion of the $14.2 million
non-cash impariment charge on mortgage servicing rights as compared to $181,000
in 2001, a $1.0 million charge to write-off the goodwill balance at ABS, a
$700,000 loss on subleasing office space associated with the move to Matrix
Financial Center and $1.0 million incremental reserves against other assets
during the year ended December 31, 2002. In addition, the Company experienced
increases in compensation and benefits expense and other general and
administrative expense due to increases to support growth and volume at Matrix
Bank, Matrix Financial and First Matrix. The following table details the major
components of noninterest expense for the periods indicated:
Year Ended
December 31,
-------------------------------
2002 2001
--------------- --------------
(In thousands)
Compensation and employee benefits $ 59,484 $ 52,573
Amortization of mortgage servicing rights .......................................... 24,176 21,862
Occupancy and equipment............................................................. 7,862 6,525
Postage and communication........................................................ 4,580 4,063
Professional fees................................................................... 3,175 2,883
Data processing..................................................................... 3,140 2,907
Impairment of mortgage servicing rights.......................................... 14,219 181
Other general and administrative.................................................... 35,421 24,905
--------------- --------------
Total.......................................................................... $152,057 $115,899
=============== ==============
Compensation and employee benefits increased $6.9 million, or 13.1%, to
$59.5 million for fiscal year 2002 as compared to $52.6 million for fiscal year
2001. This increase was primarily the result of increases in personnel costs at
Matrix Bank, Matrix Financial, First Matrix and ABS. The increased costs are due
to a combination of increased personnel and the inclusion of a full year of
salary and benefits costs for employees added during 2001. The increase also
reflects increased costs of medical benefits of 55.7% for the year ended
December 31, 2002 at these and the Company's other subsidiaries. The Company had
an overall decrease of 58 employees, or 6.0%, to 902 employees at December 31,
2002 as compared to 960 employees at December 31, 2001. This decrease occurred
primarily in the fourth quarter of 2002.
Amortization of mortgage servicing rights increased $2.3 million, or 10.6%,
to $24.2 million for fiscal year 2002 as compared to $21.9 million for fiscal
year 2001. Amortization of mortgage servicing rights fluctuates based on the
size of our mortgage servicing portfolio and the prepayment rates experienced
with respect to the underlying mortgage loan portfolio. In response to the
continued low interest rates prevalent in the market, prepayment speeds on our
servicing portfolio increased to an average of 23.7% during fiscal year 2002 as
compared to 22.9% during fiscal year 2001, and the average balance of our
mortgage servicing rights increased to $81.0 million for the 2002 fiscal year as
compared to $73.4 million for the 2001 fiscal year. However, the fourth quarter
of 2002 experienced a much higher prepayment speed of 31.0% than what was
experienced in the first three quarters of 2002.
Impairment of mortgage servicing rights, which is a non-cash charge,
increased to $14.2 million for the year ended December 31, 2002 as compared to
$181,000 for the year ended December 31, 2001. With regard to the impairment
charge, the Company is required to record its investment in mortgage servicing
rights at the lower of cost or fair value. The fair value of mortgage servicing
rights is determined based on the discounted future servicing income stratified
based on one or more predominant risk characteristics of the underlying loans.
The Company stratifies its mortgage servicing rights by product type and
investor to reflect the predominant risks. To determine the fair value of its
investment, the Company uses a valuation model that calculates the present value
of future cash flows. Due to the drop in interest rates, both the actual and
anticipated prepayment speeds used in the valuation model increased causing the
fair value of the servicing to decrease below the carrying basis which resulted
in an impairment. The majority of the impairment related to the servicing rights
35
retained by the Company on its originations over the last year. Further
decreases in interest rates, or increases in anticipated future prepayment
speeds, may cause additional impairment charges in future periods.
The remainder of noninterest expense, which includes occupancy and
equipment expense, postage and communication expense, professional fees, data
processing costs and other expenses, increased $12.9 million, or 31.2%, to $54.2
million for fiscal year 2002 as compared to $41.3 million for fiscal year 2001.
The increase is primarily related to the charges and reserves noted above, as
well as increases in foreclosure expenses at Matrix Financial, miscellaneous
operation expenses associated with additional volume at Matrix Bank, First
Matrix and Matrix Asset Management, and incremental reserves and write-offs of
receivables primarily at ABS.
Income Taxes. Income taxes decreased $8.8 million to a benefit of $(4.3)
million for fiscal year 2002 as compared to expense of $4.3 million for fiscal
year 2001. Our effective tax benefit was 52.2% for fiscal year 2002 as compared
to an effective tax rate of 32.5% for fiscal year 2001 due to the pre-tax loss
in 2002. The effective tax rates are affected by the level of tax-exempt income
at ABS in proportion to the level of net income (loss).
Comparison of Results of Operations for Fiscal Years 2001 and 2000
Net Income; Return on Average Equity. Net income increased $4.2 million to
$8.5 million for fiscal year 2001 as compared to $4.3 million for fiscal year
2000. On a per share basis, net income was $1.30 per diluted share for fiscal
year 2001 and $0.63 for fiscal year 2000. Return on average equity increased to
12.8% for fiscal year 2001 as compared to 6.8% for fiscal year 2000. The
increases in net income, earnings per share and return on average equity were
caused primarily by an increase in net interest income after provision for loan
and valuation losses and large increases in loan origination income and loan
administration fees generated at Matrix Financial, offset by increases in
compensation and employee benefit costs and increased amortization expense on
mortgage servicing rights.
Net Interest Income. Net interest income before provision for loan and
valuation losses increased $10.7 million to $40.5 million for fiscal year 2001
as compared to $29.8 million for fiscal year 2000. Our net interest income
before provision for loan and valuation losses increased due to the $229
million, or 19%, increase in our interest-earning assets. Additionally, an
element of the increase was our net interest margin increasing to 2.87% for the
year ended December 31, 2001 as compared to 2.51% for the year ended December
31, 2000. Although the yield on our interest-earning assets decreased to 7.46%
for the year ended December 31, 2001 from 8.22% for the year ended December 31,
2000, that decrease was more than offset by the decrease in our cost of
interest-bearing liabilities which for the same periods decreased to 5.15% from
6.15%. Both the decrease in the yield on our interest-earning assets and cost of
interest-bearing liabilities is a direct result of the interest rate environment
prevalent in 2001, which saw significant interest rate cuts by the Federal
Reserve. Also, attributing to the increase in the margin was the overall
increase in average noninterest-bearing deposits to $205 million at December 31,
2001 as compared to $141 million at December 31, 2000. The increase in the
noninterest-bearing deposits is due to a combination of an increase in our
custodial deposits and deposits generated from our investment in Matrix
Settlement & Clearance Services. For a tabular presentation of the changes in
net interest income due to changes in volume of interest-earning assets and
changes in interest rates, see "--Analysis of Changes in Net Interest Income Due
to Changes in Interest Rates and Volumes."
Provision for Loan and Valuation Losses. The provision for loan and
valuation losses decreased $1.2 million, or 30%, to $3.0 million for fiscal year
2001 as compared to $4.2 million for fiscal year 2000. This decrease was
primarily attributable to year 2000 including a significant charge-off at ABS of
a loan to a school client which closed, as well as a high year 2000 provision at
ABS and Matrix Bank versus levels in 2001. For a discussion of the components of
the allowance for loan losses, see "--Asset and Liability Management--Analysis
of Allowance for Loan and Valuation Losses." For a discussion on the allowance
as it relates to nonperforming assets, see "--Asset and Liability
Management--Nonperforming Assets."
Loan Administration. Loan administration income represents service fees
earned from servicing loans for various investors, which are based on a
contractual percentage of the outstanding principal balance plus late fees and
other ancillary charges, as well as activity in Ginnie Mae servicing portfolios.
Loan administration fees increased $6.3 million to $30.1 million for fiscal year
2001 as compared to $23.8 million for fiscal year 2000. Loan administration fees
are affected by factors that include the size of our residential mortgage loan
servicing portfolio, the servicing spread, the timing of payment collections and
the amount of ancillary fees received. Our mortgage loan servicing portfolio
increased slightly to an average balance of $5.5 billion for fiscal year 2001 as
compared to an average balance of $5.4 billion for fiscal year 2000, despite
significant increases in prepayment rates due to the declining interest rate
environment in the latter part of 2001. The increase in loan administration fees
was primarily driven by increased revenue generated from the purchasing of
36
delinquent government loans out of our Ginnie Mae servicing and the subsequent
sale of those loans. The revenue generated from this activity was approximately
$1.8 million. There were also increases in our ancillary fees. The remainder of
the increase is attributed to a slightly higher average servicing balance and a
higher balance of government servicing which tends to have higher servicing
fees.
Brokerage Fees. Brokerage fees represent income earned from brokerage and
consulting services performed pertaining to mortgage servicing rights. Brokerage
fees continued with 2000 trends and decreased $3.3 million, or 41%, to $4.8
million for fiscal year 2001 as compared to $8.1 million for fiscal year 2000.
This decrease was the result of a decrease in the balance of residential
mortgage servicing portfolios brokered by Matrix Capital Markets, which in terms
of aggregate unpaid principal balances on the underlying loans, decreased $12.5
billion, or 34%, to $23.9 billion for fiscal year 2001 as compared to $36.4
billion for fiscal year 2000. As previously discussed, the decrease noted is due
to the consolidation that has taken place in the mortgage banking industry.
Additionally, there was a decrease in whole loan revenue, again due to market
conditions. The overall market, including the number of buyers and sellers
servicing, has decreased, and as a result, we have experienced an overall
decrease in both the portfolios brokered and the corresponding revenue. In any
event, brokerage fees vary from quarter to quarter as the timing of servicing
sales is dependent upon the seller's need to recognize a sale or to receive cash
flows.
Trust Services. Trust service fees decreased $900,000, or 18%, to $4.0
million for fiscal year 2001 as compared to $4.9 million for fiscal year 2000.
The decrease in revenue is despite the fact that trust accounts under
administration at Sterling Trust increased to 41,329 accounts at December 31,
2001 from 39,220 accounts at December 31, 2000 and total fiduciary assets under
administration increased to $6.0 billion at December 31, 2001 from $3.8 billion
at December 31, 2000. The growth in accounts and assets under administration
occurred in third party administrator accounts, which increased 147% in 2001 to
3,554 accounts, which are generally priced at lower fees based on the level of
administration required and generate revenues based on number of transactions
within accounts versus level of assets.
Real Estate Disposition Services. Real estate disposition services
represents fees earned by Matrix Asset Management for real estate management and
disposition services provided on foreclosed properties owned by third party
financial services companies and financial institutions. Real estate disposition
service income decreased $1.1 million, or 30%, between the fiscal years 2001 and
2000 to $2.6 million. The decrease was due to the decrease in the number of
properties closed during the year, which decreased 23%, from 1,872 in 2000 to
1,444 in 2001.
Gain on Sale of Loans and Securities. Gain on sale of loans and securities
increased $500,000 to $1.5 million for fiscal year 2001 as compared to $1.0
million for fiscal year 2000. Loan sales of approximately $76.1 million in 2001
were completed under standard purchase and sale agreements, with standard
representations and warranties and without recourse. Sales of securities were
approximately $59.6 million in 2001 and pertained to loans that the Company had
purchased and swapped for securities. The gains from both types of these sales
represent cash gains. Gains on sale can fluctuate significantly from year to
year based on a variety of factors, such as the current interest rate
environment, the supply and mix of loan or securities portfolios available in
the market, the type of loan or securities portfolios we purchase and the
particular loan portfolios we elect to sell.
Gain on Sale of Mortgage Servicing Rights. Gain on sale of mortgage
servicing rights decreased $2.5 million to approximately $200,000 for fiscal
year 2001 as compared to $2.7 million for fiscal year 2000. In terms of
aggregate outstanding principal balances of mortgage loans underlying such
mortgage servicing rights, we sold $1.7 billion in purchased mortgage servicing
rights during fiscal year 2001 as compared to $1.1 billion during fiscal year
2000. Gains from the sale of mortgage servicing rights can fluctuate
significantly from year to year based on the market value of our servicing
portfolio, the particular servicing portfolios we elect to sell and the
availability of similar portfolios in the market. Due to our position in and
knowledge of the market, we expect to, at times, pursue opportunistic sales of
mortgage servicing rights. The 2000-year sale was undertaken to take advantage
of aggressive pricing in the marketplace while the market was not as favorable
of 2001 with the low interest rate environment prevalent throughout the year.
Loan Origination. Loan origination income includes all mortgage loan fees,
secondary marketing activity on new loan originations for both residential and
SBA loans, and servicing release premiums on servicing sold and capitalized
servicing on new originations sold, net of origination costs. Loan origination
income increased $27.7 million, or 365%, to $35.3 million for fiscal year 2001
as compared to $7.6 million for fiscal year 2000. The increase is primarily
attributable to an increase in wholesale residential mortgage loan production at
Matrix Financial by $3.1 billion, or 602%, to $3.6 billion during fiscal year
2001 as compared to $512.5 million during fiscal year 2000. The increases in
volume were due to our 2000 initiatives to increase origination platform and by
the declining interest rate environment of 2001.
37
School Services. School services income represents fees earned by ABS for
outsourced business and consulting services provided to schools. School services
income increased $1.2 million, or 28%, to $5.4 million for fiscal year 2001 as
compared to $4.2 million for fiscal year 2000. This increase was primarily due
to an increase in new school customers during 2001.
Other Income. Other income increased $4.8 million to $7.6 million for
fiscal year 2001 as compared to $2.8 million for fiscal year 2000. The increase
in other income was primarily due to $3.4 million pre-tax gain on sale of assets
generated due to the condemnation of real estate held by Matrix Bank in Denver,
Colorado, which was going to be used for relocation of Matrix Bank's domicile.
The City and County of Denver condenmed the property in October 2001.
Noninterest Expense. Noninterest expense increased $38.1 million, or 48.9%,
to $115.9 million for fiscal year 2001 as compared to $77.8 million for fiscal
year 2000. This increase was primarily due to increased compensation and
benefits expense, increased amortization of mortgage servicing rights and
increased other general and administrative expense, offset by a decrease in
professional fees. The following table details the major components of
noninterest expense for the periods indicated:
Year Ended
December 31,
-------------------------------
2001 2000
--------------- --------------
(In thousands)
Compensation and employee benefits $ 52,573 $ 34,245
Amortization of mortgage servicing rights .......................................... 21,862 9,851
Occupancy and equipment............................................................. 6,525 4,785
Postage and communication........................................................ 4,063 2,812
Professional fees................................................................... 2,883 4,687
Data processing..................................................................... 2,907 2,413
Other general and administrative.................................................... 25,086 19,048
--------------- --------------
Total.......................................................................... $ 115,899 $ 77,841
=============== ==============
Compensation and employee benefits increased $18.3 million, or 54%, to
$52.6 million for fiscal year 2001 as compared to $34.2 million for fiscal year
2000. This increase was primarily the result of increased salary expense at
Matrix Financial, and to a lesser extent, at ABS, Matrix Bancorp and Matrix
Bank. Matrix Financial's salary expense increased related to its initiative to
develop its production platform and $15.9 million of the total company increase
in compensation and employee benefits is attributable to Matrix Financial. This
initiative involved opening two new production offices, acquiring a servicing
and production platform and hiring additional administrative and production
staff in late 2000 which operated all of 2001. The Company had an overall
increase of 225 employees, or 31%, to 960 employees at December 31, 2001 as
compared to 735 employees at December 31, 2000.
Amortization of mortgage servicing rights increased $12.0 million, or 122%,
to $21.9 million for fiscal year 2001 as compared to $9.9 million for fiscal
year 2000. Amortization of mortgage servicing rights fluctuates based on the
size of our mortgage servicing portfolio and the prepayment rates experienced
with respect to the underlying mortgage loan portfolio. In response to the lower
interest rates prevalent in the market, prepayment speeds on our servicing
portfolio increased to an average of 22.9% during fiscal year 2001 as compared
to 12.1% during fiscal year 2000.
The remainder of noninterest expense, which includes occupancy and
equipment expense, postage and communication expense, professional fees, data
processing costs and other expenses, increased $7.7 million, or 23%, to $41.5
million for fiscal year 2001 as compared to $33.8 million for fiscal year 2000.
The $6.0 million increase in other general and administrative expense was
primarily attributable to increases in foreclosure and REO expenses, increases
in travel and entertainment costs, and in other miscellaneous expenses
associated with the increased number of employees, and increases in outside
services, consulting and temporary help, as well as a $984,000 charge recorded
related to the relocation of Matrix Bank's domicile primarily for severence and
contract benefits to be paid to certain of Matrix Bank's employees. For further
discussion of these charges, see Note 2 to the consolidated financial
statements. This was offset by a $1.8 million decrease in professional fees
related mainly to high amounts in 2000 for litigation at Sterling Trust and
legal expenses associated with the Harbor settlement which were not incurred in
2001. For a discussion of the Harbor items, see Note 20 to the consolidated
financial statements.
Provision for Income Taxes. Our provision for income taxes increased $2.1
million to $4.3 million for fiscal year 2001 as compared to $2.2 million for
fiscal year 2000. The increase in pre-tax income was enhanced by a reduction in
our effective tax rate to 32.5% for fiscal year 2001 from 34.5% for fiscal year
2000. The decrease in the effective tax rate was the result of our origination
of tax-exempt financing at ABS.
38
Average Balance Sheet
The following table sets forth for the periods and as of the dates
indicated, information regarding our average balances of assets and liabilities,
as well as the dollar amounts of interest income from interest-earning assets
and interest expense on interest-bearing liabilities and the resultant yields or
costs. Ratio, yield and rate information is based on average daily balances
where available; otherwise, average monthly balances have been used. Nonaccrual
loans are included in the calculation of average balances for loans for the
periods indicated.
Year Ended December 31,
---------------------------------------------------------------------------------------
2002 2001 2000
------------------------- --------------------------- ---------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
--------- --------------- ------------------ -------- ---------------------------
(Dollars in thousands)
Assets
Interest-earning assets:
Loans receivable .....................$1,333,390 $ 88,611 6.65 % 1,338,613 102,058 7.62% 1,086,041 90,591 8.34 %
Securities.......................... 11,003 594 5.40 17,667 1,335 7.56 45,253 3,374 7.46
Interest-earning deposits............. 24,285 337 1.39 33,746 1,008 2.99 28,831 1,508 5.23
FHLB stock............................ 26,393 936 3.55 23,281 996 4.28 24,199 1,913 7.91
--------- --------------- ------------------ -------- ---------------------------
Total interest-earning assets....... 1,395,071 90,478 6.49 % 1,413,307 105,397 7.46% 1,184,324 97,386 8.22 %
Noninterest-earning assets:
Cash.................................. 42,393 24,196 16,305
Allowance for loan and valuation (9,445) (9,038) (7,302)
losses..................................
Premises and equipment................ 22,454 17,838 10,318
Other assets.......................... 178,450 142,914 116,602
--------- ---------- ----------
Total noninterest-earning assets.... 233,852 175,910 135,923
--------- ---------- ----------
Total assets........................$1,628,923 $1,589,217 1,320,247
========= ========== ==========
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Passbook accounts.....................$ 5,998 117 1.95 % $ 3,467 108 3.12% 2,981 102 3.42 %
Money market and NOW accounts......... 302,479 4,254 1.41 239,941 5,220 2.18 156,649 3,671 2.34
("NOW") accounts........................
Certificates of deposit............... 469,226 17,125 3.65 493,954 29,544 5.98 361,084 22,502 6.23
FHLB borrowings....................... 328,057 9,478 2.89 347,807 16,071 4.62 430,331 27,242 6.33
Borrowed money and guaranteed
preferred beneficial 143,843 10,304 7.16 176,980 13,944 7.88 147,377 14,084 9.56
interests.........................
--------- --------------- ------------------ -------------------------------------
Total interest-bearing liabilities.. 1,249,603 41,278 3.30 % 1,262,149 64,887 5.14% 1,098,422 67,601 6.15 %
--------- --------------- ------------------ -------------------------------------
Noninterest-bearing liabilities:
Demand deposits (including custodial 268,957 204,923 140,615
escrow balances)........................
Other liabilities..................... 39,459 55,764 18,505
--------- ---------- ----------
Total noninterest-bearing 308,416 260,687 159,120
liabilities.............................
Shareholders' equity.................. 70,904 66,381 62,705
--------- ---------- ----------
Total liabilities and shareholders' $1,628,923 $1,589,217 1,320,247
equity..................................
========= ========== ==========
Net interest income before provision
for loan and $ 49,200 40,510 29,785
valuation losses.................... ======== ======== =========
Interest rate spread.................... 3.19 % 2.32% 2.07 %
======= ======== ========
Net interest margin..................... 3.53 % 2.87% 2.51 %
======= ======== ========
Ratio of average interest-earning
assets to average 111.64% 111.98% 107.82 %
interest-bearing liabilities........ ======= ======== ========
Analysis of Changes in Net Interest Income Due to Changes in Interest Rates and
Volumes
The following table presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the increase or decrease
related to changes in balances and changes in interest rates. For each category
of interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to:
o changes in volume, in other words, changes in volume multiplied by
old rate; and
o changes in rate, in other words, changes in rate multiplied by old
volume.
For purposes of this table, changes attributable to both rate and volume, which
cannot be segregated, have been allocated proportionately to the change due to
volume and the change due to rate.
39
Year Ended December 31, 2002 vs. 2001 Year Ended December 31, 2001 vs. 2000
Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in
--------------------------------------------------------------------------------
Volume Rate Total Volume Rate Total
------------ ------------ ------------------------ ------------ ------------
(In thousands)
Interest-earning assets:
Loans receivable...................... $ (398) $ (13,049) $ (13,447) $ 19,781 $ (8,314) $ 11,467
Securities.......................... (422) (319) (741) (2,085) (2,039)
46
Interest-earning deposits............. (231) (440) (671) 225 (725) (500)
FHLB stock............................ 123 (183) (60) (70) (847) (917)
--------- ---------- ---------- --------- --------- ---------
Total interest-earning assets....... (928) (13,991) (14,919) 17,851 (9,840) 8,011
--------- ---------- ---------- --------- --------- ---------
Interest-bearing liabilities:
Passbook accounts..................... 59 (50) 9 16 (10) 6
Money market and NOW accounts......... 1,152 (2,118) (966) 1,822 (273) 1,549
Certificates of deposit............... (1,414) (11,005) (12,419) 7,984 (942) 7,042
FHLB borrowings....................... (868) (5,725) (6,593) (4,637) (6,534)
(11,171)
Borrowed money and guaranteed
preferred beneficial interest..... (2,448) (1,192) (3,640) 2,563 (2,703) (140)
--------- ---------- ---------- --------- --------- ---------
Total interest-bearing liabilities.. (3,519) (20,090) (23,609) 7,748 (10,462) (2,714)
--------- ---------- ---------- --------- --------- ---------
Change in net interest income before
provision for loan and valuation losses.. $ 2,591 $ 6,099 $ 8,690 $ 10,103 $ 10,725 $ 622
========= ========== ========== ========= ========= =========
Asset and Liability Management
General. A significant portion of our revenues and net income is derived
from net interest income and, accordingly, we strive to manage our
interest-earning assets and interest-bearing liabilities to generate what we
believe to be an appropriate contribution from net interest income. Asset and
liability management seeks to control the volatility of our performance due to
changes in interest rates. We constantly attempt to achieve an appropriate
relationship between rate sensitive assets and rate sensitive liabilities. We
have responded to interest rate volatility by developing and implementing asset
and liability management strategies designed to increase noninterest income and
improve the match between interest-earning assets and interest-bearing
liabilities. These strategies include:
o Utilizing mortgage servicing rights as a source of noninterest
income and as a countermeasure against the decline in the value of
mortgage loans during a rising interest rate environment. Increases
in interest rates tend to increase the value of mortgage servicing
rights because of the resulting decrease in prepayment rates on the
underlying loans;
o Focusing on noninterest-bearing custodial escrow balances related to
our mortgage servicing rights;
o Increasing focus on lines of business that are less interest rate
sensitive, such as brokerage activities, consulting services,
self-directed trust services, clearing operations, real estate
disposition and school business services;
o Originating and purchasing adjustable rate mortgages and selling
newly originated fixed rate residential mortgages in the secondary
market;
o Increasing emphasis on the origination of construction, multi-family
and commercial real estate lending, including SBA loans, which tend
to have higher interest rates with shorter loan maturities than
residential mortgage loans and generally are at adjustable rates;
o Acquisition and sales of guaranteed portions of SBA loans, which are
generally at adjustable rates;
o Extending the maturity of our interest-bearing liabilities by
borrowing term advances from the FHLB;
o Increasing retail deposits, which are less susceptible to changes in
interest rates than other funding sources;
o Historically, maintaining a wholesale loan origination operation.
Wholesale originations provide a form of hedge against the balance
of mortgage servicing rights. In a decreasing interest rate
environment, the value of the servicing portfolio tends to decrease
due to increased prepayments of the underlying loans. During this
same environment, however, the volume of loan originations generally
increases. Due to the declining investment in mortgage servicing
rights and the increased operation and financial risk associated
with the wholesale operations, we have elected to sell the wholesale
production platform. See "Item 1. Business-Sale of Wholesale
Production Platform";
o Pursuing institutional alliances or depository relationships that
provide fee-based income or generate liabilities that are less
expensive or less interest rate sensitive than retail deposits or
borrowings from third party institutions to fund our investing
activities;
o Using Matrix Bank as the settlement bank for settlement and clearing
services offered by Sterling Trust and Matrix Settlement & Clearance
Services to generate low-cost deposits;
o Hedging segments of our servicing portfolio and selling forward
commitments on our loan pipeline; and
o Expanding our trust activities to provide custodial services to
Matrix Settlement & Clearance Services' clients to increase fee
income and low cost deposits.
Many of the strategies outlined were successfully initiated during 2002. Matrix
Bank is positively gapped, which means that its assets will re-price quicker
than its liabilities as interest rates fluctuate. As a result, if interest rates
40
increase, the rising interest rates should have a positive impact on the net
interest income. However, if interest rates remain static or decrease further,
we should experience some compression in our net interest income as many of our
interest-bearing and noninterest-bearing liabilities cannot re-price any lower.
Due to the 40-year low interest rate environment, our investment in mortgage
servicing rights was very unprofitable in 2002, including the provision of $14.2
million to increase our impairment reserve. In 2003, we will continue to manage
interest rate risk under similar strategies.
Lending Activities. Our major interest-earning asset is our loan portfolio.
Consequently, a significant part of our asset and liability management involves
monitoring the composition of our loan portfolio, including the corresponding
maturities. The following table sets forth the composition of our loan portfolio
by loan type as of the dates indicated. The amounts in the table below are shown
net of discounts and other deductions.
As of December 31,
----------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------------- -------------------- ------------------- ------------------- ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
---------- --------- ---------- -------- --------- --------- --------- --------- -------- ---------
(Dollars in thousands)
Residential............ $1,001,892 71.88% $1,055,284 78.71% $ 903,955 81.00% $ 954,424 86.49% $732,512 86.34%
Multi-family, commercial
real estate and 313,237 22.47 192,225 14.34 123,491 11.07 78,046 7.07 52,689 6.21
commercial..........
School Financing....... 49,560 3.56 61,969 4.62 51,909 4.65 31,748 2.88 24,429 2.88
Construction .......... 34,160 2.45 35,158 2.62 36,768 3.29 36,056 3.26 27,648 3.26
Consumer............... 4,311 0.31 5,403 0.40 8,479 0.76 9,595 0.87 14,880 1.75
Total loans....... 1,403,160 100.67 1,350,038 100.70 1,124,602 100.77 1,109,869 100.57 852,158 100.44
Less allowance for loan 9,343 0.67 9,338 0.70 8,581 0.77 6,354 0.57 3,710 0.44
and valuation losses. ---------- --------- ---------- -------- --------- --------- --------- --------- -------- ---------
Loans receivable, net.. $1,393,817 100.00% $1,340,700 100.00% $1,116,021 100.00% $1,103,515 100.00% $848,448 100.00%
========== ========= ========== ======== ========= ========= ========= ========= ======== =========
The following table presents the aggregate maturities of loans in each
major category of our loan portfolio as of December 31, 2002, excluding the
allowance for loan losses. Loans held for sale are classified as maturing over
five years. Actual maturities may differ from the contractual maturities shown
below as a result of renewals and prepayments or the timing of loan sales.
As of December 31, 2002
------------------------------------------------------
Less than One to Over Five
One Year Five Years Years Total
------------- ------------ ------------ -------------
(In thousands)
Residential.............................................. $ 519,719 $ 429,471 $ 52,703 $ 1,001,893
Multi-family, commercial real estate and commercial...... 174,839 30,080 108,318 313,237
School financing......................................... 9,912 39,648 -- 49,560
Construction............................................. 34,160 -- -- 34,160
Consumer................................................. 1,230 1,182 1,898 4,310
------------- ------------ ------------ -------------
Total loans ........................................ $ 739,860 $ 500,381 $ 162,919 $ 1,403,160
============= ============ ============ =============
Included in the balance of residential loans are approximately $406.7
million of loans originated by Matrix Financial that are committed for sale at
December 31, 2002. Although the majority of the loans are fixed rate, we have
very little interest risk associated with the loans because they are committed
for sale.
Loans held for sale, excluding the allowance for loan losses, which are
primarily contractually due in less than one to five years, are split between
fixed and adjustable rates as follows:
As of December 31, 2002
-----------------------------------------------------
Less than One to Over Five
One Year Five Years Years Total
------------- ------------ ------------ ------------
(In thousands)
Fixed ................................................... $ 440,029 $ 105,822 -- $ 545,851
Adjustable............................................... 208,123 359,851 -- 567,974
------------- ------------ ------------ ------------
Total loans ........................................ $ 648,152 $ 465,673 -- $1,113,825
============= ============ ============ ============
Loans held for investment, excluding the allowance for loan losses, which
are contractually due in one or more years, are split between fixed and
adjustable rates as follows:
41
As of December 31, 2002
-----------------------------------------------------
Less than One to Over Five
One Year Five Years Years Total
------------- ------------ ------------ ------------
(In thousands)
Fixed ................................................... $ 7,151 $ 9,902 $ 16,520 $ 33,573
Adjustable............................................... 84,557 24,806 146,399 255,762
------------- ------------ ------------ ------------
Total loans ........................................ $ 91,708 $ 34,708 $ 162,919 $ 289,335
============= ============ ============ ============
Nonperforming Assets. As part of asset and liability management, we
monitor nonperforming assets on a monthly basis. Nonperforming assets consist
primarily of nonaccrual loans and foreclosed real estate. Loans are placed on
nonaccrual when full payment of principal or interest is in doubt or when they
are past due 90 days as to either principal or interest. Foreclosed real estate
arises primarily through foreclosure on mortgage loans owned. The following
table sets forth our nonperforming assets as of the dates indicated:
As of December 31,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
Nonaccrual residential mortgage loans............ $15,123 $19,039 $22,592 $20,185 $ 8,208
Nonaccrual commercial real estate, commercial
loans and school financing ...................... 15,649 18,172 5,792 5,301 4,349
Nonaccrual consumer loans........................ 46 40 132 155 652
----------- ----------- ----------- ----------- -----------
Total nonperforming loans................... 30,818 37,251 28,516 25,641 13,209
Foreclosed real estate........................... 8,343 8,355 2,646 800 916
----------- ----------- ----------- ----------- -----------
Total nonperforming assets.................. $39,161 $45,606 $31,162 $26,441 $14,125
=========== =========== =========== =========== ===========
Total nonperforming loans to total loans......... 2.20 % 2.76% 2.54% 2.31% 1.55%
Total nonperforming assets to total assets....... 2.30 % 2.77% 2.20% 2.06% 1.40%
Ratio of allowance for loan and valuation losses
to total nonperforming loans................. 30.32 % 25.07% 30.09% 24.78% 28.09%
Interest on nonperforming loans not
included in interest income.................. $ 916 $ 1,773 $ 1,016 $ 979 $ 524
We accrue for interest on government-sponsored loans such as Federal
Housing Administration insured and Veteran's Administration guaranteed loans
which are past due 90 or more days, as the majority of the interest on these
loans is insured by the federal government. The aggregate unpaid principal
balance of government-sponsored accruing loans that were past due 90 or more
days was $34.8 million, $55.2 million and $101.1 million of December 31, 2002,
2001 and 2000, respectively.
Nonaccrual residential mortgage loans as a percentage of total loans were
1.1% at December 31, 2002, 1.4% at December 31, 2001, 2.1% at December 31, 2000,
1.8% at December 1999 and 1.0% at December 31, 1998. The nonaccrual residential
mortgage loans have improved at December 31, 2002 as compared to December 30,
2001. The improvement is due to maturity and improvement in certain portfolios
acquired in 2000 and 1999 on which the recourse option we had was eliminated
with the bankruptcy of the seller/servicer. The balance of these loans in
nonaccrual at December 31, 2002 totals $2.2 million as compared to $4.9 million
at December 31, 2001. Associated with these nonaccrual loans, we have recorded
$845,000 of discounts.
The decrease in nonaccrual commercial loans and school financing in 2002 is
primarily attributable to the decreased amount of commercial real estate and
construction loans in nonaccrual status, which decreased $2.9 million to $2.2
million at December 31, 2002. This decrease was offset by increased amounts of
SBA originated and purchased loans in nonaccrual status, which increased $1.2
million to $9.3 million at December 31, 2002. It should be noted, however, that
approximately $6.7 million of the interest and principal of these loans is
guaranteed, and as such, our credit risk is minimized despite the increase in
the balances. With regard to our school financing, a majority of our origination
of tax-exempt financing for charter schools is for the purchase of real estate
and equipment. We have noted that many of our charter schools have encountered
enrollment and/or state funding delays with their start-up, which has delayed
their funding and caused the school's loans to us to become delinquent. We have
historically, however, been able to work with many of the schools on their cash
flow issues and eventually removed them from the delinquent lists. Not included
in the 2002 balance was $1.0 million of delinquent school financing and $450,000
of foreclosed real estate that was sold to a third party with recourse. The
losses related to the delinquencies and foreclosures would be recorded as part
of noninterest expense. As of December 31, 2002, no recording of a liability was
considered necessary.
42
The prior delinquency and anticipated future delinquencies are taken into
consideration in the pricing of the loans acquired. We generally purchase such
loans at discounts and, in limited instances, receive recourse from the seller
to further reduce our risk of loss associated with the loans' nonaccrual status.
At December 31, 2002, $12.6 million, or 40.9%, of the nonaccrual loans were
loans that were residential loans purchased in bulk loan portfolios and remain
classified as "held for sale." Total loans held for sale at December 31, 2002,
were $1.1 billion, of which $17.0 million, or 1.5%, were in nonaccrual status.
Analysis of Allowance for Loan and Valuation Losses. The following table
sets forth information regarding changes in our allowance for loan and valuation
losses for the periods indicated. The table includes the allowance for both
loans held for investment and loans held for sale.
As of and for the Year Ended December 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------- -------------- ------------- ------------ ------------
(Dollars in thousands)
Balance at beginning of year.................. $ 9,338 $ 8,581 $ 6,354 $3,710 1,756
Charge-offs:
Real estate - mortgage................... 1,239 872 434 98 1,922
Real estate - construction .............. -- 31 320 -- --
Commercial loans and school financing.... 1,482 746 819 -- --
Consumer................................. 276 659 476 509 789
------------ ------------ ------------ ----------- ----------
Total charge-offs................... 2,997 2,308 2,049 607 2,711
Recoveries:
Real estate - mortgage................... 97 4 1 2 2
Commercial loans and school financing.... 17 -- -- -- --
Consumer................................. 67 81 40 69 56
------------ ------------ ------------ ----------- ----------
Total recoveries.................... 181 85 41 71 58
------------ ------------ ------------ ----------- ----------
Net charge-offs............................... 2,816 2,223 2,008 536 2,653
Provision for loan losses charged to
operations................................. 2,821 2,980 4,235 3,180 4,607
------------ ------------ ------------ ----------- ----------
Balance at end of year........................ $ 9,343 $ 9,338 $ 8,581 $ 6,354 $ 3,710
============ ============ ============ =========== ==========
Ratio of net charge-offs to average loans..... 0.21 % 0.17 % 0.18% 0.06% 0.38%
============ ============ ============ =========== ==========
Average loans outstanding during the year..... $1,333,390 $1,338,613 $1,086,041 $ 877,117 $692,443
============ ============ ============ =========== ==========
The allowance for loan and valuation losses is analyzed by management as
discussed below and is increased by the provision for loan and valuation losses,
which is charged to operations, as necessary. The allowance for loan and
valuation losses is calculated, in part, based on historical loss experience. In
addition, management takes into consideration other factors, such as:
o qualitative evaluations of individual classified assets;
o geographic and other portfolio concentrations;
o new products or markets;
o evaluations of the changes in the historical loss experience
component; and
o projections of this component into the current and future
periods based on current knowledge and conditions.
These loss factors range from 0.10% for FHA/VA loans guaranteed by the HUD,
to 8.00% for credit card loans. The loss factors are applied to the outstanding
principal balance of loans in their respective categories. Loans in the
commercial and school finance portfolios are assigned loss factors based on
items similar to those listed, plus additional individual loan review on all
significant loans, including SBA loans, which result in loans being classified
as watch, substandard or doubtful.
The Company considers a loan impaired when, based on current information
and events, it is probable that it will be unable to collect all amounts due
according to the contractual terms of the loan. Accordingly, potential impaired
loans of the Company include only commercial loans, real estate construction
loans, commercial real estate mortgage loans and school financing. Impairment
allowances are considered by the Company in determining the overall adequacy of
the allowance for loan losses.
43
After an allowance has been established for the loan portfolio, management
establishes a portion of the allowance for loan losses, which is attributed to
factors that cannot be associated with a specific loan or loan portfolio. The
Company evaluates its residential loans collectively due to their homogeneous
nature. These factors include:
o general economic conditions;
o recognition of specific regional geographic concerns;
o loan type and the assessed risk inherent in each loan
category; and
o trends in the portfolio and portfolio growth trends.
Substandard and doubtful loans of homogeneous loan portfolios are assigned
loss factors of 5.00% to 50.00%. The loss factors are applied to the outstanding
principal balances of loans in their respective categories.
The total for all categories as described above determines our allowance
for loan and valuation losses. Loan losses are charged against the allowance
when the probability of collection is considered remote.
The following table shows information regarding the components of our
allowance for loan and valuation losses as of the dates indicated:
As of December 31,
---------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
--------------------- ------------------- ------------------- ------------------- ---------------------
Percentage Percentage Percentage Percentage Percentage
of Loans of Loans of Loans of Loans of Loans
in each in each in each in each in each
Category Category Category Category Category
to to to to to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
-------- ----------- --------- -------- --------- ----------- --------- --------- --------- ---------
(Dollars in thousands)
Residential.............. $3,199 71.40% $3,918 78.30% $4,133 80.39% $3,591 86.00% $2,295 85.96%
Multi-family, commercial
real estate and commercial 2,768 22.32 2,400 14.15 1,684 11.28 835 7.02 564 6.18
School financing......... 2,810 3.53 2,527 4.56 2,329 4.31 1,320 2.86 275 2.87
Construction............. 542 2.44 445 2.59 302 3.27 286 3.25 207 3.24
Consumer................. 24 0.31 48 0.40 133 0.75 322 0.87 369 1.75
------- ------- ------- ------- ------- ------- ------ ------- ------- -------
$9,343 100.00% $9,338 100.00% $8,581 100.00% $6,354 100.00% $3,710 100.00%
======= ======= ======= ======= ======= ======= ====== ======== ======= =======
The ratio of the allowance for loan and valuation losses to total loans
was 0.67% at December 31, 2002, 0.69% at December 31. 2001; 0.76% at December
31, 2000; 0.57% at December 31, 1999; and 0.44% at December 31, 1998. The
allowance for loan and valuation losses is reduced by loans charged off, net of
recoveries. The balance of the allowance for loan and valuation losses allocated
to residential has decreased, due to the decrease in these loans in nonaccrual
status, while the balance of loan and valuation losses allocated to
multi-family, commercial real estate, commercial, school financing and
construction loans has increased mainly due to the increased outstanding loan
principal balances in these loan categories. As noted in 2001, we had increased
our origination of non 1- to 4-family loans, which are perceived to be higher
risk and also are a contributor to the overall increase in the balance of the
allowance in prior year. As of December 31, 2002, we believe that the allowance,
when taken as a whole, is adequate to absorb losses in the current loan
portfolio.
Risk Sensitive Assets and Liabilities. As discussed in "Asset and
Liability Management--General" a significant portion of our operations and
ultimate success is partially dependent upon our ability to manage our interest
rate risk. Interest rate risk can be defined as the exposure of our net interest
income to adverse movements in interest rates. Although we manage other risks,
such as credit, operational and liquidity risk in the normal course of business,
we consider interest rate risk to be a significant market risk which could
potentially have the largest material effect on our financial condition and
results of operations. The majority of our market risk related to interest rates
exists within the operations of Matrix Bank. However, Matrix Financial also has
interest rate risk related to its primary asset, mortgage servicing rights, and
also related to its loan origination volumes, as well as the net interest income
earned on its originated loans that are funded through warehouse lines of
credit. With the majority of Matrix Financial's operations being funded by
Matrix Bank, this is a smaller risk to the Company as compared to when Matrix
Financial's operations were funded entirely by unaffiliated financial
institutions. The susceptibility to movements in interest rates affects the cash
flows generated from the mortgage servicing rights which are recorded in other
income versus interest income. In a decreasing interest rate environment, the
underlying servicing portfolio tends to prepay faster which reduces future
servicing income; while in an increasing interest rate environment, prepayments
tend to decrease, which increases expected future servicing income. As it
relates to Matrix Financial's lending activities, Matrix Financial originates
residential mortgage loans, which are generally pre-sold. However, between the
time that the loan is originated and sold to the ultimate investor, Matrix
Financial earns interest income. The loans are funded through the use of
44
warehouse credit facilities or borrowings from Matrix Bank, both of which are
generally priced based on short-term interest rates. Therefore, the net interest
income that is earned by Matrix Financial is generally dependent on the spread
between long-term mortgage rates and short-term interest rates. Aside from
Matrix Financial's investment in servicing rights, the majority of the risk
associated with interest rate movements relates more to the overhead associated
with our origination platform. As discussed, a significant portion of the loan
origination is directly related to the interest rate environment. Overhead
significantly increased in 2001 and continued in 2002 to support the higher
levels of originations. As a result, when interest rates increase and
originations decrease, there is a risk that we will not be able to manage our
overhead proportionally to the overall decrease in loan origination income. Due
to this risk and other risk previously discussed, in early 2003, we have elected
to sell the wholesale origination platform. See "Item 1. Business--Sale of
Wholesale Production Platform."
We currently do not maintain a trading portfolio. As a result, we are not
exposed to market risk as it relates to trading activities. The majority of our
residential loan portfolio is held for sale which requires us to perform
quarterly market valuations of the portfolio in order to properly record the
portfolio at the lower of aggregate cost or market. Therefore, we continually
monitor the interest rates of our loan portfolio as compared to prevalent
interest rates in the market.
Interest rate risk management at Matrix Bank is the responsibility of the
Asset and Liability Committee, which reports to the board of directors of Matrix
Bank. The Asset and Liability Committee establishes policies that monitor and
coordinate our sources, uses and pricing of funds. The Asset and Liability
Committee is also involved in formulating our budget and strategic plan as it
relates to investment objectives. We have engaged a third party to provide
consulting services that assists us with our asset/liability management. We meet
with this consulting firm quarterly to review the results of our interest rate
risk analysis and to discuss strategies. We have recently purchased the software
to be able to internally model our interest rate risk. The software was
developed by the third party consultant mentioned above. We will continue to
engage this consulting firm on a quarterly basis to supplement our internal
modeling. Part of the modeling is done to comply with the requirements of the
Office of Thrift Supervision.
We continue to attempt to reduce the volatility in net interest income by
managing the relationship of interest rate sensitive assets to interest rate
sensitive liabilities. To accomplish this, we focus on acquiring adjustable rate
residential mortgages and have increased our efforts regarding the origination
of residential construction loans, multi-family loans, commercial real estate
loans, SBA loans and limited consumer lending, which re-price or mature more
quickly than fixed rate residential real estate loans. In the fourth quarter of
2001, we began a strategy of purchasing with the intent to sell the guaranteed
portion of SBA loans. Again, the loans generally adjust with prime and present
very little interest rate risk. The other significant asset that we invest in is
residential mortgage servicing rights. The value and cash flows from residential
mortgage servicing rights respond counter-cyclically to the value of fixed rate
mortgages. When interest rates increase and the value of fixed rate mortgages
decrease, in turn decreasing net interest income, the value of the mortgage
servicing rights increase. In a decreasing interest rate environment, the
inverse occurs. It is important to note, however, that an equal increase or
decrease in interest rates will not affect the value of our mortgage servicing
rights portfolio equally. A decrease in interest rates causes a greater
reduction in the value of the portfolio as compared to the increase in value in
the portfolio from an equal increase in interest rates. The scenario discussed
of decreasing interest rates is exactly what happened in 2002. The interest rate
environment in 2002 was historically low. In response to the low interest rates,
we experienced significant runoff in our servicing portfolio, as well as a $14.2
million decrease in the fair value of our investment in mortgage servicing
rights. Due to the volatility of the value of mortgage servicing, we do not
anticipate increasing our investment in 2003. To the contrary, we expect our
overall investment in 2003 to decrease through normal runoff. Another
significant strategy that we focus on in managing interest rate risk is
identifying lines of business that generate noninterest rate sensitive
liabilities. Examples of this strategy are the investment in mortgage servicing
rights, which generate no cost escrow deposits; Sterling Trust's operations,
which administer deposits with relatively low costs; and our investment in
Matrix Settlement & Clearance Services that uses, or its clients use, Matrix
Bank as the clearing bank and trustee, which creates low-cost deposits.
In the ordinary course of business, we make commitments to originate
residential mortgage loans and hold originated loans until delivery to an
investor. Inherent in this business are risks associated with changes in
interest rates and the resulting change in the market value of the pipeline
loans. We mitigate this risk through the use of mandatory and best effort
forward commitments to sell loans and securities. As of December 31, 2002, we
had $917.1 million in pipeline and funded loans, offset with mandatory forward
commitments of $500.3 million and best effort forward commitments of $128.2
million. The market value of loans committed for sale is determined based on the
related forward loan sale commitments. Effective January 1, 2001, with the
adoption of SFAS 133, we were required to treat substantially all mortgage loan
commitments and loan sale commitments (both mandatory and best effort) as
derivatives and record the fair value of those derivatives on the balance sheet
and any subsequent changes in the fair value of those derivatives through
45
current earnings. As the changes in fair value of the loan commitments and the
loan sale commitments are generally expected to offset one another, we do not
anticipate any material impact to our future earnings from pipeline loans as a
result of the adoption of SFAS 133. See "Item 1. Business--Sale of Wholesale
Production Platform."
Ownership of mortgage servicing rights exposes us to impairment of their
value in certain interest rate environments. The incidence of prepayment of a
mortgage loan increases during periods of declining interest rates as the
homeowner seeks to refinance the loan to a lower interest rate. If the level of
prepayment on segments of our mortgage servicing portfolio achieves a level
higher than we projected for an extended period of time, then an impairment in
the associated basis in the mortgage servicing rights may occur. To mitigate
this risk of impairment due to declining interest rates, we initiated a hedging
program on a portion of our investment. In addition, in September 2002, we began
to sell substantially all of our newly originated servicing rights with the
intent of reducing our overall investment in mortgage servicing rights.
With regards to our interest-sensitive liabilities during 2002, in order
to take advantage of the historically low interest rates, Matrix Bank entered
into short option agreements and other longer term advances (2 to 5 years)
totaling $10.0 million, adding to short option agreements entered into primarily
in 2001 for a total of $146.0 million, which have interest rates ranging from
2.69% to 5.63%. It is anticipated that our interest margin will benefit in the
long term from locking in these interest rates.
The following tables represent, in tabular form, contractual balances of
our on balance sheet financial instruments in dollars at the expected maturity
dates, as well as the fair value of those on balance sheet financial instruments
for the periods ended December 31, 2002 and 2001. The expected maturity
categories take into consideration historical and anticipated prepayment speeds,
as well as actual amortization of principal and do not take into consideration
the reinvestment of cash. Our assets and liabilities that do not have a stated
maturity date, such as interest-earning deposits, FHLB stock and certain other
deposits, are considered to be long term in nature and are reported in the
thereafter column. We are very active in the secondary market as it relates to
the purchase and sale of mortgage loans. We use a five-year maturity assumption
for all of Matrix Bank's held for sale loans and school financing, and we use a
one-year maturity assumption for Matrix Financial's originated loans held for
sale. We also treat the FHLB and revolving borrowings as long term in nature, as
the continued availability of these amounts is anticipated indefinitely. Third
party servicers service a portion of our loan portfolio; as a result, a portion
of the information presented is based on the best available information.
For the most part, the carrying amounts of interest-earning deposits, FHLB
stock, FHLB borrowings and borrowed money approximate those assets' and
liabilities' fair values. The fair values of the loan portfolios held for sale
and held for investment are based on quoted market prices or outstanding
commitments from investors. If quoted market prices are not available, fair
values are based on quoted market prices of similar loans sold in securitization
transactions, adjusted for differences in loan characteristics. The fair values
of demand deposits are, by definition, equal to the amount payable upon demand
at the reporting date. The fair value of time deposits are based upon the
discounted value of contractual cash flows, which is estimated using interest
rates currently being offered on certificates to a schedule of aggregated
expected periodic maturities on time deposits.
Mortgage servicing rights are not included in the tabular presentation,
because the investment does not directly affect interest income. As noted,
however, earnings from mortgage servicing rights directly correlate with market
risk as it relates to interest rate fluctuations. In the past, we attempted to
mitigate a portion of this risk by the type of mortgage servicing rights we
acquire. The loans underlying the servicing rights acquired tend to be more
seasoned and have lower principal balances. Management believes that the more
seasoned, lower balance servicing portfolios carry less prepayment risk than
less seasoned, higher balance mortgage servicing, because the cost savings of
refinancing a lower balance loan tend to be less than for a higher balance loan
with a comparable interest rate. We also believe that if a loan has been
outstanding for a period of time and has been through several declining interest
rate cycles without refinancing, the risk of prepayment in the future is less
than a newly originated loan. However, due to the lack of seasoned servicing
available and the expansion of our origination platform, we began to retain a
portion of our originated servicing in 2001 and continued through August 2002.
In August 2002, the Company began to sell the majority of its newly originated
servicing under an assignment of trade contract and anticipates doing so in the
near-term. This strategy was implemented to reduce our future investment in
mortgage servicing rights. The prepayment percentages which we have experienced
over the past three years have been lower than experienced in the industry, as a
whole. The prepayment speeds for the years ended December 31, 2002, 2001 and
2000 were 23.7%, 22.9%, and 12.1%, respectively. In the tables below, prepayment
speeds of 20% and 19% for 2002 and 2001, respectively, were used for all loan
types to project expected cash flows. These assumptions are based on our
historical prepayment speeds, as well as our knowledge and experience in the
market.
46
The Company's financial instruments for the period ended December 31, 2002:
Expected Maturity Date - Fiscal Year Ended December 31,
----------------------------------------------------------------------
There-after Fair
2003 2004 2005 2006 2007 Total Value
---------- ----------- ----------- ----------- ---------- ----------- ------------ -----------
(Dollars in thousands)
Interest-earning assets:
Available for sale:
Fixed-rate securities........ $ 572 $ -- $ -- $ -- $ -- $ -- $ 572 $ 572
Average interest rate.... 6.50 % -- % -- % -- % -- % -- % 6.50 %
Adjustable-rate securities... $ 28,501 $ -- $ -- $ $ -- $ -- $ 28,501 $ 28,501
Average interest rate.... 5.67 % -- % -- % -- % -- % -- % 5.67 %
Held for sale (1)(2)(8):
Fixed-rate residential loans. $300,828 $ 16,597 $ 16,597 $ 16,597 $ 15,598 $ -- $ 367,217 $ 369,306
Average interest rate.... 6.31 % 8.33 % 8.33 % 8.33 % 8.33 % -- % 6.68 %
Adjustable-rate residential
loans.................... $213,739 $ 90,256 $ 90,256 $ 90,256 $ 90,257 $ -- $ 574,764 $ 577,237
Average interest rate.... 6.07 % 5.90 % 5.90 % 5.90 % 5.90 % -- % 5.97 %
Fixed-rate commercial and
other loans.............. $ 13,739 $ 35,611 $ -- $ -- $ -- $ -- $ 49,350 $ 49,455
Average interest rate.... 8.31 % 10.00 % -- % -- % -- % -- % 9.94 %
Adjustable-rate commercial
and other loans.......... $116,595 $ -- $ -- $ -- $ -- $ -- $ 116,595 $ 116,843
Average interest rate.... 4.71 % -- % -- % -- % -- % -- % 4.71 %
Held for investment(2):
Fixed-rate residential loans. $ 1,102 $ 871 $ 688 $ 543 $ 427 $ 1,512 $ 5,143 $ 5,190
Average interest rate(3). 7.40 % 7.40 % 7.40 % 7.40 % 7.40 % 7.40 % 7.40 %
Adjustable-rate residential
loans(4)................. $ 12,318 $ 9,658 $ 7,560 $ 5,906 $ 4,606 $ 15,063 $ 55,111 $ 55,593
Average interest rate(3). 6.08 % 6.08 % 6.08 % 6.08 % 6.08 % 6.08 % 6.08 %
Fixed-rate consumer loans.... $ 1,396 $ 1,002 $ 704 $ -- $ -- $ -- $ 3,102 $ 3,302
Average interest rate(3). 6.53 % 6.53 % 6.53 % -- % -- % -- % 6.53 %
Adjustable-rate consumer
loans(4)................. $ 273 $ 208 $ 158 $ 119 $ 88 $ 112 $ 958 $ 1,020
Average interest rate(3). 9.83 % 9.83 % 9.83 % 9.83 % 9.83 % 9.83 % 9.83 %
Fixed-rate other loans(5).... $ 8,365 $ 6,225 $ 4,577 $ 3,314 $ 2,352 $ -- $ 24,833 $ 25,180
Average interest rate(3). 7.82 % 7.82 % 7.82 % 7.82 % 7.82 % -- % 7.82 %
Adjustable-rate other
loans(4)(5).............. $ 54,879 $ 41,624 $ 31,355 $ 23,426 $ 17,324 $ 28,136 $ 196,744 $ 199,799
Average interest rate(3). 6.60 % 6.60 % 6.60 % 6.60 % 6.60 % 6.60 % 6.60 %
Federal funds sold.............. $ 2,000 $ -- $ -- $ -- $ -- $ -- $ 2,000 $ 2,000
Average interest rate.... 1.17 % -- % -- % -- % -- % -- % 1.17 %
Interest-earning deposits....... $ -- $ -- $ -- $ -- $ -- $ 1,687 $ 1,687 $ 1,687
Average interest rate.... -- % -- % -- % -- % -- % 0.79 % 0.79 %
FHLB stock...................... $ -- $ -- $ -- $ -- $ -- $ 30,379 $ 30,379 $ 30,379
Average interest rate.... -- % -- % -- % -- % -- % 2.78 % 2.78 %
Total interest-earning assets. $754,307 $202,052 $151,895 $140,161 $131,652 $ 76,889 $1,456,956 $1,466,064
========= ========== ========== ========== ========= ========= =========== =========
Interest-bearing liabilities:
Passbook accounts...............$ -- $ -- $ -- $ -- $ -- $ 5,514 $ 5,514 $ 5,514
Average interest rate.... -- % -- % -- % -- % -- % 1.95 % 1.95 %
NOW accounts(6).................$ -- $ -- $ -- $ -- $ -- $ 49,176 $ 49,176 $ 49,176
Average interest rate.... -- % -- % -- % -- % -- % 1.22 % 1.22 %
Money market accounts...........$ -- $ -- $ -- $ -- $ -- $ 334,508 $ 334,508 $ 334,508
Average interest rate.... -- % -- % -- % -- % -- % 1.22 % 1.22 %
Certificates of deposit over
$100,000.................$ 9,208 $ 3,857 $ 3,113 $ 420 $ 1,171 $ -- $ 17,769 $ 18,083
Average interest rate.... 3.38 % 4.13 % 4.77 % 5.04 % 4.76 % -- % 3.92 %
Brokered certificates of deposit.$ 293,112 $ -- $ 20,253 $ 13,970 $ -- $ -- $ 327,335 $ 327,832
Average interest rate......... 1.87 % -- % 4.47 % 4.12 % -- % -- % 2.13 %
Other certificates of deposit...$ 50,533 $ 18,508 $ 12,710 $ 6,632 $ 14,983 $ -- $ 103,366 $ 105,408
Average interest rate.... 3.18 % 4.18 % 5.72 % 5.20 % 4.66 % -- % 4.02 %
FHLB borrowings(7)..............$ -- $ -- $ -- $ -- $ -- $ 385,785 $ 385,785 $ 400,418
Average interest rate.... -- % -- % -- % -- % -- % 2.64 % 2.64 %
Revolving borrowings............$ 11,270 $ 12,567 $ 17,774 $ -- $ -- $ 747 $ 42,328 $ 42,328
Average interest rate.... 2.89 % -- % -- % -- % -- % 4.37 % 3.98 %
Term borrowings.................$ 1,457 $ 17,618 $ -- $ -- $ -- $ 64,500 $ 83,575 $ 84,521
Average interest rate.... 4.06 % 8.42 % -- % -- % -- % 9.33 % 9.04 %
Total interest-bearing
liabilities..............$ 365,580 $ 52,550 $ 53,820 $ 21,022 $ 16,154 $ 840,230 $1,349,356 $1,367,788
========= ========== ========== ========== ========= ========= =========== =========
__________
(1) Loans held for sale are assumed to mature within one year.
(2) Balances are stated net of discounts and other deductions.
(3) For the fixed-rate loans held for investment, we computed a weighted
average interest rate and a weighted average maturity for the loan
portfolio and then applied a prepayment assumption of 20% in determining
the cash flows. The same approach was used for the adjustable-rate loans,
which are generally fully indexed loans.
(4) The adjustable-rate loans generally are indexed to the 1-year treasury.
However, included in the balance are loans indexed to 11th district cost
of funds, prime and 3-, 5- and 7-year treasury.
(5) Other consists of multi-family, commercial real estate, commercial, land
and construction loans.
(6) Excludes noninterest-bearing demand deposits of approximately $96.3
million.
(7) See "--Short-term Borrowings" for additional discussion on the term of
the FHLB borrowings.
(8) The value of the hedging instruments used with our loan portfolio are
included in the balance of the loans for purposes of fair value
disclosure. See discussion regarding FAS 133 for additional information.
47
The Company's financial instruments for the period ended December 31,
2001:
Expected Maturity Date - Fiscal Year Ended December 31,
----------------------------------------------------------------------
There-after Fair
2002 2003 2004 2005 2006 Total Value
---------- ----------- ----------- ----------- ---------- ----------- ------------ ------------
(Dollars in thousands)
Interest-earning assets:
Available for sale:
Fixed-rate securities........ $ 584 $ -- $ -- $ -- $ -- $ -- $ 584 $ 584
Average interest rate.... 6.50 % -- % -- % -- % -- % -- % 6.50 %
Adjustable-rate securities... $ 6,379 $ -- $ -- $ -- $ -- $ -- $ 6,379 $ 6,379
Average interest rate.... 6.95 % -- % -- % -- % -- % -- % 6.95 %
Held for sale (1)(2)(8):
Fixed-rate residential loans. $534,200 $ 29,010 $ 29,010 $ 29,010 $ 29,011 $ -- $ 650,241 $ 653,247
Average interest rate.... 7.20 % 8.51 % 8.51 % 8.51 % 8.51 % -- % 7.43 %
Adjustable-rate residential $101,771 $ 72,335 $ 72,335 $ 72,336 $ 72,365 $ -- $ 391,142 $ 391,504
loans
Average interest rate.... 7.50 % 7.50 % 7.50 % 7.50 % 7.50 % -- % 7.50 %
Fixed-rate commercial and $ 14,610 $ 51,071 $ -- $ -- $ -- $ 795 $ 66,476 $ 66,478
other loans........................
Average interest rate.... 9.22 % 10.08 % -- % -- % -- % 9.07 % 10.38 %
Adjustable-rate commercial
and other $ 40,787 $ 10 $ 45 $ 41 $ 92 $ 705 $ 41,680 $ 41,702
loans....................
Average interest rate.... 5.64 % 8.89 % 8.89 % 8.89 % 8.89 % 8.89 % 5.71 %
Held for investment(2):
Fixed-rate residential loans. $ 856 $ 686 $ 550 $ 440 $ 353 $ 1,331 $ 4,216 $ 4,228
Average interest rate(3). 8.20 % 8.20 % 8.20 % 8.20 % 8.20 % 8.20 % 8.20 %
Adjustable-rate residential $ 466 $ 371 $ 296 $ 234 $ 186 $ 653 $ 2,206 $ 2,211
loans(4)...........................
Average interest rate(3). 7.18 % 7.18 % 7.18 % 7.18 % 7.18 % 7.18 % 7.18 %
Fixed-rate consumer loans.... $ 1,869 $ 1,403 $ 1,038 $ -- $ -- $ -- $ 4,310 $ 4,325
Average interest rate(3). 10.43 % 10.43 % 10.43 % -- % -- % -- % 10.43 %
Adjustable-rate consumer $ 261 $ 201 $ 153 $ 115 $ 87 $ 109 $ 926 $ 928
loans(4)...........................
Average interest rate(3). 7.45 % 7.45 % 7.45 % 7.45 % 7.45 % 7.45 % 7.45 %
Fixed-rate other loans(5).... $ 10,263 $ 7,789 $ 5,471 $ 4,068 $ 2,973 $ -- $ 30,564 $ 30,656
Average interest rate(3). 8.92 % 8.92 % 8.92 % 8.92 % 8.92 % -- % 8.92 %
Adjustable-rate other $ 50,290 $ 37,878 $ 18,356 $ 13,984 $ 10,557 $17,874 $ 148,939 $ 149,313
loans(4)(5)........................
Average interest rate(3). 7.42 % 7.42 % 7.42 % 7.42 % 7.42 % 7.42 % 7.42 %
Federal funds sold.............. $ 400 $ -- $ -- $ -- $ -- $ -- $ 400 $ 400
Average interest rate.... 1.81 % -- % -- % -- % -- % -- % 1.81 %
Interest-earning deposits....... $ -- $ -- $ -- $ -- $ -- $31,559 $ 31,559 $ 31,559
Average interest rate.... -- % -- % -- % -- % -- % 1.47 % 1.47 %
FHLB stock...................... $ -- $ -- $ -- $ -- $ -- $18,181 $ 18,181 $ 18,181
Average interest rate.... -- % -- % -- % -- % -- % 3.00 % 3.00 %
Total interest-earning assets. $766,222 $200,754 $127,254 $120,228 $115,624 $71,207 $1,401,289 $1,410,145
========= ========== ========== ========== ========= ========== =========== ===========
Interest-bearing liabilities:
Passbook accounts............... $ -- $ -- $ -- $ -- $ -- $ 4,291 $ 4,291 $ 4,291
accounts...........................
Average interest rate.... -- % -- % -- % -- % -- % 4.47 % 4.47 %
NOW accounts(6)................. $ -- $ -- $ -- $ -- $ -- $40,046 $ 40,046 $ 40,046
Average interest rate.... -- % -- % -- % -- % -- % 2.57 % 2.57 %
Money market accounts........... $ -- $ -- $ -- $ -- $ -- 249,234 $ 249,234 $ 249,234
Average interest rate.... -- % -- % -- % -- % -- % 2.11 % 2.11 %
Certificates of deposit over $ 16,674 $ 2,545 $ 1,960 $ 711 $ 520 $ -- $ 22,410 $ 22,797
$100,000...........................
Average interest rate.... 5.13 % 5.61 % 4.76 % 6.92 % 5.06 % -- % 5.20 %
Brokered certificates of deposit. $351,271 $ -- $ -- $ 10,000 $ -- $ -- $ 361,271 $ 362,079
Average interest rate......... 4.13 % -- % -- % 4.85 % -- % -- % 4.15 %
Other certificates of deposit... $ 82,281 $ 12,719 $ 11,788 $ 8,230 $ 6,828 $ -- $ 121,846 $ 123,631
Average interest rate.... 5.32 % 5.10 % 4.80 % 6.66 % 5.18 % -- % 5.33 %
FHLB borrowings(7).............. $ -- $ -- $ -- $ -- $ -- $303,361 $ 303,361 $ 309,931
Average interest rate.... -- % -- % -- % -- % -- % 2.94 % 2.94 %
Revolving borrowings............ $ -- $ -- $ -- $ -- $ -- $143,415 $ 143,415 $ 143,415
Average interest rate.... -- % -- % -- % -- % -- % 3.68 % 3.68 %
Term borrowings................. $ 1,478 $ 7,184 $ 10,455 $ -- $ -- $ 59,500 $ 78,617 $ 78,617
Average interest rate.... 8.00 % 8.23 % 11.50 % -- % -- % 9.76 % 9.82 %
Total interest-bearing $451,704 $ 22,448 $ 24,203 $ 18,941 $ 7,348 $799,847 $1,324,491 $1,334,041
liabilities........................
========= ========== ========== ========== ========= ========== =========== ===========
__________
(1) Loans held for sale are assumed to mature within one year.
(2) Balances are stated net of discounts and other deductions.
(3) For the fixed-rate loans held for investment, we computed a weighted
average interest rate and a weighted average maturity for the loan
portfolio and then applied a prepayment assumption of 19% in determining
the cash flows. The same approach was used for the adjustable-rate loans,
which are generally fully indexed loans.
(4) The adjustable-rate loans generally are indexed to the 1-year treasury.
However, included in the balance are loans indexed to 11th district cost
of funds, prime and 3-, 5- and 7-year treasury.
(5) Other consists of multi-family, commercial real estate, commercial, land
and construction loans.
(6) Excludes noninterest-bearing demand deposits of approximately $67.1
million.
(7) See "--Short-term Borrowings" for additional discussion on the term of
the FHLB borrowings.
(8) The value of the hedging instruments used with our loan portfolio are
included in the balance of the loans for purposes of fair value
disclosure. See discussion regarding FAS 133 for additional information.
48
Short-term Borrowings. A primary function of asset and liability management
is to ensure adequate liquidity. In addition to cash and cash equivalents, we
rely heavily on short-term borrowing capabilities for liquidity and as a funding
vehicle. The primary sources for short-term borrowings are the FHLB for Matrix
Bank, Matrix Bank and unaffiliated financial institutions for Matrix Financial,
an unaffiliated financial institution for Matrix Capital Markets, and at Matrix
Bancorp, the revolving portion of the bank stock loan. See "Liquidity and
Capital Resources."
The following table sets forth a summary of our short-term borrowings
during 2002, 2001 and 2000 and as of the end of each such period:
Average
Amount Amount Maximum Weighted Weighted
Outstanding Outstanding Outstanding Average Average
at During the at any Interest Interest
Year-End Year(1) Month-End Rate During Rate at
the Year Year-End
-------------- ---------------- -------------- -------------- ---------------
(Dollars in thousands)
At or for the year ended December 31, 2002:
FHLB borrowings(2)....................... $ 385,785 $ 328,057 $ 446,923 2.89% 2.64%
Revolving lines of credit................ 10,000 15,820 30,850 3.45 2.79
School financing......................... 32,328 41,293 50,252 4.77 4.37
At or for the year ended December 31, 2001:
FHLB borrowings(3)....................... 303,361 347,807 478,921 4.62 2.94
Revolving lines of credit................ 95,450 58,673 95,450 4.54 2.51
School financing......................... 44,965 46,160 60,100 6.02 4.65
At or for the year ended December 31, 2000:
FHLB borrowings(4)....................... 519,433 430,331 526,450 6.33 6.29
Revolving lines of credit................ 21,956 40,701 52,750 8.23 7.63
Repurchase agreements.................... 385 3,240 6,906 10.70 8.75
School financing......................... 44,308 30,262 44,308 8.18 8.56
__________
(1) Calculations are based on daily averages where available and monthly
averages otherwise.
(2) A total of $146.0 million of the FHLB borrowings outstanding at December
31, 2002 were borrowed under short option advance agreement with the FHLB.
The interest rates on the short option advance borrowings ranged from
2.69% to 5.63% at December 31, 2002 and their possible call dates varied
from December 2002 to November 2006. Additionally, $1.3 million of the
FHLB borrowings outstanding at December 31, 2002 are fixed-term/rate
advances, which were borrowed from the FHLB to offset specific loans
originated by Matrix Bank. The principal amount of these fixed-term/rate
advances adjust monthly based on an amortization schedule. The interest
rate on the fixed-term/rate advances was 5.84%, and their maturity date is
June 2, 2014.
49
(3) A total of $136.0 million of the FHLB borrowings outstanding at December
31, 2001 were borrowed under short option advance agreements with the
FHLB. The interest rates on the short option advance borrowings ranged
from 2.69% to 5.63% at December 31, 2001 and their possible call dates
varied from February 20, 2002 to November 13, 2006. Additionally, $1.4
million of the FHLB borrowings outstanding at December 31, 2001 are
fixed-term/rate advances, which were borrowed from the FHLB to offset
specific loans originated by Matrix Bank. The principal amount of these
fixed-term/rate advances adjust monthly based on an amortization schedule.
The interest rate on the fixed-term/rate advances was 5.84%, and their
maturity date is June 2, 2014.
(4) A total of $26.0 million of the FHLB borrowings outstanding at December
31, 2000 were borrowed under a short option advance agreement with the
FHLB. These short option advance borrowings have a term of ten years, but
are callable by the FHLB beginning after a six-month or one-year lockout
period depending on the particular short option advance borrowing. After
the expiration of the lockout period, the short option advance borrowings
are callable at three-month intervals. If the FHLB exercises its call
option on a short option advance borrowing, the FHLB is required to offer
replacement funding to us at a market rate of interest for the remaining
term of the short option advance borrowing. The interest rates on the
short option advance borrowings ranged from 5.40% to 5.63% at December 31,
2000 and their possible call dates varied from February 20, 2001 to March
26, 2001. Under the terms of the short option advance agreement, we are
not permitted to prepay or otherwise retire a callable short option
advance borrowing prior to the final maturity date. Additionally, $1.4
million of the FHLB borrowings outstanding at December 31, 2000 are
fixed-term/rate advances, which were borrowed from the FHLB to offset
specific loans originated by Matrix Bank. The principal amount of these
fixed-term/rate advances adjust monthly based on an amortization schedule.
The principal amount of these fixed-term/rate advances adjust monthly
based on an amortization schedule. The interest rate on the
fixed-term/rate advances was 5.84% and their maturity date is June 2,
2014. Matrix Bank also had short-term, fixed-term/rate borrowings
outstanding at December 31, 2000 from the FHLB. These short-term,
fixed-term/rate borrowings totaled $150.0 million, with interest rates
ranging from 6.00% to 6.23% and maturity dates ranging from March 27, 2001
through June 26, 2001.
Liquidity and Capital Resources
Liquidity is our ability to generate funds to support asset growth, satisfy
disbursement needs, maintain reserve requirements and otherwise operate on an
ongoing basis. To date, our principal source of funding for our investing
activities has been:
o secured senior debt provided by unaffiliated financial
institutions;
o the issuance of preferred securities through Matrix Bancorp
Capital Trust I in 1999, Matrix Bancorp Capital Trust II, III and
IV in 2001 and Matrix Bancorp Capital Trust V in 2002;
o the issuance of 11.5% senior notes in September 1997;
o a bank stock loan; and
o our initial public offering.
As of December 31, 2002, Matrix Bancorp had $81.5 million in indebtedness
outstanding. The borrowed funds have been used historically as capital
injections to Matrix Bank, Matrix Financial, Matrix Capital Markets and ABS.
On March 31, 2002, Matrix Bancorp amended its bank stock loan agreement.
The amended bank stock loan agreement has two components, an $8,215,000 term
loan and a revolving line of credit of $12.0 million. As of December 31, 2002,
the balance of the term loan was $7.5 million and the balance of the revolving
line of credit was $0. The amended bank stock loan requires Matrix Bancorp to
maintain total shareholders' equity of $60.0 million. Matrix Bank is required to
maintain classified assets of less than 3% of total assets and must also earn in
excess of $7.5 million over the previous four quarters. The covenants must be
met quarterly. As of December 31, 2002, we did not meet two of the covenants.
Due to the classification on noninterest-earning assets, our classified assets
slightly exceeded 3%. In addition, due to the impairment on our servicing rights
over the previous two quarters, Matrix Bank's earnings did not exceed $7.5
million. Subsequent to year-end, management obtained waivers for both covenants.
The term loan has a maturity date of December 31, 2004. The revolving line of
credit is annually renewed and currently has a maturity date of March 31, 2003.
We are in the process of renewing the revolving line of credit. As part of the
annual renewal process, we anticipate that the two covenants maintained above
will be amended to address to our satisfaction, prospectively, the covenant
levels that we did not meet at December 31, 2002. However, there can be no
assurances that the bank stock loan will be renewed or that, if renewed, the
issues mentioned above will be resolved to our satisfaction.
On July 30, 1999, Matrix Bancorp Capital Trust I ("Trust I"), a Delaware
business trust formed by Matrix Bancorp, completed the sale of $27.5 million of
10% preferred securities. Trust I also issued common securities to Matrix
Bancorp and used the net proceeds from the offering to purchase $28.6 million in
principal amount of 10% junior subordinated debentures of Matrix Bancorp due
September 30, 2029. The junior subordinated debentures are the sole assets of
Trust I and are eliminated, along with the related statement of operations
effects, in the consolidated financial statements.
The preferred securities accrue and pay distributions quarterly at an
annual rate of 10% of the stated liquidation amount of $25 per preferred
security. We have fully and unconditionally guaranteed all of the obligations of
50
Trust I under the preferred securities. The guarantee covers the quarterly
distributions and payments on liquidation or redemption of the preferred
securities, but only to the extent of funds held by Trust I.
The preferred securities are mandatorily redeemable upon the maturity of
the junior subordinated debentures or upon earlier redemption as provided in the
indenture. We have the right to redeem the junior subordinated debentures, in
whole or in part on or after September 30, 2004, at a redemption price specified
in the indenture plus any accrued but unpaid interest to the redemption date.
See Note 10 to the consolidated financial statements included elsewhere in this
document. Under the indenture, we are prohibited from paying dividends on our
common stock if the scheduled payments on our junior debentures and trust
preferred securities have not been made.
On March 28, 2001, Matrix Bancorp Capital Trust II ("Trust II"), a Delaware
business trust formed by the Company, completed the sale of $12.0 million of
10.18% preferred securities. Trust II also issued common securities to the
Company and used the net process from the offering to purchase $12.4 million in
principal amount of 10.18% junior subordinated debentures of the Company due
June 8, 2031. The junior subordinated debentures are the sole assets of Trust II
and are eliminated, along with the related statement of operations effects, in
the consolidated financial statements.
The preferred securities accrue and pay distributions semi-annually at an
annual rate of 10.18% of the stated liquidation amount of $1,000 per preferred
security. The Company has fully and unconditionally guaranteed all of the
obligations of Trust II under the preferred securities. The guarantee covers the
quarterly distributions and payments on liquidation or redemption of the
preferred securities, but only to the extent of funds held by Trust II.
The preferred securities are mandatorily redeemable upon the maturity of
the junior subordinated debentures or upon earlier redemption as provided in the
indentures. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after June 8, 2011, at a redemption price
specified in the indenture plus any accrued but unpaid interest to the
redemption date.
On July 16, 2001, Matrix Bancorp Capital Trust III ("Trust III"), a
Delaware business trust formed by the Company, completed the sale of $15.0
million of 10.25% preferred securities. Trust III also issued common securities
to the Company and used the net process from the offering to purchase $15.5
million in principal amount of 10.25% junior subordinated debentures of the
Company due July 25, 2031. The junior subordinated debentures are the sole
assets of Trust III and are eliminated, along with the related statement of
operations effects, in the consolidated financial statements.
The preferred securities accrue and pay distributions semi-annually at an
annual rate of 10.25% of the stated liquidation amount of $1,000 per preferred
security. The Company has fully and unconditionally guaranteed all of the
obligations of Trust III under the preferred securities. The guarantee covers
the quarterly distributions and payments on liquidation or redemption of the
preferred securities, but only to the extent of funds held by Trust III.
The preferred securities are mandatorily redeemable upon the maturity of
the junior subordinated debentures or upon earlier redemption as provided in the
indentures. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after July 25, 2006, at a redemption
price specified in the indenture plus any accrued but unpaid interest to the
redemption date.
On November 28, 2001, Matrix Bancorp Capital Trust IV ("Trust IV"), a
Delaware business trust formed by the Company, completed the sale of $5.0
million of floating rate of the six-month LIBOR plus 3.75% (5.14% for period
ended December 31, 2002) preferred securities. Trust IV also issued common
securities to the Company and used the net process from the offering to purchase
$5.2 million in principal amount of floating rate of the six-month LIBOR plus
3.75% junior subordinated debentures of the Company due December 8, 2031. The
junior subordinated debentures are the sole assets of Trust IV and are
eliminated, along with the related statement of operations effects, in the
consolidated financial statements.
The preferred securities accrue and pay distributions semi-annually at a
floating annual rate as described above of the stated liquidation amount of
$1,000 per preferred security. The Company has fully and unconditionally
guaranteed all of the obligations of Trust III under the preferred securities.
The guarantee covers the quarterly distributions and payments on liquidation or
redemption of the preferred securities, but only to the extent of funds held by
Trust IV.
The preferred securities are mandatorily redeemable upon the maturity of
the junior subordinated debentures or upon earlier redemption as provided in the
indentures. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after December 8, 2006, at a redemption
price specified in the indenture plus any accrued but unpaid interest to the
redemption date.
51
On July 25, 2002, Matrix Bancorp Capital Trust V ("Trust V"), a Delaware
business trust formed by the Company, completed the sale of $5.0 million of
floating rate of the six-month LIBOR plus 3.625% (5.015% for period ended
December 31, 2002) preferred securities. Trust V also issued common securities
to the Company and used the net process from the offering to purchase $5.2
million in principal amount of floating rate of the six-month LIBOR plus 3.625%
junior subordinated debentures of the Company due July 25, 2032. The junior
subordinated debentures are the sole assets of Trust IV and are eliminated,
along with the related statement of operations effects, in the consolidated
financial statements.
The preferred securities accrue and pay distributions semi-annually at a
floating annual rate as described above of the stated liquidation amount of
$1,000 per preferred security. The Company has fully and unconditionally
guaranteed all of the obligations of Trust III under the preferred securities.
The guarantee covers the quarterly distributions and payments on liquidation or
redemption of the preferred securities, but only to the extent of funds held by
Trust V.
The preferred securities are mandatorily redeemable upon the maturity of
the junior subordinated debentures or upon earlier redemption as provided in the
indentures. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after July 25, 2007, at a redemption
price specified in the indenture plus any accrued but unpaid interest to the
redemption date.
Capitalized expenses associated with all of the trust preferred securities
offerings of approximately $2.4 million are included in other assets at December
31, 2002 and are being amortized on a straight-line basis over the life of the
junior subordinated debentures.
On September 29, 1997, we completed a registered debt offering of $20.0
million in senior notes due 2004, raising net proceeds of approximately $19.1
million. Interest on the senior notes of 11.5% is payable semi-annually on March
31 and September 30 of each year, commenced on March 31, 1998, with a balloon
payment for the entire principal balance due in September 2004. The 11.5% senior
notes require us to:
o maintain consolidated tangible equity capital of not less than $35
million; and
o meet the requirements necessary such that Matrix Bank will not be
classified as other than "well capitalized" as defined by
applicable regulatory guidelines.
Additionally, the 11.5% senior notes contain other covenants regarding certain
restricted payments, incurrence of indebtedness and issuance of preferred stock,
liens, merger, consolidation or sale of assets and transactions with affiliates.
As of December 31, 2002, due to repurchases made by the Company of the senior
notes, there remained $9.5 million of the debt issue outstanding.
We have in place a warehouse line of credit provided to Matrix Financial
by an unaffiliated financial institution. As of December 2, 2002, the line of
credit was amended and terminated February 28, 2003. It aggregates $50.0
million, of which $40.0 million was available at December 31, 2002. As of
February 28, 2003, the line was renewed under similar terms and conditions for
the period of time from February 28, 2003 through the Final Closing Date. See
"Item 1. Business--Sale of Wholesale Production Platform."
Matrix Bancorp has guaranteed, with 50% recourse to our joint venture
partner, the indebtedness of Matrix Settlement & Clearance Services to U.S.
Bank, N.A., in an amount of no greater than $3.0 million. The guaranty relates
to a $3.0 million line of credit which is utilized by Matrix Settlement &
Clearance Services in situations where its clients do not wire funds to settle
trades. The line is used very infrequently and Matrix Settlement & Clearance
Services is adequately secured in the case that the utilization of the line is
required. There was no balance outstanding at Matrix Settlement & Clearance
Services on such indebtedness at December 31, 2002.
The trend of net cash used by our operating activities experienced over the
reported periods results primarily from the growth at Matrix Bank, Matrix
Financial, First Matrix and operating expenses incurred at ABS. We do not
anticipate that this trend will continue in 2003 for two reasons. First, we are
not anticipating any growth in 2003 and, in fact, have initiated various expense
reduction strategies. Second, the sale of the wholesale production platform will
result in significant liquidity once the warehouse line of credit provided to
Matrix Financial by Matrix Bank is repaid. See "Item 1. Business--Sale of
Wholesale Production Platform."
The Company is reliant on dividend and tax payments from its subsidiaries
in order to fund operations, meet debt obligations and grow new or developing
lines of business. A long-term inability of a subsidiary to make dividend
52
payments could significantly impact the Company's liquidity. Historically, the
majority of the dividend payments have been made by Matrix Bank and its
consolidated subsidiaries, which include Matrix Financial. The current dividend
policy approved by Matrix Bank is 75% of the consolidated cumulative earnings of
Matrix Bank. Due to the loss incurred during the year ended December 31, 2002 as
a result of the servicing asset impairment, Matrix Bank is currently not in a
position to pay dividends under its current policy for the last quarter of 2002.
Matrix Bank has not paid a dividend since August 2002 which reflected earnings
from July 2002. Matrix Bank currently anticipates that it will resume dividend
payments under current policy in March 2003. In the interim, the Company intends
to utilize dividends from its other subsidiaries and the line of credit on its
bank stock loan, as needed, to meet its own and the other subsidiaries financial
obligations.
Matrix Bank's primary source of funds for use in lending, purchasing bulk
loan portfolios, investing and other general purposes are:
o retail deposits;
o trust deposits;
o custodial escrow balances;
o brokered deposits;
o FHLB borrowings;
o sales of loan portfolios; and
o proceeds from principal and interest payments on loans.
Contractual loan payments and net deposit inflows are a generally predictable
source of funds, while loan prepayments and loan sales are significantly
influenced by general market interest rates and economic conditions. Borrowings
on a short-term basis are used as a cash management vehicle to compensate for
seasonal or other reductions in normal sources of funds. Matrix Bank utilizes
advances from the FHLB as its primary source for borrowings. At December 31,
2002, Matrix Bank had overnight and term borrowings from the FHLB of $385.8
million. The availability of FHLB borrowings is based on the level of collateral
pledged. Generally, the availability will be limited to the lesser of 90% of the
collateral pledged or 50% of total assets. The custodial escrow balances held by
Matrix Bank fluctuate based upon the mix and size of the related mortgage
servicing rights portfolios and the timing of payments for taxes and insurance,
as well as the level of prepayments which occur. For a tabular presentation of
the our short-term borrowings, see "Asset and Liability Management--Short-Term
Borrowings."
Matrix Bank offers a variety of deposit accounts having a range of
interest rates and terms. Matrix Bank's retail deposits principally consist of
demand deposits and certificates of deposit. The flow of deposits is influenced
significantly by general economic conditions, changes in prevailing interest
rates and competition. Matrix Bank's retail deposits are obtained from areas in
which it is located, as well as through an Internet service. Therefore, its
retail deposits are concentrated primarily in Las Cruces and Sun City, except
for the Internet deposits, which could be out-of-market retail deposits. Matrix
Bank relies principally on customer service, marketing programs and its
relationships with customers to attract and retain in-market deposits. Brokered
deposits are accepted and have been utilized to support growth at Matrix Bank.
In pricing deposit rates, management considers profitability, the matching of
term lengths with assets, the attractiveness to customers and rates offered by
competitors. Matrix Bank intends to continue its efforts to attract deposits as
a primary source of funds to support its lending and investing activities.
The following table sets forth the average balances for each major category
of Matrix Bank's deposit accounts and the weighted-average interest rates paid
for interest-bearing deposits for the periods indicated:
Year Ended December 31,
-------------------------------------------------------------------------------------------
2002 2001 2000
----------------------------- ----------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
-------------- -------------- -------------- -------------- -------------- --------------
(Dollars in thousands)
Passbook accounts........... $ 5,998 1.95 % $ 3,467 3.12 % $ 2,981 3.42 %
NOW accounts................ 119,585 0.48 98,872 0.94 64,523 0.96
Money market accounts....... 302,479 1.22 203,757 2.11 130,592 2.34
Time deposits............... 130,544 5.35 181,535 5.60 177,399 6.10
Brokered deposits........... 338,682 2.99 312,419 6.20 183,685 6.36
----------- ------------ ----------- ----------- ------------ -----------
Total deposits......... $ 897,288 2.40 % $ 800,050 4.36 % $ 559,180 4.70 %
=========== ============ =========== =========== ============ ===========
53
The following table sets forth the amount of Matrix Bank's certificates of
deposit that are greater than $100,000 by time remaining until maturity as of
December 31, 2002:
Weighted
Amount Average Rate
Paid
--------------- ------------------
(Dollars in thousands)
Three months or less....................................................... $ 2,753 3.40 %
Over three months through six months....................................... 2,198 3.73
Over six months through twelve months...................................... 4,257 3.19
Over twelve months......................................................... 8,561 4.49
--------------- ------------------
Total................................................................. $ 17,769 3.92 %
--------------- ------------------
We actively monitor Matrix Bank's compliance with regulatory capital
requirements. Historically, Matrix Bank has increased its core capital through
the retention of a portion of its earnings. Matrix Bank's future growth is
expected to be achieved through deposit growth, brokered deposits, borrowings
from the FHLB and custodial deposits directed by affiliates. In 2003, however,
we are not anticipating any significant growth.
Matrix Financial's principal source of funding for its loan origination
business consists of a warehouse line of credit provided to Matrix Financial by
Matrix Bank, and a warehouse line of credit provided to Matrix Financial by an
unaffiliated financial institution. As of December 2, 2002, Matrix Financial's
warehouse line of credit facility provided by an unaffiliated financial
institution was amended. It aggregates $50.0 million, of which $40.0 million was
available to be utilized as of December 31, 2002. At December 31, 2002, $10.0
million was outstanding under the warehouse line at a weighted average interest
rate of 2.59%. Borrowings under the warehouse line of credit are secured by all
of the mortgage loans funded with warehouse loan proceeds and bear interest at
the LIBOR rate plus a negotiated margin. Following the Final Closing Date, the
warehouse facility at Matrix Bank will be terminated and we anticipate that the
warehouse facility with the unaffiliated financial institution will also be
terminated. See "Item 1. Business--Sale of Wholesale Production Platform."
ABS School Services' principal source of funding for school financing
consists of its internal capital, sales of loans to a third party institution
and partnership trusts with unaffiliated financial institutions. Amounts
available to be sold and amounts to be financed are at the purchaser's and
lender's sole discretion. We continue to pursue additional third party financing
and sale options for ABS; although, we do no anticipate significantly increasing
our current loan portfolio.
The Company has placed tax-exempt financing of approximately $31.1 million
at December 31, 2002 it originated to charter schools into two grantor trusts.
The trusts then issued Class "A" Certificates and Class "B" Certificates, with
the Class "A" Certificates being sold to various third party investors under a
private placement at a price of par.
The "A" Certificates under the two grantor trusts are guaranteed by a
letter of credit issued by a third party investment bank for one, and the second
one is guaranteed equally by two unaffiliated financial institutions. The "A"
Certificates' interest rate may be determined weekly, monthly or for a term for
up to one year. The interest rate and the term of the interest rate are
determined by the Remarking Agent, which is also the investment bank. Generally,
the trusts are short-term in nature with an average life of one year or less.
The "B" Certificates are owned by the Company. The interest rate paid on
the "A" Certificates is considered the Company's financing cost. The approximate
cost of the financing at December 31, 2002 and 2001 was 1.55% and 2.75%,
respectively. The interest that the Company receives through its part ownership
of the "B" Certificates is tax-exempt.
Although "A" Certificates are guaranteed by unaffiliated entities, the
Company provides full recourse to the unaffiliated entities in all cases of loss
or default. Due to the nature of the recourse and the ability of the "A"
Certificate holders to put the certificates to the trusts, the transactions have
been accounted for as a secured financing. In addition, under a purchase and
sale agreement, ABS has sold school financings to an unaffiliated financial
institution. The school financings were sold with full recourse to ABS. ABS
services the school financings on a scheduled/scheduled remittance and in the
case of a loss or default, upon the liquidation of the underlying collateral,
ABS is required to reimburse for any shortfall. Due to the control that the
unaffiliated financial institution has over the school financing, the
transaction was accounted for as a sale. The recourse provisions were considered
by us at the time of the sale. No gain or loss was booked at the sale date. The
total balance of the school financings sold with recourse was $13 million at
December 31, 2002.
54
Matrix Bank and Sterling Trust are restricted in certain instances from
paying dividends to Matrix Bancorp due to certain regulatory requirements. See
"Item 1. Business--Regulation and Supervision."
As discussed in "Item 3. Legal Proceedings," we are from time to time party
to various litigation matters, in most cases, involving ordinary routine claims
incidental to our business. With respect to all pending litigation matters, our
ultimate legal and financial responsibility, if any, cannot be estimated with
certainty. As such, the impact on our liquidity and capital cannot be estimated
with certainty. We have not made an accrual for any losses in the consolidated
financial statements as of December 31, 2002 related to these matters. One item
of particular note, as discussed in the section noted above and in Note 15 of
our consolidated financial statements, as of December 31, 2002, a subsidiary of
the Company has been named a defendant in an action that was tried in Tarrant
County, Texas District Court in the spring of 2000. The jury returned a verdict
adverse to the Company with respect to 2 of 12 theories of liability posed by
the plaintiffs, and the court has signed a judgment for certain of the
plaintiffs in the amount of approximately $6.4 million. The Company has filed an
appeal of this judgment and believes it has meritorious points of appeal and
intends to vigorously prosecute the appeal of this action. The ultimate
resolution of this matter could result in a loss of up to $6.4 million plus
post-judgment interest and additional attorneys' fees. The ultimate legal and
financial liability, if any, of the Company cannot be estimated with certainty.
To the extent additional information arises or our strategies change, it is
possible that our liability in any of these matters may change.
During the fourth quarter of 2002, the Company executed a Shareholder
Rights Plan at which time the Board of Directors of the Company declared a
dividend of one preferred stock purchase right for each outstanding share of the
Company's common stock. Each of these Rights, which are not immediately
exercisable, entitles the holder to purchase one one-thousandth of a share of
the Company's newly designated Series A Junior Participating Preferred Stock at
an exercise price of $40.00. The Rights are not exercisable until certain events
occur, are not detachable from the Company's common stock and do not have any
immediate value to stockholders. The Rights distribution was made on November
15, 2002, payable to shareholders of record on that date. The Rights will expire
on November 5, 2012.
Inflation and Changing Prices
The consolidated financial statements and related data presented in this
document have been prepared in accordance with accounting principles generally
accepted in the United States of America, which require the measurement of
financial position and operating results in terms of historical dollars without
considering changes in the relative purchasing power of money over time due to
inflation. Unlike most industrial companies, substantially all of our assets and
liabilities are monetary in nature. As a result, interest rates have a more
significant impact on our performance than the effects of general levels of
inflation. Interest rates do not necessarily move in the same direction or in
the same magnitude as prices of goods and services.
Critical Accounting Policies
The Company and its subsidiaries have established various accounting
policies which govern the application of accounting principles generally
accepted in the United States of America in the preparation and presentation of
the Company's consolidated financial statements. The significant accounting
policies of the Company are described in Note 2 of the consolidated financial
statements. Certain accounting policies involve significant judgments,
assumptions and estimates by management that have a material impact on the
carrying value of certain assets and liabilities, which management considers to
be critical accounting policies. The judgments, assumptions and estimates used
by management are based on historical experience, knowledge of the accounts and
other factors, which are believed to be reasonable under the circumstances.
Because of the nature of the judgments and assumptions made by management,
actual results could differ from these judgments and estimates, which could have
a material impact on the carrying values of assets and liabilities and the
results of operations of the Company.
The Company believes the allowance for loan and valuation losses is a
critical accounting policy that requires the most significant judgments,
assumptions and estimates used in preparation of its consolidated financial
statements. See discussion at "--Asset and Liability Management, Analysis of
Allowance for Loan and Valuation Losses" for a detailed description of the
Company's process and methodology related to the allowance for loan and
valuation losses.
The Company also considers the valuation of mortgage servicing rights to be
a critical accounting policy that requires judgments, assumptions and estimates
concerning impairment of their value in certain interest rate environments. See
55
"--Business, Mortgage Servicing Activities" for a detailed discussion of the
nature of the servicing rights, and see Note 2 of the consolidated financial
statements for a detailed discussion concerning the use of estimates in the
valuation of mortgage servicing rights.
The Company also considers the judgments and assumptions concerning
litigation as a critical accounting policy. The Company has been notified that
we are a defendant in a number of legal proceedings. Most of these cases involve
ordinary and routine claims incidental to our business. Based on management's
analysis, no accrual for loss has been made as of December 31, 2002 for any such
cases. See a full description of such proceedings at "Item 3. Legal
Proceedings." With respect to all pending litigation matters, our ultimate legal
responsibility, if any, cannot be estimated with certainty. Based on the
ultimate outcome of such proceedings, it is possible that future results of
operations for any particular quarterly or annual period could be materially
affected by changes in our assumptions related to such proceedings.
Recent Accounting Pronouncements
In November 2002, the Financial Accountings Standards Board ("FASB") issued
FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." This interpretation expands the disclosures to be made by a guarantor
in its financial statements about its obligations under certain guarantees and
requires the guarantor to recognize a liability for the fair value of an
obligation assumed under a guarantee. FIN 45 clarifies the requirements of SFAS
5, "Accounting for Contingencies," relating to guarantees. In general, FIN 45
applies to contracts or indemnification agreements that contingently require the
guarantor to make payments to the guaranteed party based on changes in an
underlying that is related to an asset, liability, or equity security of the
guaranteed party. Certain guarantee contracts are excluded free from both the
disclosure and recognition requirements of this interpretation, including, among
others, guarantees relating to employee compensation, residual value guarantees
under capital lease arrangements, commercial letters of credit, loan
commitments, subordinated interests in an special purpose entity, and guarantees
of a company's own performance. Other guarantees are subject to the disclosure
requirements of FIN 45 but not to the recognition provisions and include, among
others, a guarantee accounted for as a derivative instrument under SFAS 133, a
parent's guarantee of debt owed to a third party by its subsidiary or vice
versa, and a guarantee which is based on performance not price. The disclosure
requirements of FIN 45 are effective for the Company as of December 31, 2002,
and require disclosure of the nature of the guarantee, the maximum potential
amount of future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. The recognition requirements of FIN 45 are to
be applied prospectively to guarantees issued or modified after December 31,
2002. Significant guarantees that have been entered into by the Company are
disclosed in Note 15. The Company does not expect the requirements of FIN 45 to
have a material impact on the consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." This interpretation of Accounting
Research Bulletin No. 51, Consolidated Financial Statements, addresses
consolidation by business enterprises of variable interest entities (selected
entities with related contractual, ownership, voting or other monetary
interests, including certain special purpose entities), and requires certain
additional disclosure with respect to these entities. The provisions of FIN 46
are immediately applicable to variable interest entities created after January
31, 2003 and for entities that existed prior to February 1, 2003. The Company
does not expect the requirements of FIN 46 to have a material impact on the
results of consolidated financial statements. The disclosure requirements, as
applicable, are included in our consolidated financial statements and notes
thereto.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," that supersedes APB Opinion No. 17. Under SFAS 142, goodwill and
intangible assets deemed to have indefinite lives are no longer amortized, but
are to be reviewed at least annually for impairment, under impairment guidelines
established in the statement. SFAS 142 also changes the amortization methodology
in intangible assets that are deemed to have finite lives and adds to required
disclosures regarding goodwill and intangible assets. SFAS 142 is effective for
fiscal years beginning after December 15, 2001. The Company adopted SFAS 142 on
January 1, 2002 and its unamortized balance of goodwill as of that date was $1.0
million. Beginning in 2002, the Company ceased its amortization of goodwill.
Goodwill amortization for 2001 and 2000 was less than $100,000, respectively.
During the second quarter of 2002, under guidelines contained in the statement,
management performed an analysis concerning potential impairment of the goodwill
carried at ABS School Services, and determined that no impairment existed. This
analysis was based on the fact that ABS School Services was engaged in an effort
to increase the client base and fee income on a national basis and believed it
would be successful. During the fourth quarter of 2002, it was determined that
the efforts were ultimately not successful in that ABS School Services was not
able to attract the amount of new contracts it had targeted for the new school
year. As such, the impairment analysis on the goodwill at ABS School Services
was re-performed in the fourth quarter of 2002, and it was determined that an
56
impairment of goodwill was present, and the entire goodwill balance of $1.0
million was written-off in the fourth quarter of 2002. After this charge, the
consolidated goodwill balance at December 31, 2002 was $0.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). SFAS 146
requires recognition of liability for a cost associated with an exit or disposal
activity when the liability is incurred, as opposed to being recognized at the
date an entity commits to an exit plan under EITF 94-3. SFAS 146 also
establishes that fair value is the objective for initial measurement of the
liability. SFAS 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The adoption of SFAS 146 on January 1, 2003
did not have a material impact on the consolidated financial statements.
In October 2002, the issued SFAS No. 147, "Acquisition of Certain Financial
Institutions, an amendment of SFAS No. 72, No. 144 and FASB Interpretation No.
9." In accordance with SFAS 147, the acquisition of all or part of a financial
institution that meets the definition of a business combination will be
accounted for by the purchase method in accordance with SFAS 141. In addition,
SFAS 147 provides that long-term customer-relationship intangible assets, except
for servicing assets, recognized in the acquisition of a financial institution,
should be evaluated for impairment by the provisions of No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. The effective date of SFAS 147
is for acquisitions on or after October 1, 2002. The adoption of SFAS 147 on
October 1, 2002 did not have any impact on the consolidated financial
statements.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." This amendment to FASB Statement No.
123 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of FASB Statement
No. 123 to require disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The provisions of this statement
are effective for financial statements of interim or annual periods after
December 15, 2002. The Company does not intend to change to the fair value
method of accounting. The required disclosures of this statement are included in
Note 2 and Note 14 of the consolidated financial statements.
Contractual Obligations, Commitments, Contingent Liabilities and Off-Balance
Sheet Arrangements
The following table presents, as of December 31, 2002, the Company's
significant fixed and determinable contractual obligations by payment date. The
payment amounts represent those amounts contractually due to the recipient and
do not include any unamortized premiums or discounts, hedge basis adjustments or
other similar carrying value adjustments. Further discussion of the nature of
each obligation is included in the referenced Note to the consolidated financial
statements.
As of December 31, 2002
------------------------------------------------------------------------------------
Note 1 Year 1 to 3 Years 3 to 5 Over 5 Years
Reference or Less Years Total
-------------- -------------------------- ------------------------------------------
(In thousands)
Contractual Obligations
Deposits (passbook, NOW and money
market).................................. 9 - - - 485,487 485,487
Certificate account......................... 9 352,854 75,452 20,164 - 448,470
Federal funds borrowed...................... 11 - - - 385,785 385,785
Borrowed money and guarantee
preferred beneficial interests........... 10 12,727 47,929 - 65,247 125,903
Operating leases............................ 15 2,748 4,191 2,124 715 9,778
A schedule of significant commitments at December 31, 2002 follows:
Commitments (In thousands)
Loans secured by mortgages.................. $ 31,154
Construction loans.......................... 10,991
Commercial lines of credit.................. 8,338
Commercial loans............................ 4,858
Consumer loans.............................. 581
57
Further discussion of these commitments is included in Note 15 of the
consolidated financial statements. In addition, the Company has contingencies
due to various litigation matters which are also discussed in Note 15 of the
consolidated financial statements.
The Company may also have liabilities under certain contractual agreements
contingent upon the occurrence of certain events. A discussion of the
significant contractual arrangements under which the Company may be held
contingently liable, including guarantee arrangements, is included in Note 15 of
the consolidated financial statements.
The Company's significant off-balance sheet arrangements include the use
of school financing sale agreements which are discussed further in Note 10 of
the consolidated financial statements.
Forward Looking Statements
Certain statements contained in this annual report that are not historical
facts, including, but not limited to, statements that can be identified by the
use of forward-looking terminology such as "may," "will," "expect,"
"anticipate," "predict," "believe," "plan," "estimate" or "continue" or the
negative thereof or other variations thereon or comparable terminology, are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, and involve a number of risks and uncertainties.
The actual results of the future events described in such forward-looking
statements in this annual report could differ materially from those stated in
such forward-looking statements. Among the factors that could cause actual
results to differ materially are: third party claims or actions in relation to
the ongoing or future bankruptcies of the Company's customers; interest rate
fluctuations; level of delinquencies; defaults and prepayments; general economic
conditions; competition; government regulation; possible future litigation; the
actions or inactions of third parties, including failure of the Buyer to perform
its obligations under the Purchase Agreement (See "Item 1. Business--Sale of
Wholesale Production Platform"), and actions or inactions of those that are
parties to the existing or future bankruptcies of the Company's customers or
litigation related thereto; unanticipated developments in connection with the
bankruptcy actions or litigation described above, including judicial variation
from existing legal precedent and the decision by one or more parties to appeal
decisions rendered; the risks and uncertainties discussed elsewhere in this
annual report and in the Company's current report on Form 8-K, filed with the
Securities and Exchange Commission on March 14, 2001; and the uncertainties set
forth from time to time in the Company's periodic reports, filings and other
public statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
See Item 7."Management's Discussion and Analysis of Financial Condition
and Results of Operations--Asset and Liability Management--Risk Sensitive Assets
and Liabilities" and Item 1."Business--Mortgage Servicing Activities--Hedging of
Servicing Rights."
Item 8. Financial Statements and Supplementary Data
See Index to Financial Statements on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On April 3, 2001, our Audit Committee recommended to our Board of
Directors that we not renew our engagement with Ernst & Young LLP as our
independent auditors and to appoint KPMG LLP to be our principal independent
auditors and to audit our consolidated financial statements for the fiscal year
ending December 31, 2001. Our Board of Directors accepted the recommendation of
the Audit Committee on April 3, 2001. The Audit Committee and the Board of
Directors based their decisions on competitive bids submitted by the two firms.
The dismissal of Ernst & Young and the appointment of KPMG both were effective
as of April 16, 2001.
Ernst & Young's reports on our consolidated financial statements for
fiscal year 2000 did not contain an adverse opinion or disclaimer of opinion,
nor were the reports qualified or modified as to uncertainty, audit scope or
accounting principles. During fiscal year 2000 and the subsequent interim
period, there were no disagreements between us and Ernst & Young on any matter
of accounting principle or practices, financial statement disclosure, or
auditing scope or procedure, which would have caused Ernst & Young to make a
reference to the subject matter of the disagreements in connection with their
reports. Ernst & Young further has not performed any work on any subsequent
period to December 31, 2000.
58
We did not consult with KPMG with regard to any matter concerning the
application of accounting principles to any specific transactions, either
completed or proposed, or the type of audit opinion that might be rendered with
respect to our financial statements prior to engaging the firm.
PART III
Items 10 through 13.
The information for these items is incorporated from the definitive proxy
statement to be filed with the Commission within 120 days of December 31, 2002.
Item 14. Controls and Procedures
Within 90 days prior to the date of this annual report, an evaluation was
performed under the supervision and with the participation of the Company's
management, including the Co-CEO's and CFO, of the effectiveness of the design
and operation of the Company's disclosure controls and procedures. Based on that
evaluation, the Company's management, including the Co-CEO's and CFO, concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic SEC
reports. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of their evaluation.
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (a) (2) Financial statements and financial statement schedules
See Index to Financial Statements on page F-1.
(b) Reports on Form 8-K
The Company filed a Form 8-K with the Securities and Exchange
Commission on November 6, 2002 (Item 5) announcing the adoption of a
Shareholder Rights Plan.
The Company filed a Form 8-K with the Securities and Exchange
Commission on March 4, 2003 (Item 5) announcing the sale of the
wholesale mortgage origination platform.
(c) Exhibits
See Exhibit Index, beginning on page II-1.
(d) Financial Statement Schedules
None.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on the 13th day of
March, 2002.
MATRIX BANCORP, INC.
Dated: March 14, 2003 /s/ D. Mark Spencer
------------------- --------------------------------
D. Mark Spencer
President and Co-Chief
Executive Officer
(Principal Executive Officer)
Dated: March 14, 2003 /s/ Richard V. Schmitz
-------------------- --------------------------------
Richard V. Schmitz
Co-Chief Executive Officer
Dated: March 14, 2003 /s/ David W. Kloos
-------------------- --------------------------------
David W. Kloos
Senior Vice President and
Chief Financial Officer
(Principal Accounting and Financial
Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signatures Title Date
- ---------- ----- ----
/s/ D. Mark Spencer President, Co-Chief Executive March 14, 2003
- --------------------------- Officer and a Director
D. Mark Spencer (Principal Executive Officer)
/s/ Richard V. Schmitz Co-Chief Executive Officer and March 14, 2003
- --------------------------- Chairman of the Board
Richard V. Schmitz
/s/ Guy A. Gibson Director March 14, 2003
- ---------------------------
Guy A. Gibson
/s/ David A. Frank Director March 14, 2003
- ---------------------------
David A. Frank
/s/ Robert T. Slezak Director March 14, 2003
- ---------------------------
Robert T. Slezak
/s/ Lester Ravitz Director March 14, 2003
- ---------------------------
Lester Ravitz
60
CERTIFICATION
I, David W. Kloos, Senior Vice President and Chief Financial Officer of Matrix
Bancorp, Inc. (the "Registrant"), certify that:
1. I have reviewed this annual report on Form 10-K of Matrix
Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in
light of the circumstances under which such statements were
made, not misleading as with respect to the period covered
by this annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the Registrant as
of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the Registrant and have:
a. designed such disclosure controls and procedures
to ensure that material information relating to
the Registrant, including its consolidated
subsidiaries, is made known to us by others within
those entities, particularly during the period in
which this report in being prepared;
b. evaluated the effectiveness of the Registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The Registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
Registrant's auditors and the audit committee of the
Registrant's Board of Directors:
a. all significant deficiencies in the design or
operation of internal controls which could
adversely affect the Registrant's ability to
record, process, summarize and report financial
data and have identified for the Registrant's
auditors any material weaknesses in internal
controls; and
b. any fraud, whether of not material, that involves
management or other employees who have a
significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have
indicated in this annual report whether there were
significant changes in internal controls or in other factors
that could significant affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies
and material weaknesses.
/s/ David W. Kloos
-----------------------------------
David W. Kloos
Senior Vice President and Chief
Financial Officer
(Principal Accounting and Financial
Officer)
March 14, 2003
61
CERTIFICATION
I, D. Mark Spencer, President and Co-Chief Executive Officer of Matrix Bancorp,
Inc. (the "Registrant"), certify that:
1. I have reviewed this annual report on Form 10-K of Matrix
Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in
light of the circumstances under which such statements were
made, not misleading as with respect to the period covered
by this annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the Registrant as
of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the Registrant and have:
a. designed such disclosure controls and procedures
to ensure that material information relating to
the Registrant, including its consolidated
subsidiaries, is made known to us by others within
those entities, particularly during the period in
which this report in being prepared;
b. evaluated the effectiveness of the Registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The Registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
Registrant's auditors and the audit committee of the
Registrant's Board of Directors:
a. all significant deficiencies in the design or
operation of internal controls which could
adversely affect the Registrant's ability to
record, process, summarize and report financial
data and have identified for the Registrant's
auditors any material weaknesses in internal
controls; and
b. any fraud, whether of not material, that involves
management or other employees who have a
significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have
indicated in this annual report whether there were
significant changes in internal controls or in other factors
that could significant affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies
and material weaknesses.
/s/ D. Mark Spencer
-------------------------------
D. Mark Spencer
President and Co-Chief
Executive Officer
(Principal Executive Officer)
March 14, 2003
62
CERTIFICATION
I, Richard V. Schmitz, Co-Chief Executive Officer of Matrix Bancorp, Inc. (the
"Registrant"), certify that:
1. I have reviewed this annual report on Form 10-K of Matrix
Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in
light of the circumstances under which such statements were
made, not misleading as with respect to the period covered
by this annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the Registrant as
of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the Registrant and have:
a. designed such disclosure controls and procedures
to ensure that material information relating to
the Registrant, including its consolidated
subsidiaries, is made known to us by others within
those entities, particularly during the period in
which this report in being prepared;
b. evaluated the effectiveness of the Registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The Registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
Registrant's auditors and the audit committee of the
Registrant's Board of Directors:
a. all significant deficiencies in the design or
operation of internal controls which could
adversely affect the Registrant's ability to
record, process, summarize and report financial
data and have identified for the Registrant's
auditors any material weaknesses in internal
controls; and
b. any fraud, whether of not material, that involves
management or other employees who have a
significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have
indicated in this annual report whether there were
significant changes in internal controls or in other factors
that could significant affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies
and material weaknesses.
/s/ Richard V. Schmitz
---------------------------------
Richard V. Schmitz
Co-Chief Executive Officer
March 14, 2003
63
INDEX TO EXHIBITS
3.1 > Amended and Restated Articles of Incorporation of the
Registrant
3.2 + Bylaws, as amended, of the Registrant (3.2)
4.1 ++ Indenture by and among the Registrant and First Trust
National Association, as trustee, relating to 11.50% Senior
Notes due 2004 (4.1)
4.2 ///// First Amendment to the Indenture, dated as of December 5,
2001, by and between the Registrant and U.S. Bank National
Association (the successor to First Trust National
Association), as trustee, relating to 11.50% Senior Notes
due 2004 (4.2)
4.3 + Specimen Certificate for Common Stock of the Registrant
(4.1)
4.4 + o Amended and Restated 1996 Stock Option Plan (4.2)
4.5 ***o Amendment No. 1 to the 1996 Amended and Restated Employee
Stock Option Plan of the Registrant (4.1)
4.6 ***o Amendment No. 2 to the 1996 Amended and Restated Employee
Stock Option Plan of the Registrant (4.2)
4.7 // o Employee Stock Purchase Plan, as amended (4.4)
4.8 ^ Indenture by and among the Registrant and State Street Bank
and Trust Company, as trustee, relating to the 10% Junior
Subordinated Debentures due 2029 (4.7)
4.9 ^ Form of Junior Subordinated Debentures (4.8)
4.10 ^ Certificate of Trust of Matrix Bancorp Capital Trust I (4.9)
4.11 ^ Amended and Restated Trust Agreement of Matrix Bancorp
Capital Trust I (4.10)
4.12 ^ Preferred Security Certificate for Matrix Bancorp Capital
Trust I (4.11)
4.13 ^ Preferred Securities Guarantee Agreement of the Company
relating to the Preferred Securities (4.12)
4.14 ^ Agreement as to the Expenses and Liabilities (4.13)
4.15 ^^ Amended and Restated Trust Agreement, dated May 11, 2001,
between Matrix Bancorp, Inc. and Matrix Bancorp, Inc., as
Trustee (4.2)
4.16 * Indenture between the Registrant and Wilmington Trust
Company, as debenture trustee, dated as of March 28, 2001,
relating to the 10.18% junior subordinated deferrable
interest debentures due June 8, 2031 (10.5)
4.17 * Amended and Restated Declaration of Trust of Matrix Bancorp
Capital Trust II, dated as of March 28, 2001 (10.6)
4.18 * Common Securities Guarantee Agreement of the Registrant,
dated as of March 28, 2001 (10.7)
4.19 * Capital Securities Guarantee Agreement of the Registrant,
dated as of March 28, 2001 (10.8)
4.20 ** Indenture between the Registrant and The Bank of New York,
as debenture trustee, dated as of July 16, 2001, relating to
the 10.25% junior subordinated deferrable interest
debentures due July 25, 2031 (10.3)
4.21 ** Amended and Restated Declaration of Trust of Matrix Bancorp
Capital Trust III, dated as of July 16, 2001 (10.4)
4.22 ** Common Securities Subscription Agreement of the Registrant,
dated as of July 16, 2001 (10.5)
4.23 ** Capital Securities Agreement of the Registrant, dated as of
June 28, 2001 (10.6)
4.24 ///// Indenture between the Registrant and Wilmington Trust
Company, as trustee, dated as of November 28, 2001, relating
to Floating Rate Junior Subordinated Debt Securities due
2031 (4.26)
4.25 ///// Amended and Restated Declaration of Trust of Matrix Bancorp
Capital Trust IV, dated as of November 28, 2001 (4.27)
4.26 ///// Guarantee Agreement of the Registrant, dated as of November
28, 2001 (4.28)
4.27 ****** Junior Indenture between the Registrant and The Bank of New
York, as trustee, dated as of July 25, 2002, relating to
Floating Rate Junior Subordinated Debt Securities, due July
25, 2032 (4.1)
4.28 ****** Amended and Restated Trust Agreement of Matrix Bancorp
Capital Trust V, dated as of July 25, 2002 (4.2)
4.29 ****** Guarantee Agreement of Matrix Bancorp Capital Trust V, dated
as of July 25, 2002 (4.3)
4.30 ++++ Rights Agreement dated as of November 4, 2002, between
Matrix Bancorp, Inc. and Computershare Trust Company, which
includes the form of Articles of Amendment to State Terms of
Series A Junior Participating Preferred Stock, $0.01 par
value, the form of Right Certificate and the Summary of
Rights (4.1)
II-1
4.31 ++++ Form of Articles of Amendment to State Terms of Series A
Junior Participating Preferred Stock (4.2)
10.1 + Assignment and Assumption Agreement, dated as of June 28,
1996, by and among Mariano C. DeCola, William M. Howdon, R.
James Nicholson and Matrix Funding Corp. (10.30)
10.2 > Amendment to Assignment and Assumption Agreement, dated as
of August 13, 2002, by and among Mariano C. DeCola, William
M. Howdon, R. James Nicholson and Matrix Funding Corp.
10.3 + Development Management Agreement, dated as of June 28, 1996,
by and among Fort Lupton, L.L.C. and Matrix Funding Corp.
(10.31)
10.4 /// Coyote Creek Planned Unit Development Agreement, dated as of
July 1, 1998, by and among Fort Lupton, L.L.C. and Matrix
Funding Corp. (10.12)
10.5 + Fort Lupton Golf Course Residential and Planned Unit
Development Agreement, dated as of November 28, 1995 (10.36)
10.6 ??? Credit Agreement, dated as of September 29, 2000, between
Matrix Financial Services Corporation, as borrower, and U.S.
Bank National Association, as agent, and certain lenders, as
lenders (10.2)
10.7 * First Amendment to Credit Agreement, dated as of March 5,
2001, by and between Matrix Financial Services Corporation,
as borrower, and U.S. Bank National Association, as agent,
and certain lenders, as lenders (10.1)
10.8 * Second Amendment to Credit Agreement, dated as of April 11,
2001, by and between Matrix Financial Services Corporation,
as borrower, and U.S. Bank National Association, as agent,
and certain lenders, as lenders (10.2)
10.9 ** Third Amendment to Credit Agreement, dated as of June 29,
2001, by and between Matrix Financial Services Corporation,
as borrower, and U.S. Bank National Association, as agent,
and certain lenders, as lenders (10.1)
10.10 *** Fourth Amendment to Credit Agreement, dated as of September
28, 2001, by and between Matrix Financial Services
Corporation, as borrower, and U.S. Bank National
Association, as agent, and certain lenders, as lenders
(10.1)
10.11 ///// Fifth Amendment to Credit Agreement, dated as of November
20, 2001, by and between Matrix Financial Services
Corporation, as borrower, and U.S. Bank National
Association, as agent, and certain lenders, as lenders
(10.11)
10.12 **** Sixth Amendment to Credit Agreement, dated as of March 31,
2002, by and between Matrix Financial Services Corporation,
as borrower, and U.S. Bank National Association, as agent,
and certain lenders, as lenders (10.1)
10.13 > Seventh Amendment to Credit Agreement, dated as of December
2, 2002, by and between Matrix Financial Services
Corporation, as borrower, and U.S. Bank National
Association, as agent, and certain lenders, as lenders
10.14 ??? Guaranty, dated as of September 29, 2000, from the
Registrant to U.S. Bank National Association, as agent
(10.3)
10.15 / o Employment Agreement, dated as of February 4, 1997, by and
between The Vintage Group, Inc. and Paul Skretny (10.38)
10.16 ++o Amendment of Employment Agreement (dated as of February 4,
1997) dated as of February 4, 2000, by and between The
Vintage Group, Inc. and Paul E. Skretny (10.32)
10.17 /////o Amendment of Employment Agreement (dated as of February 4,
1997) dated as of February 4, 2002, by and between The
Vintage Group, Inc. and Paul E. Skretny (10.15)
10.18 //// Credit Agreement, dated as of December 27, 2000, by and
between Registrant, as borrower, and U.S. Bank National
Association, as agent, and certain lenders, as lenders
(10.15)
10.19 * First Amendment to Credit Agreement, dated as of March 5,
2001, by and between Registrant, as borrower, and U.S. Bank
National Association, as agent, and certain lenders, as
lenders (10.3)
10.20 ** Second Amendment to Credit Agreement, dated as of July 27,
2001, by and between Registrant, as borrower, and U.S. Bank
National Association, as agent, and certain lenders, as
lenders (10.2)
10.21 ///// Third Amendment to Credit Agreement, dated as of December
26, 2001, by and between Registrant, as borrower, and U.S.
Bank National Association, as agent, and certain lenders, as
lenders (10.19)
10.22 **** Fourth Amendment to Credit Agreement, dated as of March 31,
2002, by and between Registrant, as borrower, and U.S. Bank
National Association, as agent, and certain lenders, as
lenders (10.2)
II-2
10.23 + Agreement and Plan of Merger, dated as of March 25, 1998,
among Fidelity National Financial, Inc., MCC Merger, Inc.
and Matrix Capital Corporation (99.2)
10.24 ? Merger Termination Agreement between Matrix Capital
Corporation, Fidelity National Financial, Inc., and MCC
Merger Sub, Inc., dated August 28, 1998 (10.1)
10.25 ??o Executive Employment Agreement, dated as of April 20, 2000,
by and between United Financial, Inc. and Carl G. de Rozario
(10.6)
10.26 //// Lease dated as of September 1, 1999, by and between Matrix
Financial Services Corporation and Suncor Development
Company (10.22)
10.27 //// Lease with a reference date of 1999, by and between the
Registrant and the Regents of the University of Colorado
(10.23)
10.28 ///// Lease dated as of December 21, 2001 by and between Matrix
Bancorp, Inc. and WXI/SEV Realty, LLC (10.1)
10.29 //// First Amendment to Lease, dated as of July, 2000, by and
between the Registrant and the Regents of the University of
Colorado, amending the Lease with a reference date of 1999
between the parties (10.24)
10.30 //// Second Amendment to Lease, dated as of October, 2000, by and
between the Registrant and the Regents of the University of
Colorado, amending the Lease with a reference date of 1999
between the parties (10.25)
10.31 ////o Matrix Bancorp, Inc. Executive Incentive Plan (10.27)
10.32 /////o Matrix Bancorp, Inc. (f/k/a Matrix Capital Corporation)
401(k) Profit Sharing Plan (10.29)
10.33 /////o Amendment No. 1, effective as of January 1, 1994, to the
Registrant's 401(k) Profit Sharing Plan (10.30)
10.34 /////o Amendment No. 2, effective as of May 20, 1996, to the
Registrant's 401(k) Profit Sharing Plan (10.31)
10.35 /////o Amendment No. 3, effective as of April 1, 1997, to the
Registrant's 401(k) Profit Sharing Plan (10.32)
10.36 /////o Amendment No. 4, effective as of December 30, 2001, to the
Registrant's 401(k) Profit Sharing Plan (10.33)
10.37 ***** Warehousing Credit and Security Agreement, dated as of March
29, 2002, by and between Matrix Capital Markets, Inc., as
borrower, and Residential Funding Corporation, as agent
(10.1)
10.38 ***** First Amendment to Warehousing Credit and Security
Agreement, dated as of May 24, 2002, by and between Matrix
Capital Markets, Inc., as borrower, and Residential Funding
Corporation, as agent (10.2)
10.39 +++o Consulting Agreement, dated as of June 5, 2002, by and
between Guy A. Gibson and Matrix Bancorp, Inc. (10.1)
10.40 /////o Promissory Note, dated as of January 31, 2002, from D. Mark
Spencer, as maker, to the Registrant, as payee (10.28)
10.41 ****o Employment Agreement of T. Allen McConnell, dated October 1,
1997 (10.3)
10.42 +++++ Purchase and Assumption Agreement, dated as of February 28,
2003, between Matrix Financial Services Corporation, as
seller, and AmPro Mortgage Corporation, as purchaser (10.1)
12 > Statement Re: Computations of Ratios
21 > Subsidiaries of the Registrant
23.1 > Consent of KPMG LLP
99.1 > Certification by D. Mark Spencer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 > Certification by Richard V. Schmitz pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.3 > Certification by David W. Kloos pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
II-3
__________
> Filed herewith
+ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's registration statement on Form S-1 (No. 333-10223), filed
by the Registrant with the Commission on August 15, 1996.
++ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's registration statement on Form S-1 (No. 333-34977), filed
by the Registrant with the Commission on September 4, 1997.
/ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's annual report on Form 10-K for the fiscal year ended
December 31, 1996, filed by the Registrant with the Commission.
// Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's annual report on Form 10-K for the fiscal year ended
December 31, 1997, filed by the Registrant with the Commission.
/// Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's annual report on Form 10-K for the fiscal year ended
December 31, 1998, filed by the Registrant with the Commission.
////Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's annual report on Form 10-K for the fiscal year ended
December 31, 2000, filed by the Registrant with the Commission.
///// Incorporated by reference from the exhibit number shown in parenthesis
from the Registrant's annual report on Form 10-K for the fiscal year ended
December 31, 2001, filed by the Registrant with the Commission.
+ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's report on Form 8-K, filed by the Registrant with the
Commission on April 8, 1998.
++ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's report on Form 8-K filed by the Registrant with the
Commission on June 30, 2000.
+++ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's report on Form 8-K filed by the Registrant with the
Commission on June 6, 2002.
++++Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's report on Form 8-K filed by the Registrant with the
Commission on November 6, 2002.
+++++ Incorporated by reference from the exhibit number shown in parenthesis
from the Registrant's report on Form 8-K filed by the Registrant with the
Commission on March 4, 2003.
? Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's quarterly report on Form 10-Q for the quarter ended
September 30, 1998, filed by the Registrant with the Commission.
?? Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's quarterly report on Form 10-Q for the quarter ended June
30, 2000, filed by the Registrant with the Commission.
??? Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's quarterly report on Form 10-Q for the quarter ended
September 30, 2000, filed by the Registrant with the Commission.
* Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's quarterly report on Form 10-Q for the quarter ended March
31, 2001, filed by the Registrant with the Commission.
** Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's quarterly report on Form 10-Q for the quarter ended June
30, 2001, filed by the Registrant with the Commission.
*** Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's quarterly report on Form 10-Q for the quarter ended
September 30, 2001, filed by the Registrant with the Commission.
****Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's quarterly report on Form 10-Q for the quarter ended March
31, 2002, filed by the Registrant with the Commission.
II-4
***** Incorporated by reference from the exhibit number shown in parenthesis
from the Registrant's quarterly report on Form 10-Q for the quarter ended
June 30, 2002, filed by the Registrant with the Commission.
****** Incorporated by reference from the exhibit number shown in parenthesis
from the Registrant's quarterly report on Form 10-Q for the quarter ended
September 30, 2002, filed by the Registrant with the Commission.
^ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's registration statement on Form S-1 (No. 333-79731), filed
by the Registrant with the Commission on June 1, 1999.
^^ Incorporated by reference from the exhibit number shown in parenthesis from
the Registrant's registration statement on Form S-8 (No. 333-75000), filed
by the Registrant with the Commission on December 12, 2001.
o Management contract or compensatory plan or arrangement.
II-5
INDEX TO FINANCIAL STATEMENTS
Consolidated Financial Statements of Matrix Bancorp, Inc. and Subsidiaries
Independent Auditors' Report, December 31, 2002 and 2001..............................................F-2
Report of Independent Auditors, December 31, 2000.....................................................F-3
Consolidated Balance Sheets--December 31, 2002 and 2001...............................................F-4
Consolidated Statements of Operations--for the years ended
December 31, 2002, 2001 and 2000......................................................................F-5
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
for the years ended December 31, 2002, 2001 and 2000..................................................F-7
Consolidated Statements of Cash Flows--for the years ended
December 31, 2002, 2001 and 2000......................................................................F-8
Notes to Consolidated Financial Statements............................................................F-10
F-1
Independent Auditors' Report
The Board of Directors and Shareholders of Matrix Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Matrix Bancorp,
Inc. and subsidiaries (the Company) as of December 31, 2002 and 2001, and the
related consolidated statements of operations, shareholders' equity and
comprehensive income (loss), and cash flows for each of the years in the
two-year period ended December 31, 2002. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Matrix Bancorp, Inc.
and subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, in 2001 the
Company changed its method of accounting for derivative instruments and hedging
activities and in 2002 changed its method of accounting for goodwill and other
intangible assets.
KPMG LLP
Denver, Colorado
February 10, 2003
F-2
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders of Matrix Bancorp, Inc.
We have audited the accompanying consolidated statements of income,
shareholders' equity, and cash flows of Matrix Bancorp, Inc. and subsidiaries
(the Company) for the year ended December 31, 2000. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations of
Matrix Bancorp, Inc. and subsidiaries and their cash flows for the year ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
Ernst & Young LLP
Phoenix, Arizona
February 23, 2001
F-3
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)
December 31,
2002 2001
------------------------------------
Assets
Cash and cash equivalents $ 58,725 $ 52,506
Interest-earning deposits and federal funds sold 3,687 31,959
Securities available for sale 29,073 6,963
Loans held for sale, net 1,107,926 1,149,539
Loans held for investment, net 285,891 191,161
Mortgage servicing rights, net 63,200 78,712
Other receivables 54,811 76,894
Federal Home Loan Bank stock, at cost 30,379 18,181
Foreclosed real estate 8,343 8,355
Premises and equipment, net 27,705 13,631
Other assets, net 31,857 19,039
------------------------------------
Total assets $ 1,701,597 $ 1,646,940
====================================
Liabilities and shareholders' equity
Liabilities:
Deposits $ 933,957 $ 866,235
Custodial escrow balances 151,790 129,665
Draft Payable 7,097 28,875
Payable for purchase of mortgage servicing rights 782 4,738
Federal Home Loan Bank borrowings 385,785 303,361
Borrowed money 61,403 162,532
Guaranteed preferred beneficial interests 64,500 59,500
Other liabilities 22,575 8,501
Income taxes payable and deferred income tax liability 6,772 12,221
------------------------------------
Total liabilities 1,634,661 1,575,628
------------------------------------
Commitments and contingencies (Note 15)
Shareholders' equity:
Preferred stock, par value $.0001; authorized
5,000,000 shares; no shares outstanding - -
Common stock, par value $.0001; authorized 50,000,000 shares;
issued and outstanding 6,489,543 and 6,518,604 shares at
December 31, 2002 and 2001, respectively 1 1
Additional paid-in capital 20,375 20,800
Retained earnings 46,534 50,486
Accumulated other comprehensive income 26 25
------------------------------------
Total shareholders' equity 66,936 71,312
------------------------------------
Total liabilities and shareholders' equity $ 1,701,597 $ 1,646,940
====================================
See accompanying notes to consolidated financial statements.
F-4
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except share information)
Years Ended December 31,
2002 2001 2000
------------------------------------------------------
Interest income:
Loans and securities $ 89,205 $ 103,393 $ 93,965
Interest-earning deposits 1,272 2,004 3,421
------------------------------------------------------
Total interest income 90,477 105,397 97,386
Interest expense:
Savings and time deposits 17,242 29,652 22,603
Demand and money market deposits 4,254 5,220 3,672
Federal Home Loan Bank borrowings 9,478 16,071 27,242
Borrowed money and guaranteed preferred
beneficial interests 10,304 13,944 14,084
------------------------------------------------------
Total interest expense 41,278 64,887 67,601
------------------------------------------------------
Net interest income before provision for loan and
valuation losses 49,199 40,510 29,785
Provision for loan and valuation losses 2,821 2,980 4,235
------------------------------------------------------
Net interest income after provision for loan and
valuation losses 46,378 37,530 25,550
Noninterest income:
Loan administration 32,243 30,113 23,850
Brokerage 8,105 4,815 8,119
Trust services 5,345 4,036 4,923
Real estate disposition services 4,153 2,572 3,677
Gain on sale of loans and securities 521 1,475 982
Gain on sale of mortgage servicing rights, net 675 167 2,634
Loan origination 35,829 35,293 7,587
School services 4,616 5,427 4,240
Other 5,923 7,618 2,780
------------------------------------------------------
Total noninterest income 97,410 91,516 58,792
Noninterest expense:
Compensation and employee benefits 59,484 52,573 34,245
Amortization of mortgage servicing rights 24,176 21,862 9,851
Occupancy and equipment 7,862 6,525 4,785
Postage and communication 4,580 4,063 2,812
Professional fees 3,175 2,883 4,687
Data processing 3,140 2,907 2,413
Impairment on mortgage servicing rights 14,219 181 -
Other general and administrative 35,421 24,905 19,048
------------------------------------------------------
Total noninterest expense 152,057 115,899 77,841
------------------------------------------------------
(Loss) income before income taxes (8,269) 13,147 6,501
Income tax (benefit) expense (4,317) 4,275 2,243
------------------------------------------------------
F-5
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Operations (continued)
(Dollars in thousands, except share information)
Years Ended December 31,
2002 2001 2000
-----------------------------------------------------
(Loss) income before cumulative effect of a
change in accounting principle (3,952) 8,872 4,258
Less cumulative effect of a change in accounting
principle, net of tax benefit of $190 - 360 -
======================================================
Net (loss) income $ (3,952) $ 8,512 $ 4,258
======================================================
Basic net (loss) income per share before change in
accounting principle $ (0.61) $ 1.36 $ 0.63
Less cumulative effect of a change in accounting
principle - 0.05 -
------------------------------------------------------
Net (loss) income per share-basic $ (0.61) $ 1.31 $ 0.63
======================================================
Net (loss) income per share assuming dilution before
change in accounting principle (0.61) 1.35 0.63
Less cumulative effect of a change in accounting
principle - 0.05 -
------------------------------------------------------
Net (loss) income per share - assuming dilution $ (0.61) $ 1.30 $ 0.63
======================================================
Weighted average shares - basic 6,462,272 6,495,583 6,713,251
======================================================
Weighted average shares - assuming dilution 6,462,272 6,560,454 6,748,857
======================================================
See accompanying notes to consolidated financial statements.
F-6
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
(Dollars in thousands)
Accumulated
Additional Other
Common Stock Paid-In Treasury Retained Comprehensive Comprehensive
---------------------
Shares Amount Capital Shares Earnings Income Total Income (loss)
-----------------------------------------------------------------------------------------------
Balance at December 31, 1999 6,759,241 $ 1 $ 22,780 $ - $ 37,716 $ - $ 60,497
Shares repurchased (237,000) - - (1,775) - - (1,775)
Issuance of stock related to
employee stock purchase
plan and options 36,663 - 224 - - - 224
Comprehensive income:
Net income - - - - 4,258 - 4,258 $ 4,258
Net unrealized holding gains - - - - 819 819 819
--------------
Comprehensive income $ 5,077
---------------------------------------------------------------------------------==============
Balance at December 31, 2000 6,558,904 1 23,004 (1,775) 41,974 819 64,023
-----------------------------------------------------------------------------------------------
Shares repurchased (86,500) - (746) - - - (746)
Shares retired (323,500 shares) - - (1,775) 1,775 - - -
Issuance of stock related to
employee stock purchase
plan and options 46,200 - 317 - - - 317
Comprehensive income:
Net income - - - - 8,512 - 8,512 $ 8,512
Net unrealized holding losses - - - - - (794) (794) (794)
--------------
Comprehensive income $ 7,718
---------------------------------------------------------------------------------==============
Balance at December 31, 2001 6,518,604 $ 1 $ 20,800 - $ 50,486 $ 25 $ 71,312
-----------------------------------------------------------------------------------------------
Shares repurchased (66,060) - - (726) - - (726)
Shares retired (389,560 shares) - - (726) 726 - - -
Issuance of stock related to
employee stock purchase 36,999 - 301 - - - 301
plan and options
Comprehensive (loss):
Net loss - - - - (3,952) - (3,952) $ (3,952)
Net unrealized holding gains(1) - - - - - 1
--------------
Comprehensive (loss) 1 1 $ (3,951)
---------------------------------------------------------------------------------==============
Balance at December 31, 2002 6,489,543 $ 1 $ 20,375 $ - $ 46,534 $ 26 $ 66,936
===============================================================================================
(1) Disclosure of reclassification amount
Unrealized holding gain arising during the year ended
December 31, 2002 $ 1
Less: reclassification adjustment of gains included in net income
(loss) -
-------------
Net unrealized holding gain on securities $ 1
=============
See accompanying notes to consolidated financial statements.
F-7
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
Years Ended December 31,
2002 2001 2000
------------------------------------------------
Operating activities
Net (loss) income $ (3,952) $ 8,512 $ 4,258
Adjustments to reconcile net (loss) income to
net cash used in operating activities:
Depreciation and amortization 4,756 3,116 2,583
Provision for loan and valuation losses 2,821 2,980 4,235
Amortization of mortgage servicing rights 24,176 21,862 9,851
Impairment of mortgage servicing rights 14,219 181 -
Unrealized gain on securities - - 819
Gain on sale of loans and securities (521) (1,475) (982)
Gain on sale of mortgage servicing rights (675) (167) (2,634)
Gain on sale of building and equipment 17 (3,425) (1,159)
Gain on sale of foreclosed real estate (284) (16) 14
Changes in assets and liabilities:
Loans originated for sale, net of loans sold 28,194 (377,628) (130,895)
Loans purchased for sale (1,127,632) (97,486) (204,922)
Proceeds from sale of loans purchased for sale 791,732 76,074 108,466
(Increase) decrease in securities available for sale (22,110) 59,586 -
Originated mortgage servicing rights, net (34,511) (30,266) (16)
Decrease (increase) in other receivables and other
assets 10,608 (19,844) (11,698)
(Decrease) increase in payable for purchase of mortgage
servicing rights (3,956) (7,791) 9,503
Increase in other liabilities, income tax payable and
deferred income taxes liability 8,625 3,672 3,142
------------------------------------------------
Net cash used in operating activities (308,493) (362,115) (209,435)
Investing activities
Loans originated and purchased for investment (253,672) (159,619) (202,300)
Principal repayments on loans 476,174 345,031 353,713
(Purchase) redemption of Federal Home Loan Bank stock
(12,198) 9,633 (5,400)
Purchases of premises and equipment (17,614) (14,415) (7,089)
Hedging of servicing portfolio, net - - 95
Acquisition of mortgage servicing rights - (530) (31,883)
Proceeds from the sale of building and equipment 45 14,601 3,664
Proceeds from sale of foreclosed real estate 8,306 1,521 2,458
Proceeds from sale of mortgage servicing rights 9,682 1,600 3,537
------------------------------------------------
Net cash provided by investing activities 210,723 197,822 116,795
F-8
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
(Dollars in thousands)
Years Ended December 31,
2002 2001 2000
-------------------------------------------------
Financing activities
Net increase in deposits $ 67,722 $ 263,566 $ 40,475
Net increase (decrease) in custodial escrow balances 22,125 52,018 (16,559)
(Decrease) increase in revolving lines and repurchase
agreements, net (18,663) (138,946) 125,743
Payments of notes payable (1,981) (13,298) (31,169)
Proceeds from notes payable 2,000 1,786 2,325
Payment of financing arrangements (61) (86) (63)
Proceeds from issuance of guaranteed preferred beneficial
interests 5,000 30,977 -
Treasury shares repurchased (726) (746) (1,775)
Proceeds from issuance of common stock related to
employee stock purchase plan and options 301 317 224
-------------------------------------------------
Net cash provided by financing activities 75,717 195,588 119,201
-------------------------------------------------
(Decrease) increase in cash and cash equivalents (22,053) 31,295 26,561
Cash and cash equivalents at beginning of the year 84,465 53,170 26,609
-------------------------------------------------
Cash and cash equivalents at end of the year $ 62,412 $ 84,465 $ 53,170
=================================================
Supplemental disclosure of noncash activity
Loans transferred to foreclosed real estate $ 8,010 $ 7,214 $ 4,318
=================================================
Supplemental disclosure of cash flow information
Cash paid for interest $ 45,050 $ 62,520 $ 68,298
=================================================
Cash (received) paid for income taxes $ (4,074) $ 4,557 $ 1,592
=================================================
See accompanying notes to consolidated financial statements.
F-9
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Organization
Matrix Bancorp, Inc. (the Company) is a unitary thrift holding company that,
through its subsidiaries, is a diversified financial services company
headquartered in Denver, Colorado. The Company's operations are conducted
primarily through Matrix Capital Bank (Matrix Bank), Matrix Financial Services
Corporation (Matrix Financial), Matrix Capital Markets, Inc. (Matrix Capital),
Matrix Asset Management Corporation (Matrix Asset Management), ABS School
Services, L.L.C. (ABS), Sterling Trust Company (Sterling) and First Matrix
Investment Services Corp. (First Matrix), all of which are wholly owned
subsidiaries of the Company.
Matrix Bank, a federally chartered savings and loan association, serves its
local communities of Las Cruces, New Mexico, and Phoenix, Arizona, by providing
personal and business depository services, offering residential loans and
providing, on a limited basis, commercial real estate, multi-family and consumer
loans. During 2002, Matrix Bank completed the relocation of its domicile from
Las Cruces to Denver, Colorado and now offers all existing banking services in
the Denver market.
The Company's mortgage banking business is primarily conducted through Matrix
Financial, and was established with the primary objective of originating,
acquiring and servicing residential mortgage loans. Matrix Financial originates
residential loans primarily through its wholesale loan origination offices in
Atlanta, Dallas, Denver, Houston, Jacksonville, Phoenix, Santa Ana and St.
Louis. Servicing mortgage loans involves the contractual right to receive a fee
for processing and administering mortgage loan payments.
Matrix Capital Markets provides brokerage and consulting services to financial
institutions and financial services companies in the mortgage banking industry,
primarily related to the brokerage and analysis of residential mortgage loan
servicing rights and residential mortgage loans, corporate and mortgage loan
servicing portfolio valuations and, to a lesser extent, consultation and
brokerage services in connection with mergers and acquisitions of mortgage
banking entities.
Matrix Asset Management provides real estate management and disposition services
on foreclosed properties owned by financial service companies and financial
institutions.
ABS provides outsourced business services and financing primarily to charter
schools.
Sterling is a non-bank trust company specializing in the administration of
self-directed individual retirement accounts, qualified business retirement
plans and personal custodial accounts, as well as corporate escrow and paying
agent services.
First Matrix is registered with the National Association of Securities Dealers
as a fully disclosed broker-dealer. First Matrix is headquartered in Denver,
Colorado and has branch offices in Fort Worth, Texas and Memphis, Tennessee.
First Matrix offers a wide range of investment options for both individual and
institutional investors, long term investing and retirement planning, and the
acquisition, brokering and sale of Small Business Administration (SBA) loan
pools.
F-10
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The accounting and reporting policies of the Company and its subsidiaries
conform to accounting principles generally accepted in the United States of
America. The following is a description of the more significant policies that
the Company follows in preparing and presenting its consolidated financial
statements.
2. Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. Inter-company accounts and
transactions have been eliminated in consolidation.
Critical Accounting Policies and Estimates
The Company and its subsidiaries have established various accounting policies
which govern the application of accounting principles generally accepted in the
United States of America in the preparation and presentation of the Company's
consolidated financial statements. Certain accounting policies involve
significant judgments, assumptions and estimates by management that have a
material impact on the carrying value of certain assets and liabilities, which
management considers to be critical accounting policies. The judgments,
assumptions and estimates used by management are based on historical experience,
knowledge of the accounts and other factors, which are believed to be reasonable
under the circumstances. Because of the nature of the judgments and assumptions
made by management, actual results could differ from these judgments and
estimates, which could have a material impact on the carrying values of assets
and liabilities and the results of operations of the Company.
The Company believes the allowance for loan and valuation losses is a critical
accounting policy that requires the most significant judgments, assumptions and
estimates used in preparation of its consolidated financial statements. See
further detail in this Note for a detailed description of the Company's process
and methodology related to the allowance for loan and valuation losses. The
Company also considers the valuation of mortgage servicing rights to be a
critical accounting policy that requires judgments, assumptions and estimates
concerning impairment of their value in certain interest rate environments. See
further detail in this Note for a detailed discussion concerning the use of
estimates in the valuation of mortgage servicing rights. The Company also
considers the judgments and assumptions concerning litigation as a critical
accounting policy. The Company has been notified that we are a defendant in a
number of legal proceedings, as discussed in detail in Note 15. Most of these
cases involve ordinary and routine claims incidental to our business. Based on
management's analysis, no accrual for loss has been made as of December 31, 2002
for any such cases. With respect to all pending litigation matters, our ultimate
legal responsibility, if any, cannot be estimated with certainty. Based on the
F-11
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
ultimate outcome of such proceedings, it is possible that future results of
operations for any particular quarterly or annual period could be materially
affected by changes in our assumptions related to such proceedings.
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts of
assets and liabilities at the date of the consolidated financial statements, and
disclosures of contingent assets and liabilities and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from these estimates. See discussion above regarding estimates used in critical
accounting policy areas.
Certain reclassifications have been made to prior periods' consolidated
financial statements and related notes to conform with current year
presentation.
Derivative Instruments and Hedging Activities
The Company, through its subsidiary Matrix Financial, enters into derivative
transactions principally to protect against the risk of adverse price or
interest rate movements on the value of certain assets and liabilities. The
Company is also required to recognize certain contracts and commitments as
derivatives when the characteristics of those contracts and commitments meet the
definition of a derivative.
Under the guidelines of Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Certain Hedging Activities", as
amended, all derivative instruments are required to be carried at fair value on
the balance sheet. The Company adopted SFAS 133 on January 1, 2001. The adoption
of SFAS 133 resulted in a pre-tax transition loss of $550,000, or $360,000 after
tax which was recorded as a cumulative effect of a change in accounting
principle for the year ended December 31, 2001. SFAS 133 provides special hedge
accounting provisions, which permit the change in the fair value of the hedged
item related to the risk being hedged to be recognized in earnings in the same
period and in the same income statement line as the change in fair value of the
derivative.
Derivative instruments designated in a hedge relationship to mitigate exposure
to changes in the fair value of an asset, liability, or firm commitment
attributable to a particular risk, such as interest rate risk, are considered
fair value hedges under SFAS 133. Fair value hedges are accounted for by
recording the fair value of the derivative instrument and the fair value related
to the risk being hedged of the hedged asset or liability on the consolidated
balance sheets with corresponding offsets recorded in the consolidated
statements of operations. The adjustment to the hedged asset or liability is
included in the basis of the hedged item, while the fair value of the derivative
is recorded as a freestanding asset or liability. Actual cash receipts or
payments and related amounts accrued during the period on derivatives included
in a fair value hedge relationship are recorded as adjustments to loan
origination income recorded on the hedged asset or liability.
F-12
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Under fair value hedges, derivative gains and losses not effective in hedging
the change in fair value are recognized immediately in the consolidated
statements of operations. At the hedge's inception and at least quarterly
thereafter, a formal assessment is performed to determine whether changes in the
fair values of the derivative instruments have been highly effective in
offsetting changes in the fair values of the hedged items and whether they are
expected to be highly effective in the future.
The Company discontinues hedge accounting prospectively when it is determined
that the derivative is no longer effective in offsetting changes in the fair
value of the hedged item, the derivative expires or is sold, terminated, or
exercised, the derivative is dedesignated as a hedging instrument, because it is
unlikely that a forecasted transaction will occur, a hedged firm commitment no
longer meets the definition of a firm commitment, or management determines that
designation of the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair-value hedge, the Company
continues to carry the derivative on the consolidated balance sheets at its fair
value, and no longer adjusts the hedged asset or liability for changes in fair
value. The adjustment of the carrying amount of the hedged asset or liability is
accounted for in the same manner as other components of the carrying amount of
that asset or liability. When hedge accounting is discontinued because the
hedged item no longer meets the definition of a firm commitment, the Company
continues to carry the derivative on the consolidated balance sheets at its fair
value, removes any asset or liability that was recorded pursuant to recognition
of the firm commitment from the consolidated balance sheets and recognizes any
gain or loss in earnings. In all other situations in which hedge accounting is
discontinued, the Company continues to carry the derivative at its fair value on
the consolidated balance sheets, and recognizes any changes in its fair value in
operations.
SFAS 133 requires the Company to record its best effort and mandatory
commitments associated with its mortgage loan origination activities on the
consolidated balance sheets. In order to hedge against the changes in the fair
value of mortgage loans, the Company enters into best effort and mandatory
commitments to deliver mortgage loans, which locks the price at which the loan
will be sold into the secondary market. These derivatives are recorded on the
consolidated balance sheets and qualify for hedge accounting, as the commitments
are highly effective in offsetting changes in fair values of the hedged items.
The ineffective portion of a hedge, which typically represents the amount by
which the derivatives exceed or is less than the hedged items, is reported in
the consolidated statements of operations.
Securities Available for Sale
Securities available for sale include mortgage-backed securities and SBA
securities. Securities available for sale are carried at estimated fair values
with the net unrealized gains or losses reported in accumulated other
comprehensive income, which is included as a separate component in shareholders'
equity. The Company records its securities portfolio at estimated fair value at
F-13
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
the end of each quarter based on public market quotes. At disposition, the
realized gain or loss is included in operations on a specific identification
basis.
Loans Held for Sale
Loans originated or purchased with the intent for sale in the secondary market
are carried at the lower of aggregate cost, net of discounts or premiums and a
valuation allowance, or estimated fair market value. Estimated fair market value
is determined using forward commitments to sell loans or mortgage-backed
securities to permanent investors, or current market rates for loans of similar
quality and type. Net unrealized losses, if any, are recognized in a valuation
allowance by charges to operations. SFAS No. 91, "Accounting for Nonrefundable
Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases," requires discounts or premiums on loans held for sale be
deferred until the related loan is sold. However, the Company accretes discounts
and amortizes premiums related to repayment of loan principal, which is included
in interest income. The loans are primarily secured by 1- to 4-family
residential real estate located throughout the United States.
Loans are considered sold when the Company surrenders control over the
transferred assets to the purchaser, with standard representations and
warranties. At such time, the loan is removed from the loan portfolio and a gain
or loss is recorded on the sale. Gains and losses on loan sales are determined
based on the difference between the allocated cost basis of the assets sold and
the proceeds, which includes the estimated fair value of any assets or
liabilities that are newly created as a result of the transaction. Losses
related to recourse provisions are accrued as a liability at the time such
additional losses are determined, and recorded as part of noninterest expense.
Losses related to asset quality are recorded against the allowance for loan and
valuation losses at the time the loss is probable and quantifiable.
Loans Held for Investment
Loans held for investment are stated at unpaid principal balances, net of
unearned discounts and premiums, deferred loan fees, and allowance for loan
losses. The loans are residential mortgage loans, commercial loans,
multi-family, SBA loans and school financing loans, and are primarily secured by
real estate.
Allowance for Loan Losses
The allowance for loan losses is calculated, in part, based on historical loss
experience. In addition, management takes into consideration other factors such
as the size and current risk characteristics of the loan portfolio, any
qualitative evaluations of individual classified assets, geographic portfolio
concentrations, new products or markets, regulatory guidance, evaluations of the
changes in the historical loss experience component, and projections of this
component into the current and future periods based on current knowledge and
conditions. The loss factors are applied to the outstanding principal balance of
loans in their respective categories, plus additional loan review is performed
F-14
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
on all significant commercial and school finance loans. After an allowance has
been established for the loan portfolio, from the factors described above,
management evaluates other factors such as trends in loans in foreclosure, loans
in bankruptcy and other relevant factors, and establishes a valuation allowance
that cannot be associated with a specific loan or loan portfolio. The Company
evaluates its residential loans collectively due to their homogeneous nature.
These factors include general economic conditions, recognition of specific
regional geographic concerns, loan type and trends in portfolio growth. Loan
losses are charged against the allowance when the probability of collection is
considered remote. In the opinion of management, the allowance is adequate to
absorb the inherent losses in the current loan portfolio.
The Company considers a loan impaired when, based on current information and
events, it is probable that it will be unable to collect all amounts due
according to the contractual terms of the loan and the recorded investment in
the loan exceeds its fair value. Estimated fair value is measured using either
the present value of expected future cash flows discounted using loan rate,
market price of the loan or fair value of the collateral, if collateral
dependent. All loans considered impaired are included in nonperforming loans.
The Company evaluates its residential loans collectively due to their
homogeneous nature. Accordingly, potential impaired loans of the Company include
only commercial loans, real estate construction loans, commercial real estate
mortgage loans, larger multi-family loans and school financing loans classified
as nonperforming loans. Impairment allowances are considered by the Company in
determining the overall adequacy of the allowance for loan losses.
Loans are placed on nonaccrual status when full payment of principal or interest
is in doubt, or generally when they are past due 90 days as to either principal
or interest, unless the interest is guaranteed by a creditworthy entity through
recourse provisions. Previously accrued but unpaid interest is reversed and
charged against interest income, if not collectible, and future accruals are
discontinued. Interest payments received on nonaccrual loans are recorded as
interest income unless there is doubt as to the collectibility of the recorded
investment. In those cases, cash received is recorded as a reduction in
principal.
Mortgage Servicing Rights
The Company recognizes mortgage servicing rights (MSRs) as an asset separate
from the underlying originated mortgage loan at the time of sale. Upon sale of a
loan, the Company measures retained MSRs by allocating the previous carrying
amount of the originated mortgage loan between the loan and the servicing right
based on their relative estimated fair values. Purchased MSRs are initially
measured at cost. MSRs are carried at the lower of cost (allocated cost for
originated MSRs), less accumulated amortization, or estimated fair value. MSRs
are amortized in proportion to and over the period of the estimated future net
servicing income.
F-15
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The estimated fair value of MSRs is determined based on the discounted future
servicing income stratified based on one or more predominant risk
characteristics of the underlying loans. The Company stratifies its MSRs by
product type, interest rate and investor to reflect the predominant risk
characteristics. To determine the estimated fair value of MSRs, the Company uses
a valuation model that calculates the present value of future cash flows. In
using this valuation model, the Company incorporates assumptions that market
participants would use in estimating future net servicing income, which includes
estimates of the cost of servicing per loan, including incremental interest cost
of servicer advances, foreclosure expenses and losses, the discount rate, float
value, an inflation rate, ancillary income per loan, prepayment speeds and
default rates. For purposes of performing an impairment analysis on MSRs, the
Company estimates fair value using the following primary assumptions: prepayment
speeds ranging from 180 PSA (Public Securities Association prepayment speed
measurement) to 1,033 PSA; discount rates ranging from 9.00% to 21.50%; and
default rates ranging from 0% to 100%. The Company records a valuation allowance
where the estimated fair value is below the carrying amount of individual
stratifications, even though the overall fair value of the servicing assets may
exceed amortized cost. As of December 31, 2002 and 2001, a valuation allowance
of $14,400,000 and $181,000, respectively, was required, and the fair value of
the aggregate MSRs was approximately $63,200,000 and $81,900,000, respectively.
Gain on sale of MSRs is recorded when title to MSRs and the risks and rewards
inherent in owning the MSRs have been transferred to the buyer.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated lives
of the assets, which range from 2 to 7 years for software, office furniture and
equipment and 30 years for buildings.
Foreclosed Real Estate
Residential or commercial real estate acquired through foreclosure, deed in lieu
of foreclosure or in judgment is carried at the lower of estimated fair value,
less estimated costs to sell, or the related loan balance at the date of
foreclosure. Valuations are periodically performed by management and an
allowance for loss is established by a charge to operations if the carrying
value of a property exceeds its estimated fair value, less estimated costs to
sell.
Income Taxes
The Company and its subsidiaries file consolidated federal and state income tax
returns. The subsidiaries are charged for the taxes applicable to their profits
calculated on the basis of filing separate income tax returns. Matrix Bank
qualifies as a savings and loan association for income tax purposes.
F-16
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The Company uses the asset and liability method in accounting for income taxes.
Under this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax basis of assets and liabilities,
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
Loan Administration Income
Loan administration income represents service fees and other income earned from
servicing loans for various investors, as well as gains from the sale of loans
bought out of our Ginnie Mae servicing portfolio and subsequently sold. Loan
administration income includes service fees that are based on a contractual
percentage of the outstanding principal balance plus late fees and other
ancillary charges. Service fees on loans and all other income is recognized when
the related payments are received.
Brokerage Income
Brokerage income represents fees earned related to third party servicing
brokerage and consulting services performed pertaining to mortgage servicing
rights, as well as brokerage income from whole loan activities, retail and fixed
income activities and SBA trading fees. Brokerage income is recognized when
services are performed.
Trust Services Income
Trust services income represents fees earned related to services provided for
self-directed individual retirement accounts, qualified benefit plans and escrow
arrangements. Trust services income is recognized over the contract period in
proportion to when the services are performed.
Real Estate Disposition Services Income
Real estate disposition services income represents fees earned related to real
estate management and disposition services provided to others. Real estate
disposition services income is recognized when services are performed.
Loan Origination Income
Loan origination income for loans originated for sale, which includes all
mortgage origination fees, secondary marketing activity including
servicing-released premiums and capitalized servicing on mortgage loans sold,
servicing retained, net of outside origination costs, is recognized as income at
the time the loan is sold and funded by the investor.
Loan origination income for loans originated for investment, which includes
mortgage origination fees and certain direct costs associated with loan
originations, is deferred and amortized as a yield adjustment over the
contractual life of the related loan using the interest method, adjusted for
estimated prepayments.
F-17
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
School Services Income
School services income represents fees earned related to outsourced business and
consulting services provided to schools. School services income is recognized
when services are performed.
Stock-Based Compensation
See discussion of SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure," under this Note, Impact of Recently
Issued Accounting Standards.
At December 31, 2002, the Company has one stock-based employee compensation
plan, which is described more fully in Note 14. We apply the intrinsic
value-based method of accounting prescribed by Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Under this
method, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. SFAS
123, "Accounting for Stock-Based Compensation" established accounting and
disclosure requirements using a fair value-based method of accounting for
stock-based employee compensation plan. As allowed by SFAS 123, we have elected
to continue to apply the intrinsic value-based method of accounting described
above, and have adopted the disclosure requirements of SFAS 123. Accordingly, we
do not recognize compensation expense for our stock-based plan, as we do not
issue options at exercise prices below the market value at the date of the
grant. Had compensation cost for our stock-based plans been determined
consistent with SFAS No. 123, our net (loss) income and (loss) income per share
would have been reduced to the pro forma amounts indicated below:
Year ended December 31,
2002 2001 2000
------------------------------------------------------
(Dollars in thousands except per share data)
Net (loss) income:
As reported $ (3,952) $ 8,512 $ 4,258
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for awards, net of related tax effects (358) (307) (278)
------------------------------------------------------
Pro forma $ (4,310) $ 8,205 $ 3,980
======================================================
(Loss) Income per share:
Basic, as reported $ (0.61) $ 1.31 $ 0.63
======================================================
Basic, pro forma $ (0.67) $ 1.26 $ 0.59
======================================================
Diluted, as reported $ (0.61) $ 1.30 $ 0.63
======================================================
Diluted, pro forma $ (0.67) $ 1.25 $ 0.59
======================================================
F-18
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Cash and Cash Equivalents
Cash equivalents, for purposes of the consolidated statements of cash flows,
consist of nonrestricted cash, federal funds sold and interest-earning deposits
with banks with original maturities, when purchased, of three months or less.
Net (Loss) Income Per Common Share
Basic (loss) income per common share (EPS) is computed by dividing net (loss)
income by the weighted average number of common shares outstanding for the
period. Net income per common share assuming dilution is computed by dividing
net income by the weighted average number of common shares outstanding for the
year and the effect of potentially dilutive securities such as stock options and
warrants outstanding for the year. Due to the net loss in 2002, the potentially
dilutive securities have not been used in the calculation of diluted loss per
share for the year ended December 31, 2002.
Restructuring Charges and Gain on Sale of Building
During the second quarter of 2001, the Company announced a plan to relocate the
domicile of Matrix Bank to Denver, Colorado from Las Cruces, New Mexico.
Associated with this relocation, the Company accrued expenses of approximately
$984,000 in 2001 primarily for severance and contract benefits to be paid to
certain of Matrix Bank's employees, mainly consisting of back office, accounting
and human resources personnel. Additionally, the accrued liability included the
payout of the contract Matrix Bank had with its prior president and chief
executive officer. As of December 31, 2002, approximately $233,000 of the
liability remains which management believes payment is probable through May
2004. The expense was charged to other general and administrative expense on the
consolidated statement of operations in 2001. The relocation was completed in
the second quarter of 2002 with the opening of Matrix Bank operations in
downtown Denver in the Matrix Financial Center, a building acquired by an
operating subsidiary of Matrix Bank, which purchase was completed in June 2002.
Matrix Financial Center was acquired to replace the original building purchased
by Matrix Bank for approximately $11.5 million in June 2001. Subsequent to that
acquisition, Matrix Bank was notified of the intent of the City and County of
Denver to condemn the building in connection with its planned expansion of the
Denver Convention Center. In October 2001, the condemnation proceedings were
held. The City and County of Denver was granted possession of the building in
consideration of a payment totaling approximately $14.9 million. The sale
resulted in a $3.4 million pre-tax gain on sale of assets recorded in the
consolidated financial statements for the year ended December 31, 2001.
Associated with the purchase of Matrix Financial Center, Matrix Bancorp and
certain subsidiaries with various leased office space throughout the Denver
metropolitan area have or will be moving their offices into Matrix Financial
Center. Associated with this move, the Company recorded a pre-tax charge of
$700,000 in other general and administrative expenses during June 2002. The
charge represents the excess of costs to be incurred on original leased space in
F-19
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
excess of expected revenues on subleasing of the space or terminating original
lease commitments. Moving expenses associated with the relocation are included
in other general and administrative expenses for the year ended December 31,
2002. Final relocations are anticipated to be completed in the second quarter of
2003.
Investment in Joint Venture
The Company has a 45%-owned investment in Matrix Settlement & Clearance
Services, L.L.C. (MSCS), and in MSCS' wholly owned subsidiary, MSCS Financial
Services, L.L.C., which is accounted for using the equity method. This
investment was classified in other assets, and had a carrying value of $802,000
and $589,000 as of December 31, 2002 and 2001, respectively. For the years ended
December 31, 2002, 2001 and 2000, the Company recorded income (losses) of
$213,000, $(175,000) and $(478,000), respectively, in other income related to
MSCS consolidated operations.
As of December 31, 2002 and 2001, MSCS had total assets of $3,362,000 and
$1,626,000; total liabilities of $1,709,000 and $499,000; and equity of
$1,653,000 and $1,127,000, respectively. For the years ended December 31, 2002,
2001 and 2000, MSCS had revenues of $7,714,000, $3,517,000 and $1,470,000; and
pre-tax income (loss) of $475,000, $(388,000) and $(955,000), respectively.
Fair Value of Financial Instruments
The Company determines the fair value of financial instruments as required by
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." The
amounts disclosed represent the Company's best estimate of fair value of
financial instruments required to be disclosed under the Statement. The Company
also has disclosed the methods and significant assumptions used to estimate the
fair value of its financial instruments.
Impact of Recently Issued Accounting Standards
In November 2002, the Financial Accountings Standards Board (FASB) issued FASB
Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." This interpretation expands the disclosures to be made by a guarantor
in its financial statements about its obligations under certain guarantees and
requires the guarantor to recognize a liability for the fair value of an
obligation assumed under a guarantee. FIN 45 clarifies the requirements of SFAS
5, "Accounting for Contingencies," relating to guarantees. In general, FIN 45
applies to contracts or indemnification agreements that contingently require the
guarantor to make payments to the guaranteed party based on changes in an
underlying that is related to an asset, liability, or equity security of the
guaranteed party. Certain guarantee contracts are excluded from both the
disclosure and recognition requirements of this interpretation, including, among
others, guarantees relating to employee compensation, residual value guarantees
F-20
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
under capital lease arrangements, commercial letters of credit, loan
commitments, subordinated interests in an special purpose entity, and guarantees
of a company's own performance. Other guarantees are subject to the disclosure
requirements of FIN 45 but not to the recognition provisions and include, among
others, a guarantee accounted for as a derivative instrument under SFAS 133, a
parent's guarantee of debt owed to a third party by its subsidiary or vice
versa, and a guarantee which is based on performance not price. The disclosure
requirements of FIN 45 are effective for the Company as of December 31, 2002,
and require disclosure of the nature of the guarantee, the maximum potential
amount of future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. The recognition requirements of FIN 45 are to
be applied prospectively to guarantees issued or modified after December 31,
2002. Significant guarantees that have been entered into by the Company are
disclosed in Note 15. The Company does not expect the requirements of FIN 45 to
have a material impact on the consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities." This interpretation of Accounting
Research Bulletin No. 51, Consolidated Financial Statements, addresses
consolidation by business enterprises of variable interest entities (selected
entities with related contractual, ownership, voting or other monetary
interests, including certain special purpose entities), and requires certain
additional disclosure with respect to these entities. The provisions of FIN 46
are immediately applicable to variable interest entities created after January
31, 2003 and for entities that existed prior to February 1, 2003. The Company
does not expect the requirements of FIN 46 to have a material impact on the
consolidated financial statements. The disclosure requirements, as applicable,
are included in our consolidated financial statements and notes hereto.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," that supersedes APB Opinion No. 17. Under SFAS 142, goodwill and
intangible assets deemed to have indefinite lives are no longer amortized, but
are to be reviewed at least annually for impairment, under impairment guidelines
established in the statement. SFAS 142 also changes the amortization methodology
in intangible assets that are deemed to have finite lives and adds to required
disclosures regarding goodwill and intangible assets. SFAS 142 is effective for
fiscal years beginning after December 15, 2001. The Company adopted SFAS 142 on
January 1, 2002 and its unamortized balance of goodwill as of that date was
$1,004,000. Beginning in 2002, the Company ceased its amortization of goodwill.
Goodwill amortization for 2001 and 2000 was less than $100,000, respectively.
During the second quarter of 2002, under guidelines contained in the statement,
management performed an analysis concerning potential impairment of the goodwill
carried at ABS School Services, and determined that no impairment existed. This
analysis was based on the fact that ABS School Services was engaged in an effort
to increase the client base and fee income on a national basis and believed it
would be successful. During the fourth quarter of 2002, it was determined that
the efforts were ultimately not successful in that ABS School Services was not
able to attract the amount of new contracts it had targeted for the new school
year. As such, the impairment analysis on the goodwill at ABS School Services
was re-performed in the fourth quarter of 2002, and it was determined that an
F-21
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
impairment of goodwill was present, and the entire goodwill balance of
$1,004,000 was written-off in the fourth quarter of 2002. After this charge, the
consolidated goodwill balance at December 31, 2002 was $0.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)". SFAS 146 requires recognition of a liability for a cost
associated with an exit or disposal activity when the liability is incurred, as
opposed to being recognized at the date an entity commits to an exit plan under
EITF 94-3. SFAS 146 also establishes that fair value is the objective for
initial measurement of the liability. SFAS 146 is effective for exit or disposal
activities that are initiated after December 31, 2002, with earlier application
encouraged. The adoption of SFAS 146 on January 1, 2003 did not have a material
impact on the consolidated financial statements.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions, an amendment to SFAS No. 72, SFAS No. 144 and FASB
Interpretation No. 9." In accordance with SFAS 147, the acquisition of all or
part of a financial institution that meets the definition of a business
combination will be accounted for by the purchase method in accordance with SFAS
141. In addition, SFAS 147 provides that long-term customer-relationship
intangible assets, except for servicing assets, recognized in the acquisition of
a financial institution, should be evaluated for impairment by the provisions of
SFAS 144. The effective date of SFAS 147 is for acquisitions on or after October
1, 2002. The adoption of SFAS 147 on October 1, 2002 did not have a material
impact on the consolidated financial statements.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." This amendment to FASB Statement No.
123 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of FASB Statement
No. 123 to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. The provisions of this
statement are effective for financial statements of interim or annual periods
after December 15, 2002. The Company does not intend to change to the fair value
method of accounting. The required disclosures are included in the Stock-Based
Compensation section of this note.
3. Subsequent Event - Sale of Wholesale Production Platform
On February 28, 2003, Matrix Capital Bank and Matrix Financial Services
Corporation entered into a Purchase and Assumption Agreement (Purchase
Agreement) to sell substantially all of Matrix Financial's assets associated
with its wholesale mortgage origination platform (Platform). The purchaser
(Buyer) is a newly formed corporation whose principals are long-time
participants in the mortgage banking industry. The Company intends for the
foreseeable future to retain Matrix Financial's servicing platform and operate
F-22
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
it in the ordinary course of business. Included in the sale are the wholesale
production offices, the back office personnel that process the loan originations
and a significant portion of the corporate operations and personnel. After the
sale, our remaining operations will primarily consist of our mortgage servicing
platform and a limited amount of corporate personnel and operations.
The following discussion is a summary of the terms of the sale of the Platform
and is not intended to be complete. For a more complete description of the terms
of the Purchase Agreement, the reader is invited to review the Purchase
Agreement, which is filed as an exhibit to the Annual Report on Form 10-K.
The Buyer is not yet licensed to engage in any mortgage banking activities under
state or federal law. It is anticipated that it will take approximately six
months for the Buyer to obtain the necessary licensing. Accordingly, Matrix
Financial, Matrix Bank and the Buyer desired to structure the transaction in a
manner that transferred substantially all the economic risks and benefits of the
operation of the Platform during the Transition Period (defined below) to the
Buyer, while at the same time having Matrix Financial and Matrix Bank maintain
continuous effective control over the operations of the Platform for regulatory
purposes. The Purchase Agreement, therefore, contemplates a two-staged closing.
The first closing (Initial Closing Date) occurred on the date the Purchase
Agreement was signed and is the effective date for the sale of the fixed assets,
and the final or second closing (Final Closing Date) will occur six months
following the Initial Closing Date. The period of operation of the Platform in
between the Initial Closing Date and the Final Closing Date is referred to as
the "Transition Period."
As Matrix Financial will maintain effective control at all times during the
Transition Period, Matrix Financial will continue to be an operating subsidiary
of Matrix Bank. The Platform will be operated, for accounting purposes, during
the Transition Period as a division of Matrix Financial.
On the Initial Closing Date, the Buyer purchased substantially all of the
tangible personal property and intangible property associated with the Platform.
The Buyer additionally will take the transfer and assignment of certain contract
rights, real property leases and equipment leases from Matrix Financial as soon
as the necessary consents have been obtained.
The parties intend for the Final Closing Date to occur within six months after
the Initial Closing Date. At that time, the Buyer will purchase any tangible and
intangible personal property of the Platform that is acquired during the
Transition Period in the ordinary course of business or otherwise inadvertently
not purchased on the Initial Closing Date (the "Subsequently Acquired Assets"),
as well as Matrix Financial's loan files, pipeline applications and sales
commitments. Due to the fact the Matrix Financial will maintain effective
control of the operation, the effective sale date for accounting purposes will
be the Final Closing Date.
F-23
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The purchase price is determined as follows:
o The Asset Payment Amount (as defined in the Agreement), which is
approximately $3,000,000 in payment for the tangible and intangible
assets of the Platform as of the Initial Closing Date; plus
o The Subsequently Acquired Assets Payment Amount (as defined in the
Agreement), which is the book value of the Subsequently Acquired
Assets as of the Final Closing Date; plus
o The Production Premium (as defined in the Agreement), which is
generally 20 basis points times the original principal balance of all
loans originated during the 12 months following the Initial Closing
Date at the Matrix Financial loan production offices purchased by
Buyer. The Production Premium is "floored" at $4,900,000 and is
"capped" at $9,100,000 plus;
o The Aggregate Locked Loan Profitability Amount (as defined in the
Agreement), which pays Matrix Financial one-half of the profit over a
specified threshold amount (the threshold being generally 30 basis
points) on loans that fund after the Initial Closing Date which have
resulted from its locked pipeline as of the Initial Closing Date; plus
or minus
o The Transition Period Gain or Loss (as defined in the Agreement). The
Transition Period Gain or Loss is a mechanism that provides for an
approximation of the accounting for the transaction as if the entire
sale and transfer occurs on the Initial Closing Date. For example, if
the Platform generates a loss during the first month of the six-month
Transition Period, then the Buyer is required to fund such loss by
paying the loss into an escrow account. And if the Platform generates
a profit during the first month of the six-month Transition Period,
then Matrix Financial is required to pay such profit into an escrow
account.
On the Initial Closing Date, the Buyer and Matrix Financial established an
escrow account (the "Escrow") with an Escrow Agent to act as a repository for
the escrow amounts described above and certain other payments contemplated by
the Purchase Agreement. On the Initial Closing Date, the Buyer deposited into
the Escrow $3.5 million as an advance against the Production Premium and paid
directly to Matrix Financial one-half of the Asset Payment Amount.
On the Final Closing Date, the Buyer will pay Matrix Financial the remaining
one-half of the Asset Payment Amount and will pay Matrix Financial the book
value of the Subsequently Acquired Assets.
The Production Premium will be paid over the 12 months following the Initial
Closing Date and the Aggregate Locked Loan Profitability Amount will be paid
over the 2 months following the Initial Closing Date.
The Company estimates that the aggregate sales price for the Platform will be
between $8,000,000 and $13,000,000.
During the six-month Transition Period, Matrix Financial will lease-back from
the Buyer the tangible and intangible assets that have been transferred to
Buyer, including any contract rights, real property leases and equipment leases.
F-24
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The operations of the Platform during the six-month Transition Period will be
governed by the terms of an Operating Plan, which is incorporated into the
Purchase Agreement. The Operating Plan requires Matrix Financial to, among other
things, continue to operate the Platform substantially in the manner in which it
currently operates and in conformity with its current policies and procedures.
Any changes to the Operating Plan must be approved in advance by an Executive
Committee consisting of the following three individuals: (a) the President of
Matrix Bank, (b) the President of Matrix Financial, and (c) another individual
selected by the Board of Directors of Matrix Financial. By establishing this
structure, the Company believes it will be able to maintain for regulatory
purposes continuous effective control over the Platform during the six-month
Transition Period.
Currently, Matrix Bank provides a warehouse line for substantially all of the
loans originated by the Matrix Financial production platform. As of December 31,
2002, the balance of the warehouse line was $458,900,000. During the six-month
Transition Period, it is contemplated that that Matrix Bank will continue to
provide a warehouse line to the Platform under similar terms that existed prior
to the sale. At the end of the Transition Period, the Buyer will be required to
utilize third party financings to fund new originations and the warehouse line
will be required to be paid-off within 60 days after the completion of the
Transition Period.
For a period of two years from the Initial Closing Date, Matrix Bank has agreed
that neither Matrix Bank nor any of its affiliates will engage in, directly or
indirectly, the single-family retail or wholesale mortgage origination business
in those states in which the acquired division operates or is located as of the
Initial Closing Date. However, this non-compete provision does not prohibit
Matrix Bank or their affiliates from engaging in such business in order to
comply with applicable law, rule, regulation, directive, agreement or order from
the Office of Thrift Supervision (OTS) or other party where it is necessary to
resolve regulatory or supervisory concerns. Additionally, the non-compete
provision does not apply in the event of a change in control of the Matrix Bank
or the Company.
The Purchase Agreement requires Matrix Bank to guarantee Matrix Financial's
obligations under the Purchase Agreement if certain events occur, such as Matrix
Financial's bankruptcy, failure to maintain a minimum net worth, or loss of
voting control of Matrix Financial.
F-25
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. Net (Loss) Income Per Share
The following table sets forth the computation of basic net (loss) income per
share and net (loss) income per share, assuming dilution:
Years Ended December 31,
2002 2001 2000
-------------------------------------------------------
(Dollars in thousands)
Numerator:
Net (loss) income available to shareholders $ (3,952) $ 8,512 $ 4,258
=======================================================
Denominator:
Weighted average shares outstanding-basic 6,462,272 6,495,583 6,713,251
Effect of dilutive securities:
Common stock options - 64,871 35,606
Common stock warrants - - -
-------------------------------------------------------
Dilutive potential common shares - 64,871 35,606
-------------------------------------------------------
Denominator for net (loss) income per share,
assuming dilution 6,462,272 6,560,454 6,748,857
=======================================================
For the year ended December 31, 2002, there were 90,702 stock options and
warrants outstanding which are potentially convertible to common stock. Assuming
conversion at the beginning of 2002, the aggregate weighted average shares would
be 6,552,974. These securities are anti-dilutive due to the net loss in 2002;
therefore, these potentially dilutive securities have not been used in the
calculation of diluted loss per share for the year ended December 31, 2002.
5. Securities Available for Sale
Securities available for sale were as follows:
December 31, 2002 December 31, 2001
----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Estimated Amortized Unrealized Estimated
Cost Gains Fair Value Cost Gains Fair Value
----------------------------------------------------------------------------
(In thousands)
Mortgage-backed securities $ 1,046 $ 40 $ 1,086 $ 1,961 $ 38 $ 1,999
SBA securities 27,987 - 27,987 4,964 - 4,964
----------------------------------------------------------------------------
Total $ 29,033 $ 40 $29,073 $ 6,925 $ 38 $ 6,963
============================================================================
The Company expects to receive payments on securities over periods that are
considerably shorter than the contractual maturities of the securities, which
range from 6 to 30 years, due to prepayments. Realized gains on the sale of
securities available for sale were approximately $78,000, $1,198,000 and $0 for
the years ended December 31, 2002, 2001 and 2000, respectively.
F-26
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Loans Held for Sale and Investment
Loans Held for Investment
Loans held for investment consist of the following:
December 31,
2002 2001
----------------------------------
(In thousands)
Residential loans $ 54,420 $ 6,833
Multi-family, commercial real estate, SBA guaranteed commercial 196,556 147,038
Construction loans 34,175 35,510
Consumer loans and other 4,313 5,431
Premium (discounts), net 570 (361)
Unearned fees (699) (514)
----------------------------------
289,335 193,937
Less:
Allowance for loan and valuation losses 3,444 2,776
----------------------------------
Loans held for investment, net $ 285,891 $ 191,161
==================================
Activity in the allowance for loan and valuation losses on loans held for
investment is summarized as follows:
Years Ended December 31,
2002 2001 2000
-----------------------------------------------------
(In thousands)
Balance at beginning of year $ 2,776 $ 2,107 $ 1,433
Provision for loan and valuation losses 1,700 1,821 1,508
Charge-offs (1,127) (1,235) (874)
Recoveries 95 83 40
-----------------------------------------------------
Balance at end of year $ 3,444 $ 2,776 $ 2,107
=====================================================
Loans Held for Sale
Loans held for sale consist of the following:
December 31,
2002 2001
------------------------------------
(In thousands)
Residential loans $ 941,256 $ 1,042,556
SBA guaranteed commercial loans, school financing and other 163,160 107,482
Purchase premiums, net 9,409 6,063
------------------------------------
1,113,825 1,156,101
Less:
Allowance for loan and valuation losses 5,899 6,562
------------------------------------
Loans held for sale, net $ 1,107,926 $ 1,149,539
====================================
F-27
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Activity in the allowance for loan and valuation losses on loans held for sale
is summarized as follows:
Years Ended December 31,
2002 2001 2000
------------------------------------------------------
(In thousands)
Balance at beginning of year $ 6,562 $ 6,474 $ 4,921
Provision for loan losses 1,121 1,159 2,727
Charge-offs (1,871) (1,075) (1,175)
Recoveries 87 4 1
------------------------------------------------------
Balance at end of year $ 5,899 $ 6,562 $ 6,474
======================================================
The following lists information related to nonperforming loans held for sale and
held for investment:
December 31,
2002 2001
------------------------------------
(In thousands)
Loans on nonaccrual status in the held for investment
portfolio $ 11,604 $ 13,760
Loans on nonaccrual status in the held for sale portfolio 19,214 23,491
------------------------------------
Total nonperforming loans $ 30,818 $ 37,251
====================================
Interest income that would have been recognized at
original contract terms $ 916 $ 1,374
====================================
The Company continues to accrue interest on government-sponsored loans such as
Federal Housing Administration (FHA) insured and Department of Veterans' Affairs
(VA) guaranteed loans which are past due 90 or more days, as the majority of the
interest on these loans is insured or guaranteed by the federal government. The
aggregate unpaid principal balance of government-sponsored accruing loans that
were past due 90 or more days was $34,791,000 and $55,200,000 as of December 31,
2002 and 2001, respectively.
F-28
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Premises and Equipment
Premises and equipment consist of the following:
December 31,
2002 2001
------------------------------------
(In thousands)
Land $ 3,520 $ 830
Buildings 13,987 6,324
Leasehold improvements 2,992 1,667
Office furniture and equipment 20,513 15,162
------------------------------------
41,012 23,983
Less accumulated depreciation 13,307 10,352
------------------------------------
Premises and equipment, net $ 27,705 $ 13,631
====================================
Included in occupancy and equipment expense is depreciation expense of premises
and equipment of approximately $3,478,000, $2,797,000 and $2,212,000 for the
years ended December 31, 2002, 2001 and 2000, respectively.
8. Mortgage Servicing Rights
The activity in the MSRs is summarized as follows:
Years Ended December 31,
2002 2001 2000
------------------------------------------------------
(In thousands)
Mortgage servicing rights
Balance at beginning of year $ 78,893 $ 71,529 $ 63,479
Purchases - 530 31,883
Originations 34,511 30,129 16
Amortization (24,176) (21,862) (9,851)
Sales (9,994) (1,433) (13,998)
------------------------------------------------------
Balance before valuation allowance at
end of year 79,234 78,893 71,529
------------------------------------------------------
Valuation allowance for impairment of mortgage
servicing rights
Balance at beginning of year (181) - -
Additions (14,219) (181) -
------------------------------------------------------
Balance at end of year (14,400) (181) -
------------------------------------------------------
Valuation allowance for foreclosure costs (1,634) - -
------------------------------------------------------
Mortgage servicing rights, net $ 63,200 $ 78,712 $ 71,529
======================================================
F-29
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The Company's servicing activity is diversified throughout 50 states with
concentrations at December 31, 2002, in California, Texas, Missouri and Arizona
of approximately 15%, 14%, 15% and 10%, respectively, based on aggregate
outstanding unpaid principal balances of the mortgage loans serviced. As of
December 31, 2002, 2001 and 2000, the Company subserviced loans for others of
approximately $26,613,000, $889,000,000 and $1,163,811,000, respectively.
The Company's servicing portfolio (excluding subserviced loans) is comprised of
the following:
December 31,
2002 2001
--------------------------------------------------------------
Principal Principal
Number Balance Number Balance
of Loans Outstanding of Loans Outstanding
--------------------------------------------------------------
(Dollars in thousands)
Freddie Mac 9,027 $ 417,583 12,422 $ 613,527
Fannie Mae 27,678 1,832,276 31,069 1,885,197
Ginnie Mae 25,453 1,823,706 26,718 1,820,691
VA, FHA, conventional and other
loans 13,489 1,260,062 15,946 1,336,950
--------------------------------------------------------------
Total servicing portfolio 75,647 $ 5,333,627 86,155 $ 5,656,365
==============================================================
The Company's custodial escrow balances shown in the accompanying consolidated
balance sheets at December 31, 2002 and 2001, pertain to payments held in escrow
in respect of taxes and insurance and the float on principal and interest
payments on loans serviced and owned by the Company. The custodial accounts are
maintained at Matrix Bank in noninterest-bearing accounts. The balance of the
custodial accounts fluctuates from month to month based on the pass-through of
the principal and interest payments to the ultimate investors and the timing of
taxes and insurance payments.
The estimated aggregate amortization of our MSR's for each of the next five
years ending December 31, 2003, 2004, 2005, 2006 and 2007 is $17,523,000,
$13,966,000, $10,362,000, $7,759,000, $5,935,000, respectively. The estimated
amortization is based on several assumptions as of December 31, 2002 with the
most significant being the anticipated prepayment speeds of the underlying
mortgages. It is reasonably possible the actual repayment speeds of the
underlying mortgage loans may differ materially from the estimate repayment
speed, and thus, the actual amortization may be significantly different than the
amounts estimated.
F-30
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Deposits
Deposit account balances are summarized as follows:
December 31,
2002 2001
----------------------------------------------------------------------------
Percent of Weighted Percent of Weighted
Total Average Rate Total Average Rate
Amount Deposits Amount Deposits
----------------------------------------------------------------------------
(Dollars in thousands)
Passbook accounts $ 5,514 0.59% 1.95% $ 4,291 0.50% 3.12%
NOW accounts 145,465 15.57 0.48 107,183 12.37 0.94
Money market accounts 334,508 35.82 1.22 249,234 28.77 2.11
----------------------------------------------------------------------------
485,487 51.98 1.02 360,708 41.64 1.74
Certificate accounts 448,470 48.02 3.65 505,527 58.36 5.98
----------------------------------------------------------------------------
Deposits $ 933,957 100.00% 2.40% $ 866,235 100.00% 4.36%
============================================================================
Included in NOW accounts are noninterest-bearing DDA accounts of $96,289,000 and
$67,137,000 at December 31, 2002 and 2001, respectively.
Contractual maturities of certificate accounts as of December 31, 2002 are as
follows:
Under 12 months 12 to 36 months 36 to 60 months Total
------------------------------------------------------------------
(In thousands)
1.00-1.99% $ 210,979 $ - $ - $ 210,979
2.00-2.99% 91,268 2,813 - 94,081
3.00-3.99% 38,151 8,927 1,905 48,983
4.00-4.99% 3,991 50,092 9,476 63,559
5.00-5.99% 4,345 3,896 8,336 16,577
6.00-6.99% 4,070 8,976 447 13,493
7.00-7.99% 50 748 - 798
------------------------------------------------------------------
$ 352,854 $ 75,452 $20,164 $ 448,470
==================================================================
Approximately $141,278,000 and $120,428,000 of fiduciary assets under
administration by Sterling are included in NOW and money market accounts as of
December 31, 2002 and 2001, respectively. Included in certificate accounts are
$327,335,000 and $361,271,000 of brokered deposits as of December 31, 2002 and
2001, respectively.
F-31
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Interest expense on deposits is summarized as follows:
Years Ended December 31,
2002 2001 2000
------------------------------------------------------
(In thousands)
Passbook accounts $ 117 $ 108 $ 102
NOW accounts 570 929 619
Money market 3,684 4,291 3,053
Certificates of deposit 17,125 29,544 22,501
------------------------------------------------------
Interest expense on deposits $ 21,496 $ 34,872 $ 26,275
======================================================
The aggregate amount of deposit accounts with a balance greater than $100,000
(excluding brokered deposits) was approximately $17,769,000 and $22,410,000 at
December 31, 2002 and 2001, respectively.
10. Borrowed Money and Guaranteed Preferred Beneficial Interests
Borrowed money and guaranteed preferred beneficial interests are summarized as
follows:
December 31,
2002 2001
----------------------------------
(In thousands)
Borrowed Money
$50,000,000 revolving warehouse loan agreement at December 31, 2002,
$120,000,000 at December 31, 2001, through April 30, 2003, renewable
annually, secured by mortgage loans held for sale, interest at LIBOR plus
1.20% at December 31, 2002 and 2001 (2.59% at December 31, 2002);
$40,000,000 available at December 31, 2002 $ 10,000 $ 95,450
Senior notes, interest at 11.50% payable semiannually, unsecured and
maturing September 30, 2004 9,545 10,455
$8,215,000 note payable to a third party financial institution due
in quarterly principal installments of $357,000 plus interest, through
December 31, 2004, collateralized by the common stock of Matrix Bank;
interest at LIBOR plus 2.65% (4.04% at December 31,
2002) 7,501 8,572
F-32
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
$12,000,000 revolving line of credit to a third party financial
institution, through March 31, 2003, renewable annually, collateralized by
the common stock of Matrix Bank; interest at LIBOR plus 2.65% (4.04% at
December 31, 2002); $12,000,000
available at December 31, 2002 - 3,000
Note payable with a bank, secured by real estate, interest only at
7% at December 31, 2002, maturing September 30, 2004 2,000 -
School financing repurchase agreements with a third-party bank to
sell school financing originated by the Company under various agreements
Interest rates are variable from prime to 8.00%. Total commitment is at the
discretion of the third-party bank. - 22,807
School financing agreements, renewable September 2004 and September 2005,
collateralized by school financing; interest rates are variable based on
the BMA mini-swap index. Future commitment is
at the discretion of the third-party lenders. 32,328 22,157
Other financing agreements 29 91
--------------------------
Total borrowed money $ 61,403 $ 162,532
==========================
Guaranteed Preferred Beneficial Interests
Matrix Bancorp Capital Trust I, 10% junior subordinated debentures payable
quarterly, unsecured and maturing September 30, 2029 $ 27,500 $ 27,500
Matrix Bancorp Capital Trust II, 10.18% junior subordinated debentures payable
semi-annually, unsecured and maturing June 8, 2031 12,000 12,000
Matrix Bancorp Capital Trust III, 10.25% junior subordinated debentures payable
semi-annually, unsecured and maturing July 25, 2031 15,000 15,000
Matrix Bancorp Capital Trust IV, LIBOR plus 3.75% (5.140% at December 31, 2002)
junior subordinated debentures payable semi-annually, unsecured and maturing
December 8, 2031 5,000 5,000
Matrix Bancorp Capital Trust V, LIBOR plus 3.625% (5.015% at December 31, 2002)
junior subordinated debentures payable semi-annually,
unsecured and maturing January 25, 2032 5,000 -
--------------------------
Total Guaranteed Preferred Beneficial Interests $ 64,500 $ 59,500
==========================
F-33
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
As of December 31, 2002, the maturities of borrowed money and guaranteed
preferred beneficial interest are as follows:
(In thousands)
2003 $ 12,727
2004 30,185
2005 17,744
2006 -
2007 -
Thereafter 65,247
-----------
$ 125,903
===========
The Company must comply with certain financial and other covenants related to
the foregoing debt agreements including, among other things, the maintenance of
specific ratios, net income, net worth and other amounts as defined in the
credit agreements, limiting the Company's and its subsidiaries' ability to
declare dividends or incur additional debt, and requirements to maintain certain
capital levels in certain subsidiaries. These covenants include requirements for
the Company to maintain "consolidated tangible capital" of not less than
$60,000,000, Matrix Bank to maintain "classified assets" of not greater than
three percent, Matrix Bank to earn not less than $7.5 million over the prior
four quarters, and maintain the requirements necessary such that Matrix Bank
will not be classified as other than "well capitalized," all as defined. As of
December 31, 2002, the Company exceeded two of the covenant requirements: Matrix
Bank's classified assets under definition were 3.15%, and Matrix Bank's earnings
over the prior four quarters were less than $7.5 million. Matrix Bank received a
wavier on both covenants subsequent to December 31, 2002. At December 31, 2002,
the Company was in compliance with the other covenants described above. We are
in the process of renewing the revolving line of credit. As part of the annual
renewal process, we anticipate that the two covenants maintained above will be
amended to address to our satisfaction, prospectively, the covenant levels that
we did not meet at December 31, 2002. However, there can be no assurances that
the bank stock loan will be renewed or that, if renewed, the issues mentioned
above will be resolved to our satisfaction.
The credit facility agreement for the $50,000,000 warehouse loan agreement
requires Matrix Financial to maintain, among other things, net worth, as
defined, of at least $30,000,000, a leverage ratio of no more than 14 to 1 and a
minimum cash flow coverage ratio for four consecutive quarters of no less than
1.3 to 1.0. At December 31, 2002, Matrix Financial was in compliance with these
covenants. The warehouse loan agreement, which matured February 28, 2003, was
amended by agreement on February 28, 2003, which extended the maturity date to
April 30, 2003 . All other terms remained unchanged.
The Company anticipates that the various borrowed money agreements which are up
for a renewal in 2003 will be renewed with similar terms and conditions as those
currently in effect.
School Financing Agreement
The Company had approximately $31,100,000 and $22,200,000 at December 31, 2002
and 2001, respectively, in tax-exempt financing it originated to charter schools
into two grantor trusts (Trusts). The Trusts then issued Class "A" Certificates
and Class "B" Certificates, with the Class "A" Certificates being sold to
various third party investors under a private placement at a price of par.
F-34
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The "A" Certificates, under the two grantor trusts, are guaranteed by a letter
of credit issued by a third party investment bank (Investment Bank) for one
trust, and the other grantor is guaranteed equally by two unaffiliated financial
institutions. The "A" Certificates' interest rate may be determined weekly,
monthly or for a term for up to one year. The interest rate and the term of the
interest rate are determined by the Remarking Agent, which is also the
Investment Bank in one case and First Matrix, LLC (a wholly owned subsidiary of
First Matrix) for the second trust. Generally, the Trusts are short-term in
nature with an average life of three years or less.
The "B" Certificates are owned in part by the Company. The interest rate paid on
the "A" Certificates is considered the Company's financing cost. The approximate
cost of the financing at December 31, 2002 and 2001 was 1.55% and 2.75%,
respectively. The interest that the Company receives through its ownership of
the "B" Certificates is tax-exempt.
Although the Investment Bank and the unaffiliated financial institutions act as
guarantors to the "A" Certificates, the Company provides full recourse to the
letter of credit providers in all cases of loss or default. Due to the nature of
the recourse and the ability of the "A" Certificate holders to put the
certificates to the Trusts, the transactions have been accounted for as a
secured financing.
Through a Purchase and Sale Agreement, the Company has sold school financing
loans to a third party financial institution. The Company provides scheduled
interest and principal plus full recourse in the case of loss or default. The
transaction was treated as a sale due to the transfer of control over the school
financing loans. No gain or loss was recorded at the time of sale. The balance
of the school financing loans sold with recourse was approximately $13,000,000
at December 31, 2002.
Guaranteed Preferred Beneficial Interests in Company's Junior Subordinated
Debentures
On July 30, 1999, Matrix Bancorp Capital Trust I (Trust I), a Delaware business
trust formed by the Company, completed the sale of $27,500,000 of 10% preferred
securities. Trust I also issued common securities to the Company and used the
net proceeds from the offering to purchase $28,600,000 in principal amount of
10% junior subordinated debentures of the Company due September 30, 2029. The
junior subordinated debentures are the sole assets of Trust I and are
eliminated, along with the related operating effects, in the consolidated
financial statements.
The preferred securities accrue and pay distributions quarterly at an annual
rate of 10% of the stated liquidation amount of $25 per preferred security. The
Company has fully and unconditionally guaranteed all of the obligations of Trust
I under the preferred securities. The guarantee covers the quarterly
distributions and payments on liquidation or redemption of the preferred
securities, but only to the extent of funds held by Trust I.
The preferred securities are mandatorily redeemable upon the maturity of the
junior subordinated debentures or upon earlier redemption as provided in the
indenture. The Company has the right to redeem the junior subordinated
F-35
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
debentures, in whole or in part on or after September 30, 2004, at a redemption
price specified in the indenture plus any accrued but unpaid interest to the
redemption date.
On March 28, 2001, Matrix Bancorp Capital Trust II (Trust II), a Delaware
business trust formed by the Company, completed the sale of $12,000,000 of
10.18% preferred securities. Trust II also issued common securities to the
Company and used the net proceeds from the offering to purchase $12,400,000 in
principal amount of 10.18% junior subordinated debentures of the Company due
June 8, 2031. The junior subordinated debentures are the sole assets of Trust II
and are eliminated, along with the related operating effects, in the
consolidated financial statements.
The preferred securities accrue and pay distributions semi-annually at an annual
rate of 10.18% of the stated liquidation amount of $1,000 per preferred
security. The Company has fully and unconditionally guaranteed all of the
obligations of Trust II under the preferred securities. The guarantee covers the
quarterly distributions and payments on liquidation or redemption of the
preferred securities, but only to the extent of funds held by Trust II.
The preferred securities are mandatorily redeemable upon the maturity of the
junior subordinated debentures or upon earlier redemption as provided in the
indenture. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after June 8, 2011, at a redemption price
specified in the indenture plus any accrued but unpaid interest to the
redemption date.
On July 16, 2001, Matrix Bancorp Capital Trust III (Trust III), a Delaware
business trust formed by the Company, completed the sale of $15,000,000 of
10.25% preferred securities. Trust III also issued common securities to the
Company and used the net proceeds from the offering to purchase $15,464,000 in
principal amount of 10.25% junior subordinated debentures of the Company due
July 25, 2031. The junior subordinated debentures are the sole assets of Trust
III and are eliminated, along with the related operating effects, in the
consolidated financial statements.
The preferred securities accrue and pay distributions semi-annually at an annual
rate of 10.25% of the stated liquidation amount of $1,000 per preferred
security. The Company has fully and unconditionally guaranteed all of the
obligations of Trust III under the preferred securities. The guarantee covers
the quarterly distributions and payments on liquidation or redemption of the
preferred securities, but only to the extent of funds held by Trust III.
The preferred securities are mandatorily redeemable upon the maturity of the
junior subordinated debentures or upon earlier redemption as provided in the
indenture. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after July 25, 2006, at a redemption
price specified in the indenture plus any accrued but unpaid interest to the
redemption date.
On November 28, 2001, Matrix Bancorp Capital Trust IV (Trust IV), a Delaware
business trust formed by the Company, completed the sale of $5,000,000 of
floating rate of six-month LIBOR plus 3.75% preferred securities. Trust IV also
issued common securities to the Company and used the net proceeds from the
F-36
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
offering to purchase $5,155,000 in principal amount of floating rate of
six-month LIBOR plus 3.75% junior subordinated debentures of the Company due
December 8, 2031. The junior subordinated debentures are the sole assets of
Trust IV and are eliminated, along with the related operating effects, in the
consolidated financial statements.
The preferred securities accrue and pay distributions semi-annually at the
floating rate as described above percent of the stated liquidation amount of
$1,000 per preferred security. The Company has fully and unconditionally
guaranteed all of the obligations of Trust IV under the preferred securities.
The guarantee covers the quarterly distributions and payments on liquidation or
redemption of the preferred securities, but only to the extent of funds held by
Trust IV.
The preferred securities are mandatorily redeemable upon the maturity of the
junior subordinated debentures or upon earlier redemption as provided in the
indenture. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after December 8, 2006, at a redemption
price specified in the indenture plus any accrued but unpaid interest to the
redemption date.
On July 25, 2002, Matrix Bancorp Capital Trust V (Trust V), a Delaware business
trust formed by the Company, completed the sale of $5,000,000 of floating rate
of six-month LIBOR plus 3.625% preferred securities. Trust V also issued common
securities to the Company and used the net proceeds from the offering to
purchase $5,155,000 in principal amount of floating rate of six-month LIBOR plus
3.625% junior subordinated debentures of the Company due July 25, 2032. The
junior subordinated debentures are the sole assets of Trust V and are
eliminated, along with the related operating effects, in the consolidated
financial statements.
The preferred securities accrue and pay distributions semi-annually at the
floating rate as described above of the stated liquidation amount of $1,000 per
preferred security. The Company has fully and unconditionally guaranteed all of
the obligations of Trust V under the preferred securities. The guarantee covers
the quarterly distributions and payments on liquidation or redemption of the
preferred securities, but only to the extent of funds held by Trust V.
The preferred securities are mandatorily redeemable upon the maturity of the
junior subordinated debentures or upon earlier redemption as provided in the
indenture. The Company has the right to redeem the junior subordinated
debentures, in whole or in part, on or after July 25, 2007, at a redemption
price specified in the indenture plus any accrued but unpaid interest to the
redemption date.
Capitalized expenses associated with all of the offerings of approximately
$2,398,000 and $2,328,000 are included in other assets at December 31, 2002 and
2001, respectively, and are being amortized on a straight-line basis over the
life of the junior subordinated debentures. Use of the straight-line basis is
not materially different from the amounts that would be recognized under the
interest method.
F-37
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. Federal Home Loan Bank Borrowings
In connection with Matrix Bank's change in domicile in 2002, Matrix Bank obtains
FHLB advances from FHLB of Topeka, which is the FHLB that serves Denver,
Colorado, and utilizes FHLB of Topeka as its primary correspondent bank. This
change was approved March 25, 2002. Long-term advances that existed at March 25,
2002 with FHLB of Dallas are still outstanding under their original terms.
The balances of FHLB borrowings are as follows:
December 31,
2002 2001
------------------------------------
(In thousands)
FHLB of Dallas borrowings $ 147,285 $ 303,361
FHLB of Topeka borrowings 238,500 -
------------------------------------
$ 385,785 $ 303,361
====================================
Advances of $266,000,000 and $136,000,000 at December 31, 2002 and 2001,
respectively, were borrowed under Convertible Advance and Short Option Advance
(SOA) Agreements with the FHLB. These SOA borrowings have a term of ten years,
but are callable by the FHLB beginning after a six-month to five-year lockout
period, depending on the particular SOA borrowing. After the expiration of the
lockout period, the SOA borrowings are callable at various intervals. If the
FHLB exercises its call option on a SOA borrowing, the FHLB is required to offer
replacement funding to the Company at a market rate of interest for the
remaining term of the SOA borrowing. Additionally, under the terms of the SOA
Agreement, the Company is not permitted to prepay or otherwise retire a callable
SOA borrowing prior to the final maturity date. At December 31, 2002, the
interest rates on the SOA borrowings ranged from 2.69% to 5.63%, and their
possible call dates varied from February 2003 to November 2006. Community
investment advances of $1,285,000 and $1,361,000 at December 31, 2002 and 2001,
respectively, were borrowed under a fixed term and rate. At December 31, 2002,
the advances are at a rate of 5.84% and mature June 2014. All advances are
secured by first lien mortgage loans of Matrix Bank and all of its FHLB stock.
Matrix Bank is on full custody status at FHLB-Dallas, which requires Matrix Bank
to place loan collateral at the FHLB-Dallas. At December 31, 2002, loans
collateralized by mortgages of $208,772,000 and securities held for sale of
$2,461,000 were pledged for FHLB-Dallas advances. Matrix Bank is on blanket
collateral status at FHLB-Topeka, which requires Matrix Bank to identify, yet
maintain in its possession, loan collateral pledged at FHLB-Topeka. At December
31, 2002, loans collateralized by mortgages of $333,731,000 and guaranteed SBA
loans of $89,763,000 were pledged for the FHLB-Topeka advances. As of December
31, 2002, Matrix Bank had available unused borrowings from the FHLB-Topeka for
advances of approximately $118,885,000.
F-38
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Income Taxes
The income tax (benefit) provision consists of the following:
Years ended December 31,
2002 2001 2000
------------------------------------------------------
(In thousands)
Current:
Federal $ 832 $ (7,713) $ 2,350
State - (15) 411
Deferred:
Federal (4,306) 11,162 (451)
State (843) 841 (67)
------------------------------------------------------
(Benefit) provision $(4,317) $ 4,275 $ 2,243
======================================================
A reconciliation of the (benefit) provision for income taxes with the expected
income taxes based on the statutory federal income tax rate follows:
Years ended December 31,
2002 2001 2000
------------------------------------------------------
(In thousands)
Expected income tax (benefit) provision $ (2,811) $ 4,470 $ 2,210
State income tax (benefit) provision (556) 545 343
Other (950) (740) (310)
------------------------------------------------------
(Benefit) provision for income taxes $ (4,317) $ 4,275 $ 2,243
======================================================
The actual tax (benefit) provision differs from the expected tax expense
(computed by applying the applicable United States Federal corporate tax rate of
34% and the composite state tax rates, which range from 4.5% to 8.0% to the
(loss) income before taxes for the years ended 2002, 2001 and 2000). This is
principally due to state income tax expense and various income and expense items
which are not deductible for tax purposes, including certain meal and
entertainment deductions and nontaxable interest income.
Deferred tax assets and liabilities result from the tax effects of temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes shown below.
December 31,
2002 2001
------------------------------------
(In thousands)
Deferred tax assets:
Allowance for loan and valuation losses $ 6,481 $ 6,541
Discounts and premiums - 71
Deferred fees 1,270 1,352
Delinquent interest 552 552
Impairment reserve 5,789 73
Net operating loss carry-forwards 1,082 1,574
Other 393 24
------------------------------------
Total deferred tax assets 15,567 10,187
Deferred tax liabilities:
Loss on sale of loans $ (17,374) $ (14,711)
Amortization of mortgage servicing rights (1,407) (4,351)
Gain on sale of building (1,368) (1,377)
Other (1,355) (834)
------------------------------------
Total deferred tax liabilities (21,504) (21,273)
------------------------------------
Net deferred tax liability $ (5,937) $ (11,086)
====================================
F-39
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The net deferred tax liability is recorded on the accompanying consolidated
balance sheets in income taxes payable and deferred income tax liability. The
current income tax payable of $835,000 as of December 31, 2002 is recorded in
income taxes payable and deferred income tax liability. .
There is no valuation allowance for gross deferred tax assets as of December 31,
2002, 2001 or 2000. In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that some portion or all
of the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible.
Management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income, and tax planning strategies in making this
assessment.
Based upon the level of historical taxable income and projections for future
taxable income over the periods that the deferred tax assets are deductible,
management believes it is more likely than not the Company will realize the
benefits of these deductible differences, and does not believe that a valuation
allowance is necessary. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carry-forward period are reduced.
13. Regulatory
The Company is a unitary thrift holding company and, as such, is subject to the
regulation, examination and supervision of the OTS.
Matrix Bank is subject to various regulatory capital requirements administered
by the OTS. Failure to meet minimum capital requirements can initiate certain
mandatory, and possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on Matrix Bank's and the
Company's consolidated financial statements. Under capital adequacy guidelines
F-40
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
and the regulatory framework for prompt corrective action, Matrix Bank must meet
specific capital guidelines that involve quantitative measures of Matrix Bank's
assets, liabilities and certain off-balance sheet commitments as calculated
under regulatory accounting practices. Matrix Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Matrix Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to total
assets (as defined). Management believes, as of December 31, 2002 and 2001, that
Matrix Bank met all applicable capital adequacy requirements.
As of December 31, 2002, the most recent notification from the OTS categorized
Matrix Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, Matrix Bank must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the table. There have been no conditions or events since that
notification that management believes have changed the institution's category.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
---------------------------------------------------------------------------
(Dollars in thousands)
As of December 31, 2002
Total Capital
(to Risk Weighted Assets) $ 100,367 11.5% $ 70,179 8.0% $ 87,724 10.0%
Core Capital
(to Adjusted Tangible Assets) 94,349 5.8 64,602 4.0 81,065 5.0
Tier Capital
(to Risk Weighted Assets) 94,349 10.8 N/A N/A 52,634 6.0
As of December 31, 2001
Total Capital
(to Risk Weighted Assets) $ 106,310 11.7% $ 72,418 8.0% $ 90,522 10.0%
Core Capital
(to Adjusted Tangible Assets) 99,949 6.5 61,671 4.0 77,089 5.0
Tier Capital
(to Risk Weighted Assets) 99,949 11.0 N/A N/A 54,313 6.0
The various federal banking statutes to which Matrix Bank is subject also
include other limitations regarding the nature of the transactions in which it
can engage or assets it may hold or liabilities it may incur.
Matrix Bank is required to maintain vault cash or balances with the Federal
Reserve Bank of Kansas City in 2002 and the Federal Reserve Bank of Dallas in
F-41
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2001 in a noninterest-earning account based on a percentage of deposit
liabilities. The required reserve balance was $6,989,000 and $10,456,000 at
December 31, 2002 and 2001, respectively.
As a wholly owned subsidiary of Matrix Bank, Matrix Financial is subject to OTS
regulation. In addition, Matrix Financial is also subject to examination by
various regulatory agencies involved in the mortgage banking industry. Each
regulatory agency requires the maintenance of a certain amount of net worth, the
most restrictive of which required $5,561,000 at December 31, 2002 and
$4,020,000 at December 31, 2001. At December 31, 2002 and 2001, Matrix Financial
was in compliance with these regulatory requirements.
First Matrix, headquartered in Denver, Colorado, a wholly owned subsidiary of
Matrix Capital Markets, is a broker-dealer registered with the Securities and
Exchange Commission (SEC) under rule 15c3-3(k)(2)(ii). First Matrix is subject
to the SEC's Net Capital Rule which requires the maintenance of minimum net
capital and requires that the ratio of aggregate indebtedness to net capital,
both as defined, shall not exceed 15 to 1. At December 31, 2002, First Matrix
had net capital of $285,000 which was $247,000 in excess of its required net
capital of $38,000. First Matrix's net capital ratio was 1.99 to 1.
Sterling, a Texas trust company, is generally required to maintain minimum
restricted capital of at least $1,000,000, and may be required to maintain
additional capital if the Texas Banking Commissioner determines that it is
necessary to protect the safety and soundness of Sterling. At December 31, 2002,
Sterling was in compliance with capital requirements under Texas law.
14. Shareholders' Equity
Stock Option Plan
The Company has elected to follow APB Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations in accounting for its employee
stock options. Under Opinion No. 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
In September 1996, the board of directors and shareholders adopted the 1996
Stock Option Plan, which amended and restated the Company's stock option plan
adopted in 1995. The Company's 1996 Stock Option Plan, as amended, allows for
the grant of options to substantially all of the Company's full-time employees
and directors for up to 750,000 shares of the Company's common stock. Options
granted generally have ten-year terms and vest based on the determination by the
Company's compensation committee.
The 1996 Stock Option Plan authorized the granting of incentive stock options
(Incentive Options) and nonqualified stock options (Nonqualified Options) to
purchase common stock to eligible persons. The 1996 Stock Option Plan is
F-42
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
currently administered by the compensation committee (administrator) of the
board of directors. The 1996 Stock Option Plan provides for adjustments to the
number of shares and to the exercise price of outstanding options in the event
of a declaration of stock dividend or any recapitalization resulting in a stock
split, combination or exchange of shares of common stock.
No Incentive Option may be granted with an exercise price per share less than
the fair market value of the common stock at the date of grant. The Nonqualified
Options may be granted with any exercise price determined by the administrator
of the 1996 Stock Option Plan. To date, all grant prices have equaled the market
price of the underlying stock on the date of the grant. The expiration date of
an option is determined by the administrator at the time of the grant, but in no
event may an option be exercisable after the expiration of ten years from the
date of grant of the option. All options granted to-date have been
non-qualified.
The 1996 Stock Option Plan further provides that, in most instances, an option
must be exercised by the optionee within 30 days after the termination of the
consulting contract between such consultant and the Company or termination of
the optionee's employment with the Company, as the case may be, if and to the
extent such option was exercisable on the date of such termination. To date, no
options have been granted to consultants.
Pro forma information regarding net (loss) income and (loss) income per share is
required by SFAS 148 and is included in Note 2. The fair value for these options
was estimated at the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions for 2002, 2001 and 2000,
respectively: risk-free interest rates of 4.5%, 5.0% and 5.1%; a dividend yield
of zero percent; volatility factors of the expected market price of the
Company's common stock of 0.52, 0.57 and 0.63; and a weighted-average expected
life of the option of four years.
The Black-Scholes option valuation model for used in estimating the fair value
of traded options which have no vesting restrictions and are fully transferable.
In addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the Company's
employee stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
A summary of the Company's stock option activity and related information is as
follows:
F-43
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Years ended December 31,
2002 2001 2000
------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------------------------------------------------------------------------
Outstanding, beginning of
year 611,825 $ 9.99 496,700 $ 10.54 431,600 $ 11.07
Granted 86,500 11.12 250,000 9.32 95,000 7.65
Exercised (1,700) 9.11 (16,250) 8.55 (500) 10.00
Forfeited (18,500) 10.44 (118,625) 11.09 (29,400) 10.77
------------- ------------- -------------
Outstanding, end of year 678,125 10.11 611,825 10.54 496,700 10.54
============= ============= =============
Exercisable end of year 397,655 10.31 306,683 10.34 286,500 10.34
Weighted average fair value
of options granted during
the year $ 6.20 $ 5.79 $ 4.86
============= ============= =============
Options outstanding at December 31, 2002, have exercise prices ranging from
$5.13 to $26.50 per share as outlined in the following table:
Weighted
Weighted Average Weighted
Number of Average Remaining Number of Average
Range of Exercise Options Exercise Price Contractual Options Exercise Price
Prices Outstanding Per Share Life Exercisable Per Share
- -----------------------------------------------------------------------------------------------------------
$ 5.13 79,500 $ 5.13 2.00 79,500 $ 5.13
7.00 - 7.88 7,500 7.29 8.50 1,500 7.29
8.00 - 8.69 123,625 8.53 7.69 44,525 8.45
9.15 - 9.86 135,000 9.68 8.70 27,000 9.68
10.00 - 10.37 173,950 10.36 6.14 107,700 10.03
11.50 - 13.88 74,800 12.45 6.04 56,030 12.46
14.25 - 17.25 80,750 15.13 4.57 78,400 15.13
3,000 26.50 5.33 3,000 26.50
-----------------------------------------------------------------------------------------
678,125 $ 10.11 6.27 397,655 $ 10.31
=========================================================================================
Employee Stock Purchase Plan
In September 1996, the board of directors and shareholders adopted an Employee
Stock Purchase Plan (Purchase Plan) and authorized 125,000 shares of common
stock (ESPP Shares) for issuance thereunder. The Purchase Plan became effective
upon consummation of the initial public offering. The price at which ESPP Shares
are sold under the Purchase Plan is 85% of the lower of the fair market value
per share of common stock on the enrollment or the purchase date. In May 2000,
the authorized number of shares available for issuance under the Purchase Plan
F-44
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
was increased to 250,000 shares. As of December 31, 2002, there were 39,102 ESPP
Shares available for future issuance.
15. Commitments, Contingencies and Related Party Transactions
Leases
The Company leases office space and certain equipment under noncancelable
operating leases. Annual amounts due under the office and equipment leases as of
December 31, 2002 are approximately as follows:
(In thousands)
2003 $ 2,748
2004 2,139
2005 2,052
2006 1,627
2007 497
Thereafter 715
------------------
$ 9,778
==================
Total rent expense aggregated approximately $3,018,000, $3,011,000 and
$2,319,000 for the years ended December 31, 2002, 2001 and 2000, respectively,
and is recorded in occupancy and equipment expense.
The Company, through Matrix Tower Holdings, LLC, an operating subsidiary of
Matrix Bank, is a lessor of office space under various operating leases for
Matrix Financial Center. Annual amounts expected for future minimum rental
income as of December 31, 2002 are approximately as follows:
(In thousands)
2003 $ 1,530
2004 1,543
2005 1,500
2006 1,248
2007 862
Thereafter 92
------------------
$ 6,775
==================
F-45
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Total rental income for the years ended December 31, 2002 and 2001 aggregated
approximately $373,000 and $0, respectively.
Included in the above office rents are the following amounts under an operating
lease with MSCS: $129,000, $129,000, $135,000, $136,000 and $113,000 for 2003,
2004, 2005, 2006 and 2007, respectively.
Off-Balance Sheet Risk and Concentration of Commitments
A summary of the contractual amount of significant commitments follows:
December 31,
2002 2001
------------------------------------
(In thousands)
Loans secured by mortgages $ 31,154 $ 27,759
Construction loans 10,991 7,355
Commercial lines of credit 8,338 9,027
Commercial loans 4,858 2,948
Consumer loans 581 620
The Company is party to various financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include undisbursed commercial mortgage
construction loans, commercial lines of credit and letters of credit. These
financial instruments involve, to varying degrees, elements of credit risk in
excess of the amounts recognized in the consolidated financial statements.
The Company's exposure to credit loss, in the event of nonperformance by the
other party, to off-balance sheet financial instruments with credit risk is
represented by the contractual amounts of those instruments. The Company uses
the same credit policies in making commitments and conditional obligations as it
does for on balance sheet instruments with credit risk.
Commercial credit off-balance sheet instruments are agreements to lend to, or
provide credit guarantee for, a customer as long as there is no violation of any
condition established in the contract. Such instruments generally have fixed
expiration dates or other termination clauses and may require the payment of a
fee. Because many of these instruments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Company evaluates each customer's creditworthiness on a
case-by-case basis, and the amount of collateral or other security obtained is
based on management's credit evaluation of the customer.
Matrix Bancorp, Inc. has guaranteed, with 50% recourse to the joint venture
partner, the indebtedness of MSCS to a third party financial institution, in an
amount of no greater than $3,000,000 at December 31, 2002. There was no balance
outstanding at MSCS on such indebtedness at December 31, 2002.
F-46
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Mortgage Banking Risk Management Activities
In the ordinary course of business, the Company makes commitments to originate
residential mortgage loans (pipeline) and holds originated loans until delivery
to an investor. Inherent in this business is a risk associated with changes in
interest rates and the resulting change in the market value of the pipeline and
funded loans. The Company mitigates this risk through the use of mandatory and
best effort forward commitments to sell loans or securities.
The Company uses derivative instruments primarily to protect against the risk of
changes in the price or interest rate movements on the value of certain assets
and liabilities. Derivative instruments represent contracts between parties that
usually require no initial net investment and result on one party delivering
cash or another type of asset to the other party based on a notional amount and
underlying as specified in the contract. A notional amount represents the number
of units of a specific item, such as currency units. An underlying represents a
variable, such as an interest rate, security price or price index. The amount of
cash or other asset delivered from one party to the other is determined based on
the interaction of the notional amount of the contract with the underlying.
Derivatives are also implicit in certain contracts and commitments.
The Company's primary use of derivative instruments is in connection with its
mortgage loan origination activities. Management uses derivative instruments to
protect against the risk of changes in fair value caused by changes in market
interest rates of originated mortgage loans and a portion of the mortgage loans
that are not yet closed but for which the interest rate has been established.
These instruments primarily include best effort commitments and mandatory
commitments. The nature and volume of the derivative instruments used to manage
the risk of change in fair value of mortgage loan originations depends on the
level of mortgage loans and commitments to originate mortgage loans on the
consolidated balance sheet.
As discussed in Note 2, on January 1, 2001, the Company adopted SFAS 133, which
requires all derivative instruments to be carried at fair value on the balance
sheet. Prior to 2001, unrealized gains and losses on derivatives used for
hedging purposes were generally not required to be reported in the financial
statements. In order to reduce the earnings volatility that would result from
having to recognize in earnings the fair value of certain derivative instruments
used to hedge risks associated with financial instruments not carried at fair
value, SFAS 133 provides special hedge accounting provisions. These provisions
permit the change in the fair value of the hedged item related to the risk being
hedged to be recognized in earnings in the same period and in the same income
statement line as the change in fair value of the derivative. The Company
usually designates derivative instruments used to manage interest rate risk into
SFAS 133 hedge relationships with the specific assets or liabilities being
hedged.
As with any financial instrument, derivative instruments have inherent risks.
Market risk is the adverse effect a change in interest rates, currency, or
implied volatility has on the value of a financial instrument. The Company
F-47
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
manages market risk associated with derivative instruments by establishing and
monitoring limits as to the amount of mortgage origination commitment coverage
obtained.
Credit risk is the risk that a counter-party to a derivative contract with an
unrealized gain fails to perform according to the terms of the agreement. Credit
risk is managed by monitoring the size and maturity structure of the derivative
portfolio and applying uniform credit standards maintained for all activities
with credit risk.
During the current year, as well as the prior year, the Company used best effort
and mandatory commitments to hedge the change in fair value of mortgage loans
and commitments to originate mortgage loans. At December 31, 2002, the Company
had $559,780,000 of commitments to originate mortgage loans and $357,305,000 of
funded loans, offset with mandatory forward commitments of $500,289,000 and best
effort forward commitments of $128,163,000. The commitments mature within 90
days of December 31, 2002. At December 31, 2001, the Company had $155,023,000 of
commitments to originate mortgage loans and $492,613,000 of funded loans,
respectively, hedged with mandatory forward commitments of $434,336,000 and best
effort forward commitments of $96,162,000. At December 31, 2002, the fair value
of the Company's derivatives to originate mortgage loans of $2,473,000 is
recorded in other assets, the increase in the fair value of the mortgage loans
committed for sale of $2,982,000 is recorded in loans held for sale, and the
fair value of commitments to sell mortgages of $5,231,000 is recorded in other
liabilities; the difference representing the ineffective portion of the hedge of
$224,000, was recorded as a credit to loan origination income in 2002.
Risk Management Activities for MSRs
Ownership of MSRs exposes the Company to impairment of the value of MSRs in
certain interest rate environments. The incidence of prepayment of a mortgage
loan increases during periods of declining interest rates as the homeowner seeks
to refinance the loan to a lower interest rate. If the level of prepayment on
segments of the Company's mortgage servicing portfolio achieves a level higher
than projected by the Company for an extended period of time, then an impairment
in the associated basis in the MSRs may occur. In 2001 and 2002, the Company
implemented a strategy to mitigate this risk of retaining a portion of
originated servicing as management believed that retaining servicing that was
generated in the lower interest rate environment will incur less prepayment
risk. During 2002, interest rates continued to decrease which resulted in the
Company incurring a significant provision against the value of its investment in
mortgage servicing rights. Due to the low interest rate environment, in late
2002 the Company began to sell the majority of its newly originated servicing.
The strategy is to reduce the Company's overall investment in mortgage servicing
rights.
At December 31, 2000, the Company used a program of exchange-traded futures and
options to hedge approximately 6.4% of its mortgage servicing portfolio. Due to
the cost of the requirements that must be met to achieve hedge accounting under
SFAS 133 for mortgage servicing rights the Company did not attempt to qualify
for hedge accounting and effective March 31, 2001 the Company sold, repurchased
or allowed to mature all derivative instruments recorded on the books associated
with mortgage servicing. In the fourth quarter 2002, the Company elected to
reinstate its hedging program to reduce the risk of loss in fair value of the
mortgage servicing rights due to declining interest rates. This program is
identical to the program instituted in 1997. The decision was based on the
historically low interest rates, the continued weakening economy, the
geopolitical environment and the impairment that the Company incurred to-date.
During the fourth quarter 2002, the Company hedged approximately $400,000,000
notional balance of its servicing portfolio, or 7.5%. As of December 31, 2002,
the company removed the hedge and recorded a gain from the sale of the
derivatives of $800,000, which is recorded in other income. The hedge was
reinstated on January 2, 2003, at approximately $600,000,000 notional balance.
Although the Company believes its hedging program could qualify for hedge
accounting under SFAS 133, the Company did not attempt to qualify for hedge
accounting treatment due to the requirements in SFAS 133 that were necessary to
do so. The decision to increase or decrease hedging coverage will be based on
several factors, including those discussed above, as well as the composition of
the curent servicing portfolio.
F-48
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Contingencies
The Company and its subsidiaries are parties to various litigation matters, in
most cases, involving ordinary and routine claims incidental to the business of
the Company. The Company accrues liabilities when it is probable that future
costs will be incurred and such costs can be reasonably estimated. Such accruals
are based upon developments to date, the Company's estimates of the outcome of
these matters and its experience in contesting, litigating and settling other
matters. Based on evaluation of the Company's litigation matters and discussions
with internal and external legal counsel, management believes that an adverse
outcome on one or more of the matters set forth below, against which no accrual
for loss has been made as of December 31, 2002, is reasonably possible but not
probable, and that the outcome with respect to one or more of these matters, if
adverse, is reasonably likely to have a material adverse impact on the
consolidated financial position, results of operations or cash flows of the
Company.
In early 1999, Matrix Bancorp and Matrix Bank instituted an arbitration action
with the American Arbitration Association in Phoenix, Arizona against Fidelity
National Financial, Inc. The arbitration action arose out of an alleged breach
by Fidelity of a Merger Termination Agreement entered into between the Company
and Fidelity in connection with the termination of their proposed merger. The
arbitration panel has ruled that the entire Merger Termination Agreement was
unenforceable. The Company and Matrix Bank filed an appeal of the arbitration
panel's decision in federal district court in Phoenix, Arizona, which has been
denied. In October 2001, Fidelity initiated a second arbitration to determine
the validity of a release given in connection with the Merger Termination
Agreement. Matrix Bancorp contested that the releases were valid and, in the
alternative, made a counterclaim against Fidelity demanding restitutional
damages for the value of the releases if they were determined valid. The
arbitration panel has held the releases to be valid and enforceable and has
denied the Company's claim for restitutional damages. Fidelity has filed a
motion requesting that it be awarded its attorney fees, and the panel has
awarded Fidelity approximately $500,000. The Company anticipates an appeal of
the findings of the arbitration panel.
Sterling Trust has been named a defendant in an action that was tried in the
District Court of Tarrant County, Texas in the spring of 2000. The jury returned
a verdict adverse to Sterling Trust with respect to two of 12 theories of
liability posed by the plaintiffs, and the court has signed a judgment for
certain of the plaintiffs in the amount of approximately $6,400,000. Sterling
Trust has filed an appeal of this judgment and believes it has meritorious
points of appeal. It intends to vigorously prosecute the appeal of this action.
The ultimate resolution of this appeal, which is expected at any time, could
result in a loss of up to $6,400,000 million plus post-judgment interest and
additional attorneys' fees. The ultimate legal and financial liability, if any,
of the Company cannot be estimated with certainty at this time.
F-49
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Related to the matter described in the previous paragraph, Sterling Trust and
several officers have been named defendants in an action in which the plaintiffs
have asserted various theories of liability, including control person theories
of liability under the Texas Securities Act and fraudulent transfer theories of
liability, to seek to impose liability on the defendants for the judgment
described above. The parties have agreed to abate this action pending the
outcome of the appeal mentioned in the previous paragraph. The defendants
believe they have adequate defenses and intend to vigorously defend this action.
The ultimate legal and financial liability, if any, of the Company cannot be
estimated with certainty at this time.
Sterling Trust was named a defendant in several putative class action lawsuits
instituted in November 2000 by one law firm in Pennsylvania. All of such
lawsuits were originally filed in the United States District Court for the
Western District of Pennsylvania. On April 26, 2001, the District Court for the
Western District of Pennsylvania ordered that all of such cases be transferred
to the United States District Court for the Western District of Texas so that
Sterling Trust could properly present its motion to compel arbitration. Sterling
Trust filed separate motions to compel arbitration in these actions, all of
which were granted. Each of the six plaintiffs timely filed arbitration demands
with the American Arbitration Association. The demands seek damages and allege
Sterling Trust breached fiduciary duties and was negligent in administrating
each claimant's self-directed individual retirement account holding a nine-month
promissory note. Sterling Trust believes it has meritorious defenses and is
defending the matters vigorously. The ultimate legal and financial liability, if
any, of the Company cannot be estimated with certainty at this time.
Sterling Trust has been named a defendant in an action filed in August 2002 in
the Second Judicial District Court in the County of Bernalillo, State of New
Mexico. The plaintiffs have claims they were defrauded in connection with their
investment of approximately $200,000 through their self-directed IRA held by
Sterling Trust. Sterling Trust has filed a motion to compel arbitration based
upon the account agreements entered into by the plaintiffs. Sterling Trust
believes it has meritorious defenses to the claims and intends to defend the
matter vigorously. The ultimate legal and financial liability, if any, of the
Company cannot be estimated with certainty at this time.
Sterling Trust has been named a defendant in an action filed in July 2001 in the
Superior Court for the County of San Diego, State of California. The plaintiffs
have alleged various theories of liability against Sterling Trust relating to
their investments of an indeterminable amount through their self-directed IRAs
held by Sterling Trust. Sterling Trust believes it has meritorious defenses to
the claims and intends to defend the matter vigorously. The ultimate legal and
financial liability, if any, of the Company cannot be estimated with certainty
at this time.
Sterling Trust has been named in an arbitration action filed in July 2002 in the
Judicial Arbiter Group of Denver, Colorado. The plaintiffs have alleged breach
of contract against Sterling Trust relating to their investments of
approximately $850,000 through their self-directed IRAs held by Sterling Trust.
In January 2003, this action was settled and the matter has been closed.
F-50
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Sterling Trust has been named a defendant in an action pending in Superior Court
of the State of California. The complaint seeks class action status, requests
unspecified damages and alleges negligent misrepresentation, breach of fiduciary
duty and breach of written contract on the part of Sterling Trust. On December
10, 2002, the court denied Sterling Trust's motion to compel arbitration.
Sterling Trust believes it has meritorious defenses and is defending the matter
vigorously. The ultimate legal and financial liability, if any, of the Company
cannot be estimated with certainty at this time.
In addition to the other litigation matters described above, Sterling Trust has
been the subject of numerous lawsuits and arbitration proceedings in which
customers and, in some cases, persons who are not customers allege various
theories of liability against the Company for losses suffered by these claimants
in connection with their failed investments in several enterprises. To the
extent that Sterling Trust has had any relationship with any of such claimants,
it has been solely as custodian of such claimants self-directed IRAs pursuant to
contracts that specify the limited nature of Sterling Trust's obligations. We
believe Sterling Trust has in each case acted in accordance with its obligations
under the contracts and/or as otherwise imposed by law. We further believe that
the ultimate outcome of each of these cases will not be material to the
consolidated financial position and results of operations of Company; but, there
can be no assurances that there will not be an adverse outcome in any one or
more of these cases or that any such adverse outcome will not have a material
adverse effect on the consolidated financial position and results of operations
of the Company.
A former customer of the Company is a debtor in a Chapter 11 proceeding under
the Bankruptcy Code pending in the United States Bankruptcy Court for the
Eastern District of New York. Prior to the bankruptcy filing, the Company had
provided the customer with a purchase/repurchase facility under which the
Company purchased residential mortgage loans from the customers, with the
customer having the right or obligation to repurchase such mortgage loans within
a specified period of time. The Company purchased approximately $12,400,000 in
original principal amount (the Purchased Loans) at the time of the Chapter 11
filing. The principals of the customer were indicted for fraud in connection
with financial improprieties committed.
Various third parties have instituted lawsuits, adversary proceedings or
competing bankruptcy claims against the Company claiming an equitable interest
in approximately eighteen of the Purchased Loans (approximately $2,100,000 in
original principal amount). These third parties consist primarily of title
companies, closing attorneys and other closing agents that provided settlement
funds in connection with the funding of a borrower's mortgage loan, in many
cases, we believe in violation of various "good funds" laws, which typically
require a closing agent to wait for receipt of "good funds" prior to
disbursement of settlement funds on the origination of a loan. After providing
settlement funds, these closing agents discovered that the customer had placed a
stop payment on the checks provided to the closing agent to fund the mortgage.
To date, the Company has successfully litigated two claims and has reached
tentative agreements to settle claims asserted against five others upon terms
satisfactory to the Company.
F-51
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Additionally, certain parties in the chain of title to property securing
approximately $2,700,000 of loans, including sellers and prior lien holders, are
seeking to void or rescind their transactions on the theory that they never
received consideration. The Company has reached tentative agreement to settle 13
of these purchased loans upon terms satisfactory to the Company. These
settlements can be consummated once the trustee's claims have been settled as
discussed below.
The trustee for the customer received an order from the Bankruptcy Court finding
that the Purchased Loans are a part of the estate of the customer. Nevertheless,
the trustee and the Company have reached an agreement, approved by the
Bankruptcy Court, in which the trustee relinquished any and all claims to
approximately $8,300,000 of the loans, in exchange for a fee of approximately
5.8% of the principal balance of the loans. Of the $8,300,000 settled with the
trustee, approximately $1,700,000 remains subject to the third party claims
discussed above.
The trustee has also filed two separate adversarial actions against the Company.
One such action claims the Company does not have a perfected ownership or
security interest in 17 of the Purchased Loans. The second adversarial action is
in the approximate amount of $6,000,000, claiming preferential payments by the
customer to the Company during the 90 days proceeding the filing of bankruptcy.
These payments were funds returned by the customer's escrow agent to the Company
for funds the Company paid for the purchase of customer loans which did not
close.
The Company believes it has adequate defenses and intends to vigorously defend
the actions discussed in the previous five paragraphs. The ultimate legal and
financial liability of the Company, if any, in any of these matters cannot be
estimated with certainty at this time.
Additionally, the Company has initiated an adversary claim against the
depository bank for the customer discussed above. The Company believes that the
depository bank bears liability for any loss sustained by the Company as a
result of the fraud perpetrated by the customer. The Company also believes that
any loss it may sustain as a result of its dealings with the customer are
insured. The Company cannot accurately assess at this time whether and to what
extent it will receive compensation from any source for any loss it may incur as
a result of its relationship with the customer.
Matrix Financial has been named a defendant in an arbitration claim pending
before the American Arbitration Association in Denver, Colorado. The claim was
filed on May 22, 2002 by a former employee, who was terminated in early 2002.
The claimant claims that he was not terminated "for cause," as specified in his
employment agreement and has made claims for, among other things, breach of good
faith and fair dealing, breach of his employment agreement, back pay and other
economic loss, violation of the Colorado wage act and attorneys' fees and costs.
Matrix Financial believes it has meritorious defenses to this claim and intends
to defend the matter vigorously. The ultimate legal and financial liability, if
any, of the Company cannot be estimated with certainty at this time.
F-52
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
ABS has been named a defendant in an action filed in the Superior Court of
Arizona, Maricopa County on June 3, 2002 by a former employee. The former
employee claims that she is entitled to approximately $450,000 in commissions
owed to her at the time of termination of her employment. She has also made
claims under the Arizona wage act and for an award of her attorneys' fees. ABS
believes it has meritorious defenses to this claim and intends to defend the
matter vigorously. The ultimate legal and financial liability, if any, of the
Company cannot be estimated with certainty at this time.
Related Party Transactions
From time to time, Matrix Financial has originated mortgage loans to various
employees, including executive officers of the Company. These mortgage loans
generally are sold to third party investors on a servicing released basis within
30 to 60 days after closing, and are made in the ordinary course of business,
are made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons, and do not involve more than the normal risk of collectibility or
present other unfavorable features. At December 31, 2002, the Company had
approximately $424,000 of closed mortgage loans, and $0 of commitments for
mortgage loans to related parties.
In June of 2002, the Company accepted the resignation of Guy A. Gibson as the
President and Chief Executive Officer of the Company. Mr. Gibson is still
serving on the Board of Directors of the Company and is providing ongoing
consulting services to the Company. Under the terms of a Consulting Agreement
entered into with Mr. Gibson, the Company paid Mr. Gibson $250,000 in 2002 for
his consulting services. The expense is recorded in compensation and employee
benefits expense in the consolidated statements of operations.
16. Defined Contribution Plan
The Company has a 401(k) defined contribution plan (Plan) covering all employees
who have elected to participate in the Plan. Each participant may make pre-tax
contributions to the Plan up to 25% of such participant's earnings with a
maximum of $11,000 in 2002. The Company makes a matching contribution of 50% of
the first 6% of the participant's compensation deferred of the participant's
total contribution. Matching contributions made by the Company vest over five
years. The Company contributed approximately $716,000, $298,000 and $261,000
during the years ended December 31, 2002, 2001 and 2000, respectively, and was
recorded in compensation and employee benefits expense in the consolidated
statements of operations.
F-53
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
17. Fair Value of Financial Instruments
The carrying amounts and estimated fair value of financial instruments are as
follows:
December 31,
2002 2001
------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------------------
(In thousands)
Financial assets:
Cash and cash equivalents $ 62,412 $ 62,412 $ 84,465 $ 84,465
Securities 29,073 29,073 6,963 6,963
Loans held for sale, net 1,107,926 1,112,841 1,149,539 1,152,931
Loans held for investment, net 285,891 290,084 191,161 191,661
FHLB stock 30,379 30,379 18,181 18,181
Financial liabilities:
Deposits 933,957 936,809 866,235 869,215
Custodial escrow balances 151,790 151,790 129,665 129,665
Payable for purchase of MSRs 782 782 4,738 4,738
FHLB borrowings 385,785 400,418 303,361 309,931
Borrowed money and guaranteed preferred
beneficial interests 125,903 126,849 222,032 222,032
The following methods and assumptions were used by the Company in estimating the
fair value of the financial instruments:
The carrying amounts reported in the consolidated balance sheets for cash and
cash equivalents, securities, FHLB stock, payable for purchase of MSRs and
certain components of borrowed money approximate those assets' and liabilities'
fair values based on the nature of the asset or liability.
The fair values of loans are based on quoted market prices where available or
outstanding commitments from reputable investors. If quoted market prices are
not available, fair values are based on quoted market prices of similar loans
sold in securitization transactions, adjusted for differences in loan
characteristics. The value of derivative financial instruments used to hedge the
loan portfolio is included in the carrying amount and fair value of the loans.
The fair value disclosed for FHLB borrowings is estimated using a discounted
cash flow calculation that applies interest rates currently being offered on
FHLB borrowings. The fair value for the remainder of borrowed money, which
includes the Company's 11.50% senior notes and guaranteed preferred beneficial
interests, is based on over the counter market prices, if available.
F-54
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The fair value disclosed for demand deposits (e.g., interest and noninterest
checking, savings and money market accounts) are, by definition, equal to the
amount payable on demand at the reporting date (i.e., their carrying amounts).
Fair values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected periodic maturities
on time deposits. The component commonly referred to as deposit base intangible,
was not estimated at December 31, 2002 and 2001, and is not considered in the
fair value amount. The fair value disclosed for custodial escrow balances
liabilities (noninterest checking) is, by definition, equal to the amount
payable on demand at the reporting date (i.e., their carrying amounts).
18. Parent Company Condensed Financial Information
Condensed financial information of Matrix Bancorp, Inc. (Parent) is as follows:
December 31,
2002 2001
------------------------------------
(In thousands)
Condensed Balance Sheets
Assets:
Cash $ 854 $ 155
Loans receivable 2,430 3,500
Other receivables 491 9
Premises and equipment, net 915 1,139
Other assets 3,046 3,168
Investment in and advances to subsidiaries 157,480 151,755
------------------------------------
Total assets $ 165,216 $ 159,726
====================================
Liabilities and shareholders' equity:
Borrowed money and guaranteed preferred beneficial
interests (a) $ 86,046 $ 81,527
Other liabilities 12,234 6,887
------------------------------------
Total liabilities 98,280 88,414
Shareholders' equity:
Common stock 1 1
Treasury shares - -
Additional paid-in capital 20,375 20,800
Retained earnings 46,560 50,511
------------------------------------
Total shareholders' equity 66,936 71,312
------------------------------------
Total liabilities and shareholders' equity $ 165,216 $ 159,726
====================================
(a) The Parent's debt is set forth in a table following the condensed
statements of cash flows. The Parent also guarantees the revolving
warehouse loan agreement and the financing related to charter schools.
See Note 10 for additional information regarding the debt.
F-55
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Years ended December 31,
2002 2001 2000
----------------------------------------------------
(In thousands)
Condensed Statements of Operations
Income:
Interest income on inter-company advances
$ 1,232 $ 2,395 $ 2,202
Other 57 1,230 1,362
----------------------------------------------------
Total income 1,289 3,625 3,564
Expenses:
Compensation and employee benefits 4,584 3,529 3,686
Occupancy and equipment 817 748 674
Interest on borrowed money 7,766 8,511 6,923
Professional fees 299 437 510
Other general and administrative 943 2,553 2,209
----------------------------------------------------
Total expenses 14,409 15,778 14,002
----------------------------------------------------
Loss before income taxes and equity income of
subsidiaries (13,120) (12,153) (10,438)
Income taxes (b) - - -
----------------------------------------------------
Loss before equity income of subsidiaries (13,120) (12,153) (10,438)
Equity income of subsidiaries 9,168 20,665 14,696
----------------------------------------------------
Net (loss) income $ (3,952) $ 8,512 $ 4,258
====================================================
(b) The Company's tax sharing agreement with its subsidiaries provides that the
subsidiaries will pay the Parent an amount equal to its individual current
income tax (benefit) provision calculated on the basis of the subsidiary
filing a separate return. In the event a subsidiary incurs a net operating
loss in future periods, the subsidiary will be paid an amount equal to the
current income tax refund the subsidiary would be due as a result of
carry-back of such loss, calculated on the basis of the subsidiary filing a
separate return. Accordingly, the Parent's condensed statements of
operations do not include any income tax benefit for the current losses.
F-56
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Years ended December 31,
2002 2001 2000
------------------------------------------------------
(In thousands)
Condensed Statements of Cash Flows
Operating activities:
Net (loss) income $ (3,952) $ 8,512 $ 4,258
Adjustments to reconcile net (loss)
income to net cash provided (used) by
operating activities:
Equity income of subsidiaries (9,168) (20,665) (14,696)
Dividend from subsidiaries 8,485 11,996 6,509
Depreciation and amortization 757 703 621
Unrealized gain (loss) on securities
available for sale 1 (794) 819
Loss on sublease 700 - -
Gain on sale of building - - (823)
Increase (decrease) in other
liabilities 4,647 (888) 3,800
Decrease (increase) in other
receivables and other assets 534 (3,133) 1,459
------------------------------------------------------
Net cash provided (used) by operating
activities 2,004 (4,269) 1,947
Investing activities:
Purchases of premises and equipment (274) (606) (457)
Proceeds from sale of building - - 2,191
Investment in and advances to subsidiaries (5,042) (19,331) 1,722
------------------------------------------------------
Net cash (used) provided by investing
activities (5,316) (19,937) 3,456
Financing activities:
Repayments of notes payable and revolving
line of credit (34,877) (49,437) (39,554)
Proceeds from notes payable and revolving
line of credit 34,396 43,250 35,700
Shares repurchased (726) (746) (1,775)
Proceeds from junior subordinated -
debentures 4,917 30,977
Proceeds from issuance of common stock
301 317 224
------------------------------------------------------
Net cash provided (used) by financing
activities 4,011 24,361 (5,405)
------------------------------------------------------
Increase (decrease) in cash 699 155 (2)
Cash at beginning of year 155 - 2
------------------------------------------------------
Cash at end of year $ 854 $ 155 $ -
======================================================
F-57
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Parent Company Debt is set forth below:
December
2002 2001
------------------------------------
(In thousands)
Senior notes $ 9,545 $ 10,455
Bank stock loan 7,501 8,572
------------------------------------
Total term notes 17,046 19,027
Bank stock revolving line of credit - 3,000
Guaranteed preferred beneficial interests 64,500 59,500
Other 4,500 -
------------------------------------
Total debt $ 86,046 $ 81,527
====================================
As of December 31, 2002, the maturities of debt are as follows:
(In thousands)
2003 $ 1,428
2004 6,073
2005 9,545
Thereafter 69,000
----------------------
$ 86,046
======================
19. Selected Quarterly Financial Data (Unaudited)
2002
-----------------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------------------
(In thousands except share data)
Operations
Net interest income before
provision for loan and
valuation losses $ 12,721 $ 12,576 $ 12,279 $ 11,623
Provision for loan and valuation
losses 392 1,308 642 1,058
Noninterest income 26,992 23,875 23,497 23,426
Noninterest expense 42,405 44,378 34,182 30,893
-----------------------------------------------------------------
(Loss) income before income taxes (3,084) (9,235) 952 3,098
(Benefit) provision for income
taxes (1,391) (4,034) 48 1,060
-----------------------------------------------------------------
Net (loss) income $ (1,693) $ (5,201) $ 904 $ 2,038
=================================================================
Net (loss) income per share data
-----------------------------------------------------------------
Basic $ (0.26) $ (0.81) $ 0.14 $ 0.31
=================================================================
Diluted $ (0.26) $ (0.81) $ 0.14 $ 0.31
=================================================================
Balance Sheet
Total assets $1,702,000 $1,778,000 $1,623,000 $1,570,000
Total loans, net 1,394,000 1,450,000 1,304,000 1,210,000
Shareholders' equity 67,000 68,000 74,000 73,000
F-58
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2001
-----------------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------------------
(In thousands except share data)
Operations
Net interest income before
provision for loan and $ 11,379 $ 9,335 $ 11,133 $ 8,663
valuation losses
Provision for loan and valuation
losses 830 648 526 976
Noninterest income 28,679 22,500 21,951 18,386
Noninterest expense 32,668 30,415 30,006 22,810
-----------------------------------------------------------------
Income before income taxes 6,560 772 2,552 3,263
Provision for income taxes 2,255 144 924 952
Less cumulative effect of a change
in accounting principle, net of
tax benefit - - - 360
-----------------------------------------------------------------
Net income $ 4,305 $ 628 $ 1,628 $ 1,951
=================================================================
Net Income per share data
Basic before accounting change $ 0.66 $ 0.10 $ 0.25 $ 0.30
Cumulative effect of a change in
accounting principle - - - 0.05
-----------------------------------------------------------------
Basic $ 0.66 $ 0.10 $ 0.25 $ 0.30
=================================================================
Diluted before accounting change 0.66 0.10 0.34 0.34
Cumulative effect of a change in
accounting - - - 0.05
-----------------------------------------------------------------
Diluted $ 0.66 $ 0.10 $ 0.25 $ 0.29
=================================================================
Balance Sheet
Total assets $1,647,000 $1,530,000 $1,685,000 $1,692,000
Total loans, net 1,341,000 1,256,000 1,387,000 1,455,000
Shareholders' equity 71,000 67,000 66,000 65,000
F-59
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
20. Transactions with Harbor Financial Mortgage Corporation
During 1999 and 1998, the Company entered into several transactions with Harbor
Financial Mortgage Corporation and its wholly owned subsidiary New America
Financial Inc. (collectively Harbor). The transactions included the purchase of
nonperforming FHA/VA loans, servicing retained, on a scheduled/actual
remittance; the purchase of performing residential mortgage loans including
sub-prime loans, servicing retained, on a scheduled/scheduled remittance with
full recourse; the acquisition of MSRs; and the purchase of receivables related
to servicing sales by Harbor to third parties.
In July 1999, Harbor, as servicer for the nonperforming FHA/VA loans, breached
its servicing contract. As a result, in September 1999, the Company transferred
the servicing of the loans to Matrix Financial.
In October 1999, Harbor filed for bankruptcy. Subsequent to the bankruptcy there
were several lawsuits filed by and against the Company and third parties,
generally surrounding the ownership and competing interest in certain of the
Harbor assets that the Company had acquired. In August 2000, the Company entered
into a global settlement with all of the third parties.
The most significant assets which remain from the Harbor transactions are the
FHA/VA loans with a balance of $18,102,000 and $50,397,000 at December 31, 2002
and 2001, respectively. Because the principal and interest is largely insured or
guaranteed by the federal government at a stated debenture rate, the Company
continues to accrue interest on the loans. However, both the interest and
advances made on the loans are subject to certain curtailments. The interest and
advances are analyzed quarterly by the Company for collectibility.
21. Transactions with Island Mortgage Network
In 2000, the Company provided Island Mortgage Network (Island), a New York
mortgage banking entity, with a purchase/repurchase facility under which the
Company purchased residential mortgage loans from Island, with Island having the
right or obligation to repurchase such mortgage loans within a specified period
of time. In June 2000, Island breached terms of its agreement with the Company
and, in October 2000, Island filed for bankruptcy. At the time of the
bankruptcy, the Company had approximately $12,400,000 of loans that it had
acquired from Island. At December 31, 2002, relating to $2,000,000 of the loans,
there have been lawsuits initiated by third parties alleging a competing
interest in the loans. With respect to an additional $2,700,000 of loans, the
Company believes that the loans were never closed with good funds. As of
December 31, 2002 and 2001, the Company had $7,500,000 and $10,100,000,
respectively, of loans and receivables originated by Island. The Company has an
allowance for loan losses for these loans and receivables of approximately
$2,300,000 and $2,900,000 as of December 31, 2002 and 2001, respectively.
22. Segments of the Company and Related Information
The Company has four reportable segments under SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information": a traditional banking
subsidiary, a mortgage banking subsidiary, two servicing brokerage and
consulting subsidiaries and a school services subsidiary. The traditional
banking subsidiary provides deposit and lending services to its customers and
also makes investments in residential mortgage loans. The mortgage banking
subsidiary originates residential mortgage loans through its wholesale loan
origination offices, as well as acquires residential MSRs and services the
F-60
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
mortgage loans underlying those MSRs. The servicing brokerage subsidiaries offer
brokerage and consulting services for residential MSRs and brokerage services
for whole loan activities, retail and fixed income activities, and SBA loans and
securities. The school services subsidiary provides outsourced business and
consulting services, as well as financing to charter schools. The remaining
subsidiaries are included in the "all other" category for purposes of Statement
No. 131 disclosures and consist primarily of the Company's trust operations,
real estate disposition services and the Parent company operations.
The Company evaluates performance and allocates resources based on operating
profit or loss before income taxes. The accounting policies of the reportable
segments are the same as those described in the summary of significant
accounting policies. Transactions between affiliates, the resulting revenues of
which are shown in the intersegment revenue category, are conducted at market
prices (i.e., prices that would be paid if the companies were not affiliates).
For the years ended December 31:
Servicing
Traditional Mortgage Brokerage and School
Banking Banking Consulting Services All Others Total
-----------------------------------------------------------------------------------
(In thousands)
2002
Revenues from external
customers:
Interest income $ 55,172 $ 27,858 $ 123 $ 6,823 $ 501 $ 90,477
Noninterest income 4,677 66,595 9,273 6,445 10,420 97,410
Intersegment revenues 19,167 3,694 1,192 11 2,260 26,324
Interest expense 31,037 19,723 154 2,771 (12,407) 41,278
Depreciation/amortization 602 25,433 109 1,405 1,383 28,932
Segment income (loss)
before income taxes 20,081 (10,621) 2,311 (6,736) (13,304) (8,269)
Segment assets (a) 1,556,268 527,328 7,209 70,237 50,842 2,211,884
2001
Revenues from external
customers:
Interest income $ 67,752 $ 30,602 $ 14 $ 6,854 $ 175 $ 105,397
Noninterest income 9,652 64,019 3,658 7,252 7,125 91,706
Intersegment revenues 20,821 4,418 2,345 - 3,346 30,930
Interest expense 51,008 23,548 85 4,931 (14,685) 64,887
Depreciation/amortization 489 23,013 124 360 992 24,978
Segment income (loss)
before income taxes 21,529 7,803 (1,406) (1,177) (13,412) 13,337
Segment assets (a) 1,410,072 669,317 6,506 78,131 57,367 2,221,393
2000
Revenues from external
customers:
Interest income $ 86,535 $ 5,973 $ 11 $ 4,691 $ 176 $ 97,386
Noninterest income 9,144 27,430 8,214 4,240 9,764 58,792
Intersegment revenues 3,620 5,746 220 - 2,233 11,819
Interest expense 47,978 8,296 7 4,413 6,907 67,601
Depreciation/amortization 2,447 8,469 164 269 1,085 12,434
Segment income (loss)
before income taxes 17,170 2,209 1,542 (4,019) (10,401) 6,501
Segment assets (a) 1,286,971 259,726 2,628 62,245 30,394 1,641,964
(a) See reconciliation to total consolidated assets in the following table.
F-61
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2002 2001 2000
------------------------------------------------------
(In thousands)
Revenues for year ended December 31:
Interest income for reportable segments $ 89,976 $ 105,222 $ 97,210
Noninterest income for reportable segments 86,990 84,581 49,028
Intersegment revenues for reportable segments 24,064 27,584 9,586
Other revenues 13,181 10,646 12,173
Elimination of intersegment revenues (26,324) (30,930) (11,819)
------------------------------------------------------
Total consolidated revenues $ 187,887 $ 197,103 $ 156,178
======================================================
(Loss) income for year ended December 31:
Total profit for reportable segments $ 5,035 $ 26,749 $ 16,902
Other loss (12,664) (13,339) (10,914)
Elimination of intersegment profit (loss) (640) (73) 513
------------------------------------------------------
(Loss) income before income taxes $ (8,269) $ 13,337 $ 6,501
======================================================
Assets as of December 31:
Total assets for reportable segments $ 2,161,042 $ 2,164,026 $1,611,570
Other assets 50,842 57,367 30,394
Elimination of intersegment receivables (497,514) (563,304) (215,998)
Other intersegment eliminations (12,773) (11,149) (7,193)
------------------------------------------------------
Total consolidated assets $ 1,701,597 $ 1,646,940 $1,418,773
======================================================
F-62
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Other Significant Items for the year ended December 31:
2002 2001 2000
------------------------------------------------------
(In thousands)
Depreciation/amortization expense:
Segment totals $ 27,549 $ 23,986 $ 11,349
Intersegment adjustments 1,383 992 1,085
------------------------------------------------------
Consolidated totals $ 28,932 $ 24,978 $ 12,434
======================================================
Interest expense:
Segment totals $ 53,685 $ 79,572 $ 60,694
Intersegment adjustments (12,407) (14,685) 6,907
------------------------------------------------------
Consolidated totals $ 41,278 $ 64,887 $ 67,601
======================================================
F-63