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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, 2003
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 9, 2004, 6,518,981 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
June 30, 2003 was $22,756,700. 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 14, 2004 are incorporated by reference into Part
III of this Form 10-K.
TABLE OF CONTENTS Page
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PART I
Item 1. Business..............................................................................................1
Item 2. Properties...........................................................................................24
Item 3. Legal Proceedings....................................................................................24
Item 4. Submission of Matters to a Vote of Security Holders..................................................27
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities....................................................................................28
Item 6. Selected Financial Data..............................................................................29
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................30
Item 7A. Quantitative and Qualitative Disclosures about Market Risk...........................................52
Item 8. Financial Statements and Supplementary Data..........................................................52
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.................52
Item 9A. Controls and Procedures..............................................................................52
PART III
Item 10. Directors and Executive Officers of the Registrant...................................................53
Item 11. Executive Compensation...............................................................................53
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.......53
Item 13. Certain Relationships and Related Transactions.......................................................53
Item 14. Principal Accountant Fees and Services...............................................................53
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................53
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, trust and clearing activities, lending activities, mortgage
banking 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; offering
brokerage, consulting and analytical services to financial services companies
and financial institutions; servicing residential mortgage portfolios for
investors; 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 a limited amount of financing to charter schools for the purchase of
school sites and equipment. Other fee-based services also include nationwide
real estate management and disposition services provided to financial service
companies and financial institutions.
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."
Discontinued Operations
On February 28, 2003, Matrix Capital Bank and Matrix Financial Services
Corporation entered into a Purchase and Assumption Agreement, as amended (the
"Purchase Agreement") to sell substantially all of Matrix Financial's assets
associated with its wholesale mortgage origination platform (the "Platform") to
AmPro Mortgage Corporation ("AmPro" or the "Buyer"). On September 2, 2003, the
Company announced the final closing and substantial completion of the sale by
Matrix Bank and Matrix Financial of substantially all of its assets associated
with its wholesale mortgage origination platform. The effective sale date for
accounting purposes was August 31, 2003. Included in the sale were the wholesale
production offices, the back office personnel that processed the loan
originations and a significant portion of the corporate operations and
personnel. After the sale, our remaining operations at Matrix Financial consist
of our mortgage servicing platform, where we service loans for ourselves and
third parties.
As a result of the sale, the Company recorded an after tax loss on the sale
of the Platform of $(2.7) million, or $(0.43) per diluted share, which is
included in the income from discontinued operations of $3.3 million, net of tax
effect, on the consolidated statements of operations for the year ended December
31, 2003. For comparative purposes, the operating income of the discontinued
production platform is reflected in discontinued operations beginning in the
first quarter of 2001, and the consolidated financial statements have been
restated to reflect the production platform as a discontinued operation. For
further discussion and detail of the accounting for, and effects of, the sale of
the Platform, see Note 3 to the consolidated financial statements included
elsewhere in this document.
Prior to and at the time of the signing of the Purchase Agreement, and
throughout the period from signing of the Purchase Agreement through the Final
Closing Date (the "Transition Period"), Matrix Bank provided a warehouse line of
credit for substantially all of the loans originated by the Platform. At the end
of the Transition Period, the Buyer was required to utilize third party
financings to fund new originations by the buyer and the warehouse line was
required to be paid-off. With the warehouse line paid-off, Matrix Bank had a
significant amount of liquidity to re-invest, which has been re-invested
primarily in bulk loan portfolios of adjustable rate loans, guaranteed portions
of Small Business Administration ("SBA") loans and mortgaged-backed securities.
For a period of two years from February 28, 2003, 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 operated or was located as of
such date. However, this non-compete provision does not prohibit Matrix Bank or
its 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 another party where it is
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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.
Sale of Matrix Capital Bank Branches
On January 30, 2004, Matrix Bank entered into definitive agreement to sell
its two branches in Las Cruces, New Mexico to FirstBank, a subsidiary of Access
Anytime BanCorp, Inc. The sale is subject to regulatory approval and other
customary conditions, and is expected to be completed in the second quarter of
2004. The sale will include deposits of the Las Cruces branches that totaled
approximately $84.1 million at December 31, 2003, and loans of approximately
$23.8 million at December 31, 2003. The sale will allow us to reduce costs
associated with the operations of the retail branch locations, and will provide
us the opportunity to focus our efforts on pursuing additional institutional
depository relationships, in line with our strategic plan. The sale of the
branches is not anticipated to significantly impact our operations or liquidity,
or that of Matrix Bank.
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 Colorado, New Mexico and Arizona,
Matrix Bank serves its local communities by providing a broad range of personal
and business depository services, offering residential loans and commercial real
estate loans, including Small Business Administration loans, and providing
consumer 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, renamed Matrix Financial Center. In addition to
Matrix Bank, the Company and several of its subsidiaries relocated their offices
to Matrix Financial Center during 2002 and 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 bulk purchases of residential
mortgage loan portfolios throughout the United States, a portion of which are
serviced for Matrix Bank by Matrix Financial. As of December 31, 2003, Matrix
Bank had total assets of $1.6 billion.
Matrix Bank and several of our other subsidiaries have significant
experience in purchasing mortgage loans, originating multi-family and other
loans secured by real estate, including Small Business Administration loans,
have familiarity with real estate markets throughout the United States and have
traditionally had access to 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 is a wholly
owned subsidiary of Matrix Bank, historically has acquired mortgage servicing
rights on a nationwide basis through purchases in the secondary market, has
retained originated mortgage servicing rights, and services the loans underlying
the purchased mortgage servicing rights and a portion of our originated mortgage
servicing rights.
As of December 31, 2003, Matrix Financial serviced over 50,000 borrower
accounts representing $3.2 billion in principal balances, excluding $176.9
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, 2003, the
custodial escrow accounts related to our servicing portfolio maintained at
Matrix Bank were $85.5 million.
Prior to the sale of the production platform as discussed in "Item 1.
Business--Discontinued Operations", Matrix Financial originated residential
mortgage loans through its wholesale loan origination network, with offices
located in Atlanta, Dallas, Denver, Houston, Jacksonville, Phoenix, Sacramento,
Santa Ana and St. Louis. The mortgage loans originated by Matrix Financial were
retained and sold in the secondary market. Prior to the sale of the production
platform,
4
for the period January 1, 2003 through February 28, 2003, Matrix Financial
originated $758.9 million in residential mortgage loans.
Matrix Bancorp Trading, Inc. Matrix Bancorp Trading, formerly known as
Matrix Capital Markets, Inc., 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, analysis and sales of residential mortgage loan
servicing rights;
o 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 Bancorp Trading's volume of brokerage activity and the expertise of
its analytics department gives 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 that are well suited to our particular servicing platform, investment
objectives and unique corporate structure.
First Matrix Investment Services Corporation. First Matrix, which became a
wholly owned subsidiary of Matrix Bancorp Trading 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 services 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. The Fort Worth office focuses primarily on
long-term investing and retirement planning for individuals. The Denver office
works primarily with financial institutions in managing their investment
portfolios. The Memphis office focuses on the acquisition, brokering,
securitization and sale of SBA loans and loan pools. SBA loans 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, mortgage companies and
financial institutions. In addition to the unaffiliated clients currently served
by Matrix Asset Management, Matrix Bank and Matrix Financial utilize Matrix
Asset Management to handle the disposition of foreclosed real estate for which
it is responsible as servicer. As of December 31, 2003, Matrix Asset Management
had approximately 3,200 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.
During 2003, Matrix Asset Management began operations of an internet based
business, reoSource, that allows buyers and agents to utilize the web to make
offers on the foreclosed properties managed by Matrix Asset Management, and
posted on the site by clients of Matrix Asset Management.
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, 2003, Sterling Trust administered approximately 36,000 accounts,
with assets under administration of over $2.3 billion. As of December 31, 2003,
approximately $179.0 million of the $2.3 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, and operates under the name The GEO Group.
Charter schools are public schools that are an alternative to traditional public
schools. The primary services offered include fund accounting, cash management,
budgeting, governmental reporting, payroll and accounts payable. The GEO Group
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
5
programs. Additionally, The GEO Group has a financing division, which offers a
limited amount of 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
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, 2003, Matrix Settlement & Clearance Services
consolidated had $9.1 million of revenues and pre-tax net income of
approximately $2.6 million.
As of December 31, 2003, Matrix Settlement & Clearance Services had 126
customers under contract. These customers administer and trade through Matrix
Settlement & Clearance Services approximately $26.2 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, 2003, Matrix Settlement &
Clearance Services' customers had $85.3 million of deposits at Matrix Bank. In
addition, many of Matrix Settlement & Clearance Services' customers require
trust and custody services. As of December 31, 2003, Matrix Bank held in custody
$11.0 billion of assets for customers of Matrix Settlement & Clearance Services.
Please see Note 21 to the consolidated financial statements for further
financial information about our subsidiaries.
Lending Activities
Purchase and Sale of Bulk Loan Portfolios. The majority of our assets
consist of residential mortgage loans that we generally acquire through bulk
acquisitions 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 Bancorp Trading, 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.
Over 75% 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 classified as held for sale 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. 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 loans generally
reduces 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,
yield, the current liquidity of Matrix Bank and the product mix in its existing
mortgage loan portfolio.
In the past, Matrix Bank has purchased nonperforming Federal Housing
Administration ("FHA") and Veteran's Administration ("VA") loans from third
party sellers, and currently Matrix Financial purchases all of the eligible
delinquent FHA and VA loans out of its servicing portfolio. 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
6
relatively short average life since the loans are typically liquidated through
the foreclosure and subsequent claim process with HUD. As of December 31, 2003,
we owned $12.2 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, potentially less interest income and higher capital
ratios.
During the year ended December 31, 2003, we made bulk purchases of mortgage
loans of approximately $637.3 million. We made bulk sales of 1-4 family,
multi-family and originated SBA loans of approximately $252.2 million for a net
gain on sale of bulk mortgage loans of $12.0 million.
Residential Mortgage Loan Origination. We originate residential mortgage
loans on a retail basis through Matrix Bank, and prior to the sale of the
production platform as discussed in "Item 1. Business--Discontinued Operations",
on a wholesale and retail basis through Matrix Financial. Since August 31, 2003,
we have not originated mortgage loans on a wholesale basis, with the exception
of our participation in the New Mexico Housing Authority program, which was
excluded from the sale of the production platform, and as noted in "Item 1.
Business--Discontinued Operations", we have agreed with the Buyer not to compete
in certain respects. Our participation in the New Mexico Housing Authority
program is anticipated to terminate in the second quarter of 2004.
Retail Originations. Matrix Bank originates residential loans on a retail
basis through its branches in Las Cruces, New Mexico. Matrix Bank's lending
office in Denver, Colorado primarily originates multi-family loans on a national
basis, and residential construction loans and commercial loans in that 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. As
discussed in "Item 1. Business--Sale of Matrix Capital Bank Branches", an
agreement for the sale of the Matrix Bank branches in Las Cruces, New Mexico was
entered into January 2004, subject to regulatory approval and other customary
conditions. This sale, anticipated to be finalized in the second quarter of
2004, will eliminate our retail originations operations in New Mexico.
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 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.
Sale of Originated Loans. We generally sell the residential mortgage loans
that we originate. Prior to the sale of the Platform as discussed in "Item 1.
Business--Discontinued Operations.", under programs established with Fannie Mae,
Freddie Mac and Ginnie Mae, conforming conventional and government loans were
sold on a cash basis or pooled by us and exchanged for securities guaranteed by
Fannie Mae, Freddie Mac or Ginnie Mae. We then sold those securities to national
or regional broker-dealers. Mortgage loans sold to Fannie Mae, Freddie Mac or
Ginnie Mae were sold on a nonrecourse basis, except for standard representations
and warranties, so that foreclosure losses were generally borne by Fannie Mae,
Freddie Mac or Ginnie Mae and not by us.
Prior to the sale of the Production Platform, we also sold nonconforming
and conforming residential mortgage loans on a nonrecourse basis to other
secondary market investors. Currently, all of the originated residential loans,
absent the
7
loans originated under the New Mexico Housing Authority Program, are sold under
this method. 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.
In the past, we sold residential mortgage loans on a servicing-retained or
servicing-released basis. Currently, all loans are sold servicing released, with
the exception of loans under the New Mexico Housing Authority program. 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 past experience has been that
giving such representations and warranties have not resulted in material
repurchases. However, due to the increased originations activity that occurred
in 2001 and 2002, we have experienced an increase in repurchases. The Company
has provided a reserve for anticipated losses related to the representations and
warranties. 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. We remain responsible for all
loans originated through the Platform through February 28, 2003, as discussed in
"Item 1. Business--Discontinued Operations."
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 Production Platform
originated loans are recorded in net income from discontinued operations, and
net gains and losses on all other originated loans are recorded in gain or loss
on sale of loans and securities.
Commercial and Other Lending. We have sought to diversify and enhance the
yield of our loan portfolio by originating multi-family, 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 a limited amount of 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.
Matrix Bank's small business lending division, headquartered in Denver,
Colorado, offers the following loan products: SBA 7a loans; first trust deed
loans through the SBA 504 program; first trust deed companion loans senior to
SBA 7a loans; and Business and Industry Guaranteed Loans offered through the
United States Department of Agriculture, as well as certain secondary market
qualified conventional lending. Matrix Bank has been a SBA Preferred provider in
the Colorado market area since 1999, and was awarded expansion of that
designation into New Mexico, Utah, Arizona, Oregon, Washington, Idaho and Texas.
Preferred lender status allows Matrix Bank delegated authority to approve SBA
guaranteed loan applications without prior review from the SBA, in most cases,
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 2003, Matrix Bank originated $33.0 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
properties have been pre-sold to the homeowner. It is generally considered that
construction lending involves a higher level
8
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 are located throughout the United States and are generally on
properties of between 5 to 150 units. In 2003, Matrix Bank originated over $41.0
million of multi-family loans and sold $31.0 million of multi-family loans. At
December 31, 2003, Matrix Bank had a multi-family loan portfolio of
approximately $58.0 million.
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 limited 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. During 2003, we began limiting to a large degree the
financing activities at ABS. We expect this trend to continue for the
foreseeable future because our objective is to reduce the overall size of our
charter school loan portfolio. As of December 31, 2003, we had a total of $46.8
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
100% and for furniture, fixtures and equipment and modular space it is
100%;
o there are generally no personal guarantees; and
o cash flow to service the financing is derived from the school's
student enrollment. If the school's student enrollment 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, 2003, Matrix
Financial serviced approximately $3.2 billion of mortgage loans, excluding
$176.9 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, 2003, Matrix Financial's annual
weighted-average servicing fee, including ancillary fees, was 0.50%.
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, 2003, on the basis of outstanding principal balances,
approximately 1.16% 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
9
mortgage loans also require the servicer to advance insurance premiums and tax
payments on schedule even though sufficient escrow funds may not be available.
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, 2003, we had
advanced approximately $12.9 million in funds on behalf of third party
investors. For the VA loans sold and serviced for Ginnie Mae, which are sold on
a nonrecourse basis, the VA loan guarantees may not cover the entire principal
balance and, in that case, we are responsible for the losses which exceed the
VA's guarantee. Estimated losses related to foreclosure are estimated and
reserved for, and included in the consolidated financial statements.
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 Fidelity Information Services,
formerly known as Alltel Information Services, Inc. Because Fidelity Information
Services is one of the largest mortgage banking service bureaus in the United
States, we believe that this system gives Matrix Financial capacity to support
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,
---------------------------------------------------
2003 2002 2001
-------------- -------------- ----------------
(In thousands)
FHA insured/VA guaranteed residential........................ $ 1,318,485 $ 2,128,363 $ 2,187,686
Conventional loans 1,742,096 3,053,368 3,272,109
Other loans.................................................. 122,955 151,896 196,570
------------ -------------- ---------------
Total mortgage servicing portfolio...................... $ 3,183,536 $ 5,333,627 $ 5,656,365
=============== ============== ===============
Fixed rate loans............................................. $ 2,697,892 $ 4,688,672 $ 5,009,501
Adjustable rate loans........................................ 485,644 644,955 646,864
--------------- -------------- ---------------
Total mortgage servicing portfolio...................... $ 3,183,536 $ 5,333,627 $ 5,656,365
=============== ============== ===============
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. The higher
levels of delinquencies result in a higher cost of servicing, however, a portion
of the higher cost is offset by the collection of late fees.
As of December 31,
---------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------ -------------------------------- -----------------------------
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.......... 3,366 6.62 4,276 5.65 4,610 5.35
60-89 days.......... 1,018 2.00 1,021 1.35 932 1.08
90 days and over.... 1,433 2.82 647 0.86 616 0.72
------------- -------------- ------------- --------------- ------------- --------------
Total delinquencies. 5,817 11.44 5,944 7.86 6,158 7.15
============= ============== ============= =============== ============= ==============
Foreclosures........ 438 0.86 540 0.71 757 0.88
============= ============== ============= =============== ============= ==============
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:
10
As of December 31,
-----------------------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------------- -----------------------------------------------------------------------
Percentage Percentage Percentage
Number Aggregate of Aggregate Number Aggregate of Aggregate Number Aggregate of Aggregate
Rate of Principal Principal of Principal Principal of Principal Principal
Loans Balance Balance Loans Balance Balance Loans Balance Balance
-------- --------- ----------- -------- ---------- ---------- ------- ----------- ------------
(Dollars in thousands)
Less than 7.00%.... 17,240 1,446,158 45.43% 23,345 $2,196,944 41.19% 16,024 $ 1,443,862 25.53%
7.00%--7.99%...... 10,950 846,330 26.58 19,043 1,634,054 30.64 23,815 1,895,797 33.52
8.00%--8.99%...... 8,492 390,254 12.26 13,424 724,053 13.57 19,002 1,144,290 20.23
9.00%--9.99%...... 6,237 215,188 6.76 8,755 349,308 6.55 12,122 542,621 9.59
10.00% and over.... 7,936 285,606 8.97 11,080 429,268 8.05 15,192 629,795 11.13
-------- --------- ----------- -------- ---------- ---------- -------- ----------- ---------
Total............ 50,855 3,183,536 100.00% 75,647 $5,333,627 100.00% 86,155 $ 5,656,365 100.00%
========== ========= =========== ========= ========== ========== ======== =========== =========
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.
As of December 31,
------------------------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------------------------------------------------------------------------------------------
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...... 11,431 22.48% $ 190,283 5.98% 11,647 15.40% $ 188,463 3.53% 11,539 13.39% 169,794 3.00%
6--10 years...... 4,958 9.75 169,379 5.32 8,954 11.84 271,438 5.09 14,711 17.08 442,458 7.82
11--15 years...... 7,055 13.87 394,119 12.38 10,728 14.18 662,439 12.42 12,101 14.05 729,162 12.89
16--20 years...... 8,080 15.89 620,435 19.49 12,914 17.07 1,042,962 19.56 18,013 20.91 1,428,794 25.26
21--25 years...... 1,274 2.51 87,013 2.73 1,588 2.10 134,967 2.53 2,219 2.57 246,835 4.37
More than 25 years 18,057 35.50 1,722,307 54.10 29,816 39.41 3,033,358 56.87 27,572 32.00 2,639,322 46.66
------ ------ ---------- ------ ------ ------ ---------- ------ ------ ------ --------- -------
Total.......... 50,855 100.00% $3,183,536 100.00% 75,647 100.00% $5,333,627 100.00% 86,155 100.00% 5,656,365 100.00%
====== ====== ========== ====== ====== ====== ========== ====== ====== ====== ========= =======
Our servicing activity is diversified throughout all 50 states with
concentrations in Missouri, Texas, California, Arizona, New Mexico and Florida
of approximately 14.50%, 14.28%, 13.87%, 9.03%. 8.16% and 5.01%, respectively,
based on aggregate outstanding unpaid principal balances of the mortgage loans
serviced at December 31, 2003.
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
because the cost savings to the borrower from refinancing can be significant.
During 2003, existing low interest rates continued to decrease throughout the
year. We purchased only nominal amounts of servicing in 2003 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,
-----------------------------------------------------
2003(1)(4) 2002(2)(4) 2001(3)(4)
---------------- ---------------- ----------------
Quarter ended:
December 31.... 30.27 % 31.03 % 24.67%
September 30... 41.23 23.30 25.13
June 30........ 38.90 19.00 24.63
March 31....... 31.30 21.60 17.13
---------------- ---------------- ----------------
Annual average.... 35.43 % 23.73 % 22.89%
================ ================ ================
11
__________
(1) These prepayment rates exclude prepayment experience for mortgage servicing
rights subserviced for us by others of $176.9 million, $192.8 million,
$17.6 million and $13.1 million for the quarters ended December 31,
September 30, June 30, and March 31, 2003, respectively.
(2) These prepayment rates exclude prepayment experience for mortgage servicing
rights subserviced for us by others of $26.6 million, $600 thousand, $5.8
million and $34.6 million for the quarters ended December 31, September 30,
June 30, and March 31, 2002, respectively.
(3) 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.
(4) These prepayment rates do not include prepayments that resulted from us
targeting our own servicing portfolio for refinance opportunities.
Prior to 2001, we acquired substantially all of our mortgage servicing
rights in the secondary market. The industry expertise of Matrix Bancorp Trading
and Matrix Financial allowed 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
and for all of 2003, 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, 2003, in terms of unpaid
principal amount, approximately $1.4 billion of the underlying mortgage loans in
our servicing portfolio were from loans originated and sold by Matrix Financial
prior to the sale of the production platform, as discussed in "Item 1.
Business--Discontinued Operations". Based on the fact that we have sold our
Platform, and the limited amount of seasoned servicing available in the market
place, it is unlikely that we will acquire or add significantly to our servicing
portfolio. To the extent that any additions to our servicing portfolio are done,
the acquisitions are likely to 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. Historically, we have sold a portion of our
purchased mortgage servicing portfolios and sold a portion of the mortgage
servicing rights on loans that we originated prior to the sale of the Platform
as discussed in "Item 1. Business--Discontinued Operations", and as mentioned
above. Sales generate cash at the time of sale but reduce future cash flow and
servicing fee income. We did not have any sales of mortgage servicing rights
during 2003 due to the prevailing market conditions. We will pursue strategic
sales of segments of our portfolio if market conditions are favorable.
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.
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 or the
12
estimated future prepayment activity on segments of our mortgage servicing
portfolio reaches levels higher than we projected for an extended period of
time, the associated basis in the mortgage servicing rights may be impaired. To
mitigate a portion of this risk of impairment due to declining interest rates,
through December 31, 2000, we initiated a hedging strategy that used a program
of exchange-traded future and options, and 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. Consistent
with the program implemented in the fourth quarter of 2002, in 2003 we elected
to reinstate our hedging program to mitigate a portion of our investment in
mortgage servicing rights from further impairment, identical to the previously
used program. 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 2003, we hedged approximately 15% of our
portfolio. As of December 31, 2003, we have maintained consistency with the
percentage of coverage at approximately 19%. We did not attempt to qualify for
hedge accounting treatment due to the requirements in SFAS 133 that were
necessary to do so. During 2003, we earned approximately $700 thousand from
hedging activities. 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.
Our servicing portfolio is valued at least quarterly in accordance with the
guidelines set forth in SFAS 140. Under SFAS 140, we are required to record our
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. We stratify our mortgage servicing
rights by product type and investor to reflect the predominant risks. To
determine the fair value of this investment, we use a valuation model that
calculates the present value of discounted future cash flows. In the fiscal
years 2003 and 2003, we made no changes to the significant assumptions inherent
in the valuation of the servicing portfolio. These significant assumptions are
more fully described in Note 2 to the consolidated financial statements included
elsewhere in this document.
During 2002, based on a valuation model which incorporates among other
things, prepayment speeds, we recorded provisions for impairment on our mortgage
servicing rights totaling approximately $14.2 million. Prepayment speeds are
highly impacted by changes in interest rates, as when interest rates decline
there is a greater incentive for the homeowners to refinance their mortgages. In
2002, mortgage rates increased in the first quarter of the year and we recovered
$181 thousand of previously recorded impairment. In the quarters ended June 30,
2002, September 30, 2002 and December 31, 2002, we recorded an impairment charge
of $1.4 million, $8.0 million and $5.0 million, respectively. These impairments
are highly correlated to the decline in mortgage interest rates that occurred
during these periods. During 2003, based on our servicing valuation model, we
recorded impairment in the amount of $2.4 million in the quarter ended June 30,
2003 as mortgage interest rates reached their lowest level in over 45 years. In
the quarter ended September 30, 2003, mortgage interest rates increased and we
recorded an impairment recovery of $5.1 million. Also, in the quarter ended
September 30, 2003, we determined that it was remote that $5.0 million of
previously recorded impairment would be recovered, and thus recorded a direct
write-down to the value of the servicing asset for such amount. Based on our
valuation model, we recorded an additional impairment recovery of $250 thousand
for the quarter ended December 31, 2003. Our impairment reserve as of December
31, 2003 was $6.5 million. Further decreases in interest rates, or other factors
that result in an increase in anticipated future prepayment speeds, may cause
additional impairment charges in future years.
Brokerage, Consulting and Outsourcing Services
Brokerage Services. We provide brokerage services through our subsidiaries,
Matrix Bancorp Trading and First Matrix Investment Services Corporation.
Matrix Bancorp Trading. Matrix Bancorp Trading operates as a full-service
mortgage servicing and mortgage loan broker. 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 Bancorp Trading promotes its services to all types and
sizes of market participants, thereby developing diverse relationships.
Matrix Bancorp Trading brokers and principals all types of loan products
with the majority of the loan products centering on residential mortgages. In
most cases, Matrix Bancorp Trading acts as the intermediary between the sellers
and buyers of the various loan products.
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
13
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 Bancorp Trading 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 Bancorp
Trading 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 Bancorp
Trading's national market presence. These contacts also enable Matrix Bancorp
Trading to identify prospective clients for our other subsidiaries and make
referrals when appropriate. See "Item 1. Business--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
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 Bancorp Trading 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 2003 that 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. As interest rates increase,
and the level of mortgage originations decrease, we would expect that the market
for bulk servicing trades would increase. If that occurs, we believe we are well
positioned to take advantage of the increased brokerage activity. .........
First Matrix Investment Services Corporation. First Matrix is registered with
the NASD as a fully disclosed broker-dealer, headquartered in Denver, Colorado.
First Matrix 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 securities transactions through
First Southwest Company based in Dallas, Texas on a fully disclosed basis.
First Matrix provides brokerage services through fixed income trading and
SBA pooling, retail brokerage, and structured finance deals. 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.
Through the SBA group in Memphis, First Matrix has diversified its client
base and its product mix. 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 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.
In retail brokerage services, 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.
Consulting and Analytic Services. Matrix Bancorp Trading 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 on servicing portfolios. Matrix Bancorp Trading utilizes
a nationally recognized valuation model to fit its customers' many different
needs and unique situations in performing valuations and analyses. In addition,
14
Matrix Bancorp Trading 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 Bancorp Trading helps 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
Bancorp Trading 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.
Because of our analytics capabilities, we are able to attract brokerage clients
that we may not otherwise be able to do. In addition, Matrix Bancorp Trading 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 Bancorp Trading and its affiliates further
strengthens Matrix Bancorp Trading'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, mortgage 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 Bancorp Trading, Matrix Bank and Matrix Financial use 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, because 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 or loan holder. 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.
In the third quarter of 2003, Matrix Asset Management began operations of
our internet based business, reoSource, that allows buyers and agents to utilize
the web to make offers on the foreclosed properties managed by Matrix Asset
Management, and posted on the site by clients of Matrix Asset Management. We
believe this will provide Matrix Asset Management significant growth
opportunities.
School Services. In addition to providing limited financing to charter
schools as mentioned in "Lending Activities - Commercial and Other Lending,"
ABS, operating under the name The GEO Group, 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, we consult with and offer programs to charter schools in the
following areas:
o facility and safety management;
o technology;
o policy development; and
o grant administration.
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.
15
The business services provided by ABS are integral to the financing
division, as these services allow us to use our 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 us a significant advantage in the servicing and ongoing monitoring of
the schools, which we believe is imperative to the collection process and the
overall success of our financing efforts.
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, 2003, Sterling Trust had 35,688 accounts with assets under
administration of over $2.3 billion, and the trust department of Matrix Bank had
14,563 accounts with assets under administration of approximately $11.0 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. At December 31, 2003, Matrix Settlement &
Clearance Services had 126 customers under contract with those customers
administering approximately $26.2 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 on January 2, 2002 as a NASD
registered broker-dealer.
Through our wholly owned subsidiary, Matrix Advisory Services, LLC, we
began to offer in 2003 an Internet-based private wealth management service
through the utilization of proprietary asset allocation models 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 Matrix Advisory Services' product offers is a turnkey approach
with the automation of the mutual fund clearing and custody of plan assets, if
needed.
16
Competition
We compete nationally for 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
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 other 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 Bancorp
Trading 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--Discontinued Operations."
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, 2003, the Company had 509 employees. We believe that our
relations with our employees are good. The Company is not party to any
collective bargaining agreement.
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.
17
Aspects of the Company's public disclosure, corporate governance principles
and internal control environment are subject to the Sarbanes-Oxley Act of 2002
and related regulations and rules of the SEC and the NASDAQ. 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 declaring 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 OTS 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 commercial 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 through or in concert with one or more other persons,
may acquire control of a savings association unless the OTS 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
OTS. Any company that acquires such control becomes a savings and loan holding
company subject to registration, examination and regulation by the OTS. 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 OTS 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.
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.
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.
18
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 have established policies,
procedures and systems designed to comply with these regulations.
The Sarbanes-Oxley Act of 2002 was signed into law on July 30, 2002. The
Sarbanes-Oxley Act of 2002 is a law that addresses, among other issues,
corporate governance, auditing and accounting, executive compensation, and
enhanced and timely disclosure of corporate information. As directed by Section
302(a) of Sarbanes-Oxley Act of 2002, the Company's Co-Chief Executive Officers
and Chief Financial Officer are each required to certify that the Company's
quarterly and annual reports do not contain any untrue statement of a material
fact. The rules have several requirements, including having these officers
certify that: they are responsible for establishing, maintaining and regularly
evaluating the effectiveness of our internal controls; they have made certain
disclosures to our auditors and the audit committee of the Board of Directors
about our internal controls; and they have included information in our quarterly
and annual reports about their evaluation and whether there have been
significant changes in our internal controls or in other factors that could
significantly affect internal controls subsequent to the evaluation. We have
existing policies, procedures and systems designed to comply with these
regulations, and are further enhancing and documenting such policies, procedures
and systems to ensure continued compliance with these regulations.
Federal Savings Bank Operations. Matrix Bank is subject to extensive
regulation, examination and supervision by the OTS, as its primary federal
regulator, and potentially by the Federal Deposit Insurance Corporation
("FDIC"), 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 OTS to fund their 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 OTS. 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 OTS, the FDIC or Congress, could have a
material impact on Matrix Bank and its operations.
Transactions with Affiliates. Sections 23A and 23B of the Federal Reserve
Act and its implementing regulations, 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 OTS 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
19
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 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 for the purpose of
acquiring 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 OTS 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.
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 FDIC. The deposits of Matrix Bank are insured up to
$100 thousand per depositor by the FDIC. This insurance is backed by the full
faith and credit of the United States. As insurer, the FDIC imposes deposit
insurance assessments and is authorized to conduct examinations of and to
require reporting by institutions insured by the FDIC. It also may prohibit any
FDIC-insured institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious risk to the insurance fund. The FDIC 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 FDIC'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 FDIC for each semi-annual assessment period.
The FDIC 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 FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC 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 FDIC.
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, 2003, the FICO
assessment for both Savings Association Insurance Fund and Bank Insurance Fund
insured institutions was equal to 1.52 basis points 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 FDIC 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, 2003, Matrix Bank had $104.6 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.
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
20
purposes, the law establishes five categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized.
The OTS 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, 2003, 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 OTS 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 OTS 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, 2003
----------------------------------
Core Risk-Based
Capital Capital
------------------ -----------------
(Dollars in thousands)
Shareholder's equity/GAAP capital............................................. $ 106,194 $ 106,194
Intangible assets............................................................. (877) (877)
Disallowed assets............................................................. (3,816) (3,816)
Unrealized gain on available for sale securities.............................. (208) (208)
Additional capital items:
General valuation allowances............................................. - 7,396
Residual interests.................................................... - -
------------------ -----------------
Regulatory capital as reported to the OTS..................................... 101,293 108,689
Minimum capital requirement as reported to the OTS............................ 65,715 72,104
------------------ -----------------
Regulatory capital--excess.................................................... $ 35,578 $ 36,585
================== =================
Capital ratios................................................................ 6.17% 12.06%
Well capitalized requirement.................................................. 5.00% 10.00%
FHLBank System. Matrix Bank is a member of the FHLBank system, which
consists of 12 regional FHLBanks. The FHLBank provides a central credit facility
primarily for member associations and administers the home financing credit
function of savings associations. The FHLBank advances must be secured by
specified types of collateral. The FHLBank funds its operations primarily from
proceeds derived from the sale of consolidated obligations of the FHLBank
system. Matrix Bank, as a member of the FHLBank system, must acquire and hold
shares of capital stock in its regional FHLBank in an amount equal to the
greater of 1% of the aggregate principal amount of its unpaid residential
mortgage loans and
21
similar obligations at the beginning of each year, 0.3% of
total assets, or 5% of its advances ("borrowings") from the FHLBank. Prior to
relocating its domicile, Matrix Bank was a member of the FHLBank of Dallas.
Effective March 25, 2002, Matrix Bank became a member of the FHLBank of Topeka.
Matrix Bank was in compliance with the requirement discussed with an investment
in FHLBank of Dallas and FHLBank of Topeka stock at December 31, 2003 totaling
$30.7 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, 2003, 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". Matrix
Bank is deemed by the Federal Reserve to be generally sound and thus is eligible
to obtain primary credit from its Federal Reserve Bank. Generally, primary
credit is extended on a very short-term basis to meet the liquidity needs of the
institution. Loans must be secured by acceptable collateral and carry a rate of
interest of 100 basis points above the Federal Open Market Committee's federal
funds target rate.
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 OTS, as primary regulatory authority over Matrix Bank (the parent
of Matrix Financial), examines our mortgage banking operations as well. See
discussion of the sale of the production platform, which was the bulk of our
mortgage banking operations as discussed in "Item 1. Business--Discontinued
Operations."
Regulation of Sterling Trust Company. Sterling Trust provides custodial
services and directed, non-discretionary trustee services. Sterling Trust is
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 FDIC.
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 did not pay
cash dividends in 2003 and anticipates that it will not pay cash dividends
during 2004.
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
22
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.
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, 2003.
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, 2003, as adjusted, First Matrix had a net capital deficiency of
$(211) thousand, which was $281 thousand under its required net capital of $69
thousand. In connection with a routine examination of First Matrix's books and
records by the NASD, differences were identified between First Matrix's net
capital calculation performed at December 31, 2003 and the calculation prepared
by the NASD.
23
The NASD noted two technical exceptions related to excess cash on hand at an
affiliated bank, and to deductible limits on fidelity bonds. Upon receipt of the
NASD's calculation of net capital deficiency, First Matrix transferred cash from
Matrix Bank to its clearing firm, which cured the capital deficiency.
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.
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)
Phoenix, AZ..........(4) 62,771 Leased through February 28, 2007 Matrix Financial and ABS $ 62,771
Las Cruces, NM.......(3) 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
Waco, TX............. 11,294 Leased through June 30, 2006 Sterling Trust $ 13,553
Waco, TX............. 928 Leased through January 31, 2005 Sterling Trust $ 1,021
Waco, TX............. 1,204 Leased through December 31, 2006 Sterling Trust $ 1,385
Fort Worth, TX.......(5) 1,148 Leased through November 30, 2004 First Matrix $ 1,710
Fort Worth, TX.......(6) 1,856 Leased through September 30, 2008 First Matrix $ 3,498
Memphis, TN.......... 3,305 Leased through September 7, 2006 First Matrix and Matrix $ 5,731
Bancorp Trading
Cottonwood, AZ....... 1,879 Owned ABS N/A
Houston, TX.......... 71,437 Owned ABS N/A
Phoenix, AZ.......... 11,304 Owned ABS N/A
Phoenix, AZ.......... 5 Acres Owned ABS N/A
Mesa, AZ............. 6.729 Acres Owned ABS N/A
Mesa, AZ............. 7,616 Owned ABS N/A
Springerville, AZ.... 12,904 Owned ABS N/A
Lakeland, FL......... 8,521 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. 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. This space will be included
in the sale of the Las Cruces branches as discussed in "Item 1.
Business--Sale of Matrix Capital Bank Branches."
(3) This space will be included in the sale of the Las Cruces branches as
discussed in "Item 1. Business--Sale of Matrix Capital Bank Branches."
(4) Of this 62,771 square fee, approximately 29,725 square feet are leased to
Matrix Financial and ABS. Substantially all of the remaining space is
subleased to the buyer of the production platform, an unaffiliated third
party. See "Item 1. Business--Discontinued Operations."
(5) This lease had been subleased by First Matrix to an unaffiliated third
party at no gain or loss to the Company.
(6) The lease is with a limited partnership in which an officer of First Matrix
is a limited partner.
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. We
accrue for contingent liabilities with respect to litigation matters in
accordance with the requirements of Statement of Financial Accounting Standards
("SFAS") No. 5, "Accounting for Contingencies", which generally requires the
Company to accrue a loss for a litigation matter involving a contingent
liability if the loss is probable and the amount of the loss is reasonably
estimable. In order to determine whether the two conditions necessary for
accrual are met, management necessarily makes a number of judgments and
assumptions. Because the outcome of most litigation matters is inherently
uncertain, the Company will generally only accrue a loss for a pending
litigation matter if,
24
for example, the parties to the matter have entered into definitive settlement
agreements or a final judgment adverse to the Company has been entered.
In many cases, these settlements or final judgments are not material to the
consolidated financial position, results of operations or cash flows of the
Company. Nevertheless, an adverse decision in certain matters, as described
below, may have a material, adverse impact on our consolidated financial
position, results of operations or cash flows.
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 claimed 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 thousand. The
Company has appealed the decision of the arbitration panel, and the ultimate
legal and financial liability of the Company, if any, in this matter cannot be
estimated with certainty at this time.
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. The ultimate legal and financial liability of the
Company, if any, in this matter cannot be estimated with certainty at this time.
Matrix Bancorp, Matrix Bank , The Vintage Group, Inc. and Vintage Delaware
Holdings, Inc. have also been named as defendants in the Munoz matter described
below. See "--Sterling Trust."
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 was
approximately $12.4 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 instituted lawsuits, adversary proceedings or
competing bankruptcy claims against Matrix Bank claiming an equitable interest
in approximately eighteen of the Purchased Loans (approximately $2.1 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
settlements or prevailed on the merits in connection with all of these loans,
with the exception of third parties claiming ownership of, or an interest in,
seven loans having an original principal balance of approximately $830 thousand.
Matrix Bank to date has paid approximately $210 thousand in connection with the
claims in this category that it has settled. Matrix Bank intends to continue to
vigorously defend the claims of these third parties with respect to the
remaining seven loans in this category to which there continues to be a
25
dispute. The ultimate legal and financial liability of the Company, if any, in
any of the matters involving these seven loans cannot be estimated with
certainty at this time.
Additionally, certain parties in the chain of title to property securing
approximately $2.7 million of loans (a total of twenty 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
settlements with respect to all of these loans, with the exception of third
parties claiming ownership of, or an interest in, seven of these properties.
Matrix Bank to date has paid approximately $1.1 million in connection with the
claims in this category that it has settled. Matrix Bank intends to continue to
vigorously defend the claims of these third parties with respect to the
remaining seven loans in this category to which there continues to be a dispute.
The ultimate legal and financial liability of the Company, if any, in any of the
matters involving these seven loans cannot be estimated with certainty at this
time.
In connection with his review of the relationship between Matrix Bank and
Island Mortgage, the trustee for Island Mortgage claimed an interest in each of
the loans that had been purchased by Matrix Bank from Island Mortgage. His
claims included theories that, with respect to certain loans, Matrix Bank was a
secured creditor (as opposed to a purchaser) and, with respect to certain other
loans, Matrix Bank was an unsecured creditor (as opposed to a purchaser).
Accordingly, the trustee concluded, depending on which of the above theories a
particular loan fit into, that he was either entitled to a surcharge with
respect to the loans or that the estate in fact continued to own the loans.
During 2003, Matrix Bank and the trustee reached an agreement to settle these
claims, under which Matrix Bank paid the trustee approximately $930 thousand for
the trustee to relinquish any right the estate might have in any of these loans.
This matter has now been closed.
The trustee also initiated an adversary action against Matrix Bank seeking
to recover as an avoidable preference the $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 this action. 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 Bancorp, Matrix Bank, The Vintage Group, Inc. and Vintage Delaware
Holdings, Inc. have also been named as defendants in the Munoz matter described
below. See "--Sterling Trust."
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, plus post-judgment interest and conditional
attorneys' fees for the plaintiffs in connection with any appeals. Sterling
Trust appealed the judgment to the Court of Appeals for the Second District of
Texas (Fort Worth). On July 31, 2003, the Court of Appeals affirmed and reversed
in part the jury verdict. The Court of Appeals affirmed the jury's award for
actual damages of approximately $6.2 million, plus post-judgment interest and
conditional attorneys' fees for the appeals (currently estimated to be
approximately $2.8 million), but denied the punitive award of approximately $250
thousand. Sterling Trust continues to believe it has meritorious points of
appeal to the decision. On October 31, 2003, Sterling Trust filed its Petition
for Review with the Supreme Court of Texas. On January 29, 2004, the Supreme
Court of Texas notified the parties that it was requesting full briefing from
the parties on the matter. We consider this request to be a significant step in
possibly having the Court grant our petition for review and agree to hear the
case. However, we continue to caution that an appeal to the Supreme Court of
Texas is discretionary in nature, meaning that the Supreme Court of Texas does
not automatically have to hear the case. Notwithstanding the request by the
Court for full briefing on the matter, there can be no assurances that the
Supreme Court of Texas will agree to hear the case or that, if heard, Sterling
Trust's appeal will be successful. Despite the fact that a final judgment from
the trial court and the intermediate appellate court has been entered against
Sterling in this matter, management has determined that the loss in this matter
is not probable within FAS 5; accordingly, no accrual for loss with respect to
this matter has been recorded in the consolidated financial statements. The
ultimate legal and financial liability of the Company, if any, in this matter
cannot be estimated with certainty at this time.
26
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. Each of these arbitration actions has been abated pending the outcome of
the Munoz matter described below. Sterling Trust believes it has meritorious
defenses and is defending the matters vigorously. The ultimate legal and
financial liability of the Company, if any, in this matter cannot be estimated
with certainty at this time.
Sterling Trust had 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 claimed they were defrauded in connection with their
investment of approximately $200 thousand through their self-directed IRA held
by Sterling Trust. In November 2003, the Court dismissed the plaintiffs claims
without prejudice.
Sterling Trust, Matrix Bancorp, Matrix Bank, The Vintage Group, Inc. and
Vintage Delaware Holdings, Inc. have been named a defendant in an action filed
in December 2001 styled Heraclio A. Munoz, et al. v. Sterling Trust Company, et.
al. 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. The Company believes it has meritorious defenses and
is defending the matter vigorously. The ultimate legal and financial liability
of the Company, if any, in this matter cannot be estimated with certainty at
this time.
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.
Matrix Financial. Matrix Financial has been named as a defendant in an
arbitration action filed on September 17, 2003 with the American Arbitration
Association styled Veteran Home Loans, Inc. v. Matrix Financial Services
Corporation. The complaint alleges that Matrix Financial underpaid Veteran Home
Loans for services provided to Matrix Financial by Veteran Home Loans in
connection with its assistance in originating mortgage loans, and seeks general
damages for breach of contract and an accounting. Matrix Financial believes it
has meritorious defenses and is defending this matter vigorously. The ultimate
legal and financial liability of the Company, if any, in this matter cannot be
estimated with certainty at this time.
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, 2003.
27
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
-------------------------------------
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, 2003................................................ $ 9.321 $ 8.010
September 30, 2003............................................... 10.350 8.790
June 30, 2003.................................................... 10.240 8.600
March 31, 2003................................................... 9.590 8.000
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
On March 9, 2004, the closing price of our common stock was $10.65 per
share. Also, as of that date, the approximate number of holders of record of our
common stock was 36. 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 $3.0 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, 2003, 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 $3.0 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 Notes 10 and 11 to the
consolidated financial statements included elsewhere in this document. In
addition, the ability of Sterling Trust, First Matrix and Matrix Bank to pay
dividends to Matrix Bancorp may be restricted due to certain regulatory
requirements. See "Item 1. Business--Regulation and Supervision."
The following table provides information as of December 31, 2003 regarding
compensation plans (including individual compensation arrangements) under which
equity securities of the Company are authorized for issuance. For further
information, see Note 15 to the consolidated financial statements.
28
Number of
securities
remaining
available for
future issuance
under equity
Number of securities Weighted average compensation plans
to be issued upon exercise price of (excluding
exercise of outstanding securities
outstanding options, options, warrants reflected in
Plan Category warrants and rights and rights column (a))
- ---------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity compensation plans approved by
security holders (1) 609,750 10.10 362,741
======================= =================== ====================
(1) Column (a) includes the options granted under the 1996 Stock Option
Plan, which amended and restated the Company's Stock Option Plan adopted in
1995. Column (a) does not include outstanding options under the Company's
Amended and Restated Employee Stock Purchase Plan (the "ESPP"), which has a
shareholder approved reserve of 250,000 shares that is included in column (c).
Under the ESPP, each eligible employee may purchase a limited number of shares
of common stock at annual intervals each year at a purchase price per share
equal to 85% of the fair market value of the Company's common stock as of either
the beginning or ending date of the annual purchase period.
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.
Information presented in this table is from continuing operations, which
excludes the financial results of the wholesale production platform for all of
the years presented. The platform was sold in 2003 as discussed in "Item 1.
Business - Discontinued Operations." The results from continuing operations as
reflected herein are not necessarily reflective of the financial results that
might have occurred had the disposition of the platform had actually been
completed on the indicated date, and are not indicative of any future results.
See further discussion at "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Discontinued Operations - Sale
of Wholesale Production Platform."
As of and for the
Year Ended December 31,
----------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------- ------------- -------------- ------------
(Dollars in thousands, except per share data)
Statement of Operations Data
Net interest income before provision for
loan $ 41,708 $ 42,710 $ 30,183 $ 28,552 $ 28,397
and valuation losses.....................
Provision for loan and valuation losses.... 3,641 2,821 2,980 3,840 3,180
------------ ------------- ------------ -------------- ------------
Net interest income after provision for
loan and valuation losses.................. 38,067 39,889 27,203 24,712 25,217
------------ ------------- ------------ -------------- ------------
Noninterest income:
Loan administration...................... 21,668 27,359 28,273 23,850 23,686
Brokerage................................ 10,873 8,105 4,815 8,119 6,156
Trust services......................... 6,781 5,345 4,036 4,923 4,840
Real estate disposition services....... 6,624 4,153 2,572 3,677 3,659
Gain on sale of loans and securities . 14,267 5,480 4,163 982 3,247
Gain on sale of mortgage servicing
rights, net............................ - 675 167 2,634 363
School services.......................... 2,420 4,616 5,427 4,240 2,813
Other.................................... 6,696 6,201 8,934 4,536 9,445
------------ ------------- ------------ -------------- ------------
Total noninterest income............... 69,329 61,934 58,387 52,961 54,209
Noninterest expense........................ 110,968 118,848 85,585 67,635 61,403
------------ ------------- ------------ -------------- ------------
(Loss) income from continuing operations
before income taxes..................... (3,572) (17,025) 5 10,038 18,023
Income tax (benefit) expense............... (2,575) (7,756) (887) 3,632 6,658
------------ ------------- ------------ -------------- ------------
(Loss) income from continuing operations... $ (997) $ (9,269) $ 892 $ 6,406 $ 11,365
============ ============= ============ ============== ============
(Loss) income from continuing operations
per share assuming dilution(1) ......... $ (0.15) $ (1.43) $ 0.14 $ 0.95 $ 1.66
Weighted average common shares assuming
dilution................................ 6,539,195 6,462,272 6,560,454 6,748,857 6,833,546
Balance Sheet Data
Total assets............................... $1,723,924 $ 1,701,405 $ 1,646,940 $ 1,418,773 $ 1,283,746
Securities................................. 152,508 29,073 6,963 66,616 --
Total loans, net........................... 1,344,256 1,393,810 1,340,700 1,095,045 1,103,515
Mortgage servicing rights, net............. 39,744 63,200 78,712 71,529 63,479
29
As of and for the
Year Ended December 31,
----------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------- ------------- -------------- ------------
(Dollars in thousands, except per share data)
Deposits(2)................................ $ 974,059 $ 933,957 $ 866,235 $ 602,669 $ 562,194
Custodial escrow balances.................. 85,466 151,790 129,665 77,647 94,206
FHLBank borrowings......................... 458,204 385,785 303,361 519,433 405,000
Other borrowings........................... 114,495 125,903 222,032 124,503 142,101
Total shareholders' equity................. 69,684 66,936 71,312 64,023 60,497
Operating Ratios and Other Selected Data
Return from continuing operations on
average assets(3)....................... (0.06)% (0.57)% 0.56% 0.49% 1.08%
Return from continuing operations on
average equity(3)....................... (1.45) (13.07) 1.34 10.22 20.87
Average equity to average assets(3)........ 4.16 4.35 4.18 4.75 5.16
Net interest margin(3)(4).................. 2.88 3.06 2.14 2.41 3.13
Operating efficiency ratio(5).............. 73.33 76.88 71.95 70.89 54.48
Total amount of loans purchased for sale... $ 1,636,986 $ 1,127,632 $ 97,486 $ 204,922 $ 701,952
Balance of owned servicing portfolio (end
of period).............................. 3,183,536 5,333,627 5,656,365 5,517,963 5,889,715
Trust assets under administration (end of
period) ................................ 13,280,435 7,876,329 6,017,085 3,847,038 2,545,060
Ratios of Earnings to Fixed Charges(6)
Including interest on deposits............. 0.89x 0.60x 1.00x 1.15x 1.40x
Excluding interest on deposits............. 0.82x 0.18x 0.99x 1.23x 1.79x
Loan Performance Ratios and Data
Allowance for loan and valuation losses.... $ 9,789 $ 9,343 $ 9,338 $ 8,581 $ 6,354
Nonperforming loans(7) .................... 31,450 30,818 37,251 28,516 25,641
Nonperforming loans/total loans(7) ........ 2.32% 2.20% 2.76% 2.54% 2.31%
Nonperforming assets/total assets(7) ...... 2.32 2.30 2.77 2.20 2.06
Net loan charge-offs/average loans(3) ..... 0.23 0.21 0.17 0.18 0.06
Allowance for loan and valuation losses/
total loans ............................ 0.72 0.67 0.69 0.76 0.57
Allowance for loan and valuation losses/
nonperforming loans .................... 31.13 30.32 25.07 30.09 24.78
_________
(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) At December 31, 2003, 2002, 2001, 2000 and 1999, the total balance of
brokered deposits was $95.5 million, $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
from continuing operations before loan and valuation loss provision by
average interest-earning assets.
(5) The operating efficiency ratio has
been calculated by dividing noninterest expense from continuing operations,
excluding amortization of mortgage servicing rights, by operating income
from continuing operations. Operating income from continuing operations 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 from continuing operations 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.
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.
Overview
The primary source of the Company's revenue is net interest income, which
is the difference between interest income earned on loans and investments, and
interest expense paid on deposits and borrowed money. Net interest income can
change significantly from period to period based on general levels of interest
rates, customer prepayment patterns, the mix of interest earning assets and the
mix of interest bearing and non-interest bearing deposits and borrowings. The
Company manages the risk of changes in interest rates on its net interest income
through an Asset/Liability Committee and through related interest rate risk
monitoring and management policies and practices. In addition, the Company
generates revenue through fee- based services. Many of these services provide
additional low-cost deposits for, or have other synergies with, the core banking
operations.
30
During 2003, the Company sold its wholesale loan origination production
platform (as discussed in "Item 1. Business - Discontinued Operations.") We sold
the Platform because we were concerned that, over an extended period of time, we
would find it difficult to compete in the highly competitive, lower margin
mortgage origination industry, and believe that the synergies provided to our
core operations from this line of business were no longer beneficial from an
operational risk standpoint. The Company was able to successfully reinvest the
liquidity generated by the sale of the production platform without substantially
impacting its net interest income.
The historically low interest rates in 2003 were a significant challenge to
our Asset/Liability Committee. We have maintained our positive net interest gap,
which means that our assets are expected to re-price quicker than our
liabilities as interest rates change. See a detailed discussion of our
strategies to manage our risk in "Item 7. - Asset and Liability Management"
which follows. The low interest rate environment in 2003 caused continued
compression of our net interest income and was the cause of a significant amount
of amortization expense on our mortgage servicing rights. The mortgage servicing
rights are amortized based on the expected pattern and life of related servicing
revenues and our investment is also evaluated quarterly for impairment. As
interest rates fall, there is a higher probability of prepayment as the borrower
can generally refinance the loan. The historically low mortgage interest rate
environment in 2003 led to high prepayments and refinancing resulting in
continued high levels of servicing rights amortization. If interest rates remain
at current levels or increase in 2004, there should be reduced refinance
activity and reduced related amortization, and a possibility of additional
recovery on the recorded impairment. Conversely, if interest rates decrease to
levels of the summer of 2003, levels of amortization and impairments could be
significant.
Certain of our fee based business, including the acquisition, brokerage and
sale of SBA loans and loan pools, fees generated from the management and
disposition of foreclosed properties owned by independent financial services
companies, and our investment in Matrix Settlement and Clearance Services
continue to be a strong point in our operations, and in positively impacting our
core banking operations. Growth in core deposits continued in 2003, primarily
driven by deposits generated by subsidiaries of the Company for Matrix Bank. We
will focus on these businesses and our core banking operations in 2004 and
beyond.
The following portions of the Management's Discussion and Analysis focus in
more detail on the results of operations for 2003, 2002 and 2001 and on
information about the Company's balance sheet, credit quality, liquidity and
funding resources, capital, critical accounting estimates and other matters.
General
Matrix Bancorp was formed in June 1993 when the founding shareholders of
Matrix Financial and United Financial, now known as Matrix Bancorp Trading, 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 Bancorp Trading.
The principal components of our revenues consist of:
o net interest income recorded by Matrix Bank, Matrix Financial and ABS
School Services;
o brokerage and consulting fees generated by Matrix Bancorp Trading and
First Matrix;
o disposition services fees generated by Matrix Asset Management;
o gains on sales of mortgage loans generated by Matrix Bank and Matrix
Financial;
o loan administration fees generated by Matrix Financial;
o trust service fees generated by Sterling Trust and Matrix Bank; and
o school service fees generated by ABS.
31
Our results of operations are influenced by changes in interest rates and
the effect of these changes on our interest margins, 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.
Discontinued Operations - Sale of Wholesale Production Platform
On September 2, 2003, we announced the final closing, and substantial
completion of the sale by Matrix Financial of substantially all of its assets
associated with its wholesale mortgage origination platform. See "Item 1.
Business--Discontinued Operations" for a more detailed discussion. We agreed to
sell the Platform because we were concerned that, over an extended period of
time, we would find it difficult to compete in the highly competitive mortgage
origination 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 sale of
platform has allowed us to reduce our operational risks and the costs associated
with the platform. We were successful in reinvesting the liquidity created from
the sale into predominately adjustable rate loans, SBA loans and high quality
mortgage-backed securities, thereby reducing the financial impact of being
underinvested due to the sale of the production platform.
The operations of the production platform, which reflect income from
discontinued operations, net of tax effect, of $3.3 million, $5.3 million and
$7.6 million for the years ended December 31, 2003, 2002 and 2001, respectively,
are reported as discontinued operations in the consolidated financial
statements, and will be presented as such in future releases and filings, and as
such are not included in the discussion of results from continuing operations
below. It should be noted the discontinued operations are based upon the
Company's historical results from operations of the production platform,
adjusted to reflect the impact of the sale of the production platform. Because
there was an opportunity cost of owning the production platform, the historical
results are not necessarily indicative of the results that might have occurred
if the disposition had actually been completed on the indicated date, and are
not indicative of any future results.
Comparison of Results of Operations for Fiscal Years 2003 and 2002
Loss from Continuing Operations. A loss of $(1.0) million for the fiscal
year 2003 was recognized, an improvement of $8.3 million to the loss of $(9.3)
million for fiscal year 2002. On a basic and diluted per share basis, loss was
$(0.15) for the fiscal year 2003 as compared to $(1.43) for fiscal year 2002.
Our loss in 2003 was primarily caused by the incurrence of $32.5 million of
amortization of our mortgage servicing asset, which increased $8.3 million from
2002 levels. This increase was due to an increase in the prepayment speeds on
the loans underlying the mortgage servicing asset caused by the historical low
interest rate environment. The impact of the increased amortization was offset
by a recovery of $2.9 million of impairment charges recorded against our
mortgage servicing rights asset, whereas in 2002 there was a $14.2 million, net
pre-tax, impairment charge against the value of the mortgage servicing rights.
Net Interest Income. Net interest income before provision for loan and
valuation losses decreased $(1.0) million to $41.7 million for fiscal year 2003
as compared to $42.7 million for fiscal year 2002. Our net interest margin
decreased 15 basis points to 2.88% for the year ended December 31, 2003 from
3.06% for the year ended December 31, 2002, and interest rate spread decreased
to 2.57% for the year ended December 31, 2003 from 2.72% for the year ended
December 31, 2002. The decrease in net interest margin and the interest rate
spread is due to a combination of a 94 basis point decrease in the average rate
earned on average interest-earning assets to 5.08% for the year ended December
31, 2003 as compared to 6.02% for the year ended December 31, 2002. The effects
of the decrease in rates on interest-earning assets was offset partially by a
decrease in the cost of our interest-bearing liabilities of 79 basis points to
2.51% for the year ended December 31, 2003 as compared to 3.30% for the year
ended December 31, 2002. Both the decrease in the rate earned on our average
interest-earning assets, and the decrease in the cost of our average
interest-bearing liabilities is driven by continued low levels of market
interest rates prevalent throughout 2003. The impact of the low interest rate
environment is not as direct for the average interest-bearing liabilities as
certain of the term borrowings are at fixed rates. 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 increased $800 thousand, or 29.1%, to $3.6 million for fiscal
year 2003 as compared to $2.8 million for fiscal year 2002. This increase was
attributable to increased levels of reserves as a result of an increase in our
homogeneous residential
32
loan portfolio acquired to replace the originated
wholesale loans, which liquidity was available due to the sale of the production
platform as discussed in "Item 1. Business--Discontinued Operations". The
Company's historic experience is that our homogeneous residential loan portfolio
has slightly greater losses than mortgage loans that are sold within 45 days of
origination. 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. Loan administration fees decreased $(5.7) million to
$21.7 million for fiscal year 2003 as compared to $27.4 million for fiscal year
2002. Loan service 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 decreased to an average balance of $4.2 billion for
fiscal year 2003 as compared to an average balance of $5.7 billion for fiscal
year 2002. The impact of the decrease in the average balance of the servicing
portfolio was partially offset by an increase in the average service fee
(including all ancillary income) to 0.50% for the year ended December 31, 2003
as compared to 0.45% for the year ended December 31, 2002. Matrix Financial
anticipates loan administration fees to continue to decrease as its servicing
portfolio decreases through normal prepayments.
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 and retail activities, and SBA
trading fees. Brokerage fees increased $2.8 million, or 34.2%, to $10.9 million
for fiscal year 2003 as compared to $8.1 million for fiscal year 2002. This
increase was primarily the result of strong performance and the revenues
generated from the acquisition, pooling and selling of SBA loans and securities,
which increased to $3.1 million for the year ended December 31, 2003 as compared
to $1.7 million for the year ended December 31, 2002.
Trust Services. Trust service fees increased $1.4 million, or 26.9%, to
$6.8 million for fiscal year 2003 as compared to $5.4 million for fiscal year
2002. The increase is due to an increase in total trust accounts under
administration of 50,251 accounts at December 31, 2003 from 45,097 accounts at
December 31, 2002, and total fiduciary assets under administration which
increased to $13.3 billion at December 31, 2003 from $7.9 billion at December
31, 2002. The growth was due to increases at Matrix Bank's trust department,
driven by the 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 revenue increased $2.5 million, or 59.5%, between the fiscal years 2003
and 2002 to $6.6 million for the year ended December 31, 2003 as compared to
$4.1 million for the year ended December 31, 2002. The increase was due to the
increase in the number of properties closed during the year, which increased
54.2%, to 3,521 from 2,283 in 2002. Additionally, the increase is due to new
clients obtained, and increased volumes from existing clients. Properties under
management were 3,183 at December 31, 2003 as compared to 2,071 at December 31,
2002.
Gain on Sale of Loans and Securities. Gain on sale of loans and securities
increased $8.8 million, or 160.3%, to $14.3 million for fiscal year 2003 as
compared to $5.5 million for fiscal year 2002. The increase includes gains on
sale of repurchased FHA and VA loans previously sold from our mortgage servicing
rights portfolio of $10.2 for the year ended December 31, 2003 as compared to
$4.9 million for the year ended December 31, 2002. Gains on sale of repurchased
FHA and VA loans relate to delinquent loans that are purchased out of loan pools
of which Matrix Financial acts as servicer and then re-sells into the secondary
market. The gains on sale of loans and securities also includes an increase of
$1.7 million in gains on the sale of originated SBA and multi family loans at
Matrix Bank, to $1.8 million for the year ended December 31, 2003, as compared
to $100 thousand for the year ended December 31, 2002. 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 decreased to $0 for fiscal year 2003 from $700 thousand for
fiscal year 2002. Due to the low interest rate environment prevalent in the
second half of 2002 and all of 2003, the market conditions were not favorable
for our servicing portfolio. If interest rates increase and prices become more
attractive, we may sell a portion of our servicing asset. 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.
33
School Services. School services income represents fees earned by ABS,
operating as The GEO Group, for outsourced business and consulting services
provided primarily to charter schools. School services income decreased $(2.2)
million, or 47.6%, to $2.4 million for fiscal year 2003 as compared to $4.6
million for fiscal year 2002. This decrease was primarily due to a decrease in
the number of, and rates paid by our core business service clients, as a result
of the strategic decision in mid 2002 to downsize the level of capital committed
to ABS, and to reduce our operating exposure in this line of business.
Other Income. Other income, which includes loan origination income, equity
in earnings of unconsolidated subsidiaries, service and ATM fees, rental income,
structured finance trading activities, and other miscellaneous items, increased
$500 thousand, or 8.0%, to $6.7 million for fiscal year 2003 as compared to $6.2
million for fiscal year 2002. The increase was primarily due to an increase of
$900 thousand in income generated from our equity investment in Matrix
Settlement and Clearance, to $1.1 million for fiscal 2003 as compared to $200
thousand for fiscal 2002.
Noninterest Expense. Noninterest expense decreased $(7.9) million, or 6.6%,
to $111.0 million for fiscal year 2003 as compared to $118.9 million for fiscal
year 2002. This decrease was primarily due to a $14.2 million non-cash
impariment charge on mortgage servicing rights incurred in 2002 as compared to a
$3.0 million recovery of such impairment in fiscal 2003. This decrease was also
due to a $1.0 million charge to write-off the goodwill balance at ABS incurred
in 2002, whereas a similar charge was not incurred in fiscal 2003. The decrease
was offset by an increase in the level of amortization on our mortgage servicing
rights asset. The following table details the major components of noninterest
expense for the periods indicated:
Year Ended
December 31,
-------------------------------
2003 2002
--------------- --------------
(In thousands)
Compensation and employee benefits $ 34,984 $ 36,350
Amortization of mortgage servicing rights .......................................... 32,497 24,176
Occupancy and equipment............................................................. 6,172 5,600
Postage and communication........................................................ 2,435 2,676
Professional fees................................................................... 3,357 2,770
Data processing..................................................................... 2,860 2,796
(Recovery of) impairment on mortgage servicing rights............................ (2,950) 14,219
Other general and administrative.................................................... 31,613 30,261
--------------- --------------
Total.......................................................................... $ 110,968 $ 118,848
=============== ==============
Compensation and employee benefits decreased $(1.4) million, or 3.8%, to
$35.0 million for fiscal year 2003 as compared to $36.4 million for fiscal year
2002. This decrease was primarily the result of decreased salaries and wages
associated with reductions in the overall number of employees, primarily at ABS,
and by decreases in medical benefits expense associated with the structural rate
changes implemented for the 2003 benefit year. The Company had an overall
decrease of 47 employees, or 8.5%, to 509 employees at December 31, 2003 as
compared to 556 employees at December 31, 2002.
Amortization of mortgage servicing rights increased $8.3 million, or 34.4%,
to $32.5 million for fiscal year 2003 as compared to $24.2 million for fiscal
year 2002. 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 historic low interest rates prevalent in the market, prepayment speeds
on our servicing portfolio continued to increase to an average of 35.4% during
fiscal year 2003 as compared to 23.7% during fiscal year 2002, which increase
offset the effects of a decrease in the average balance of our mortgage
servicing rights to $48.7 million for the 2003 fiscal year as compared to $81.0
million for the 2002 fiscal year.
(Recovery of) impairment on mortgage servicing rights, which is a non-cash
item, reflects a recovery for the year ended December 31, 2003 of $2.9 million
as compared to an impairment charge of $14.2 million for the year ended December
31, 2002. 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 increases in interest rates in 2003, a portion of
the previously recorded impairment was recovered increasing the carrying basis
to fair value. It is not possible to estimate if future recoveries will occur,
and further decreases in market interest rates, or increases in anticipated
future prepayment speeds, may cause additional impairment charges in future
periods.
34
The remainder of noninterest expense, which includes occupancy and
equipment expense, postage and communication, professional fees, data processing
costs and other expenses increased $2.3 million, or 5.3%, to $46.4 million for
fiscal year 2003 as compared to $44.1 million for fiscal year 2002. The increase
is primarily related to increased levels of subaccounting fees paid by Matrix
Bank, increased consulting fees, consisting of accounting, auditing, information
services, legal and other, incurred at Matrix Bank, Matrix Financial and Matrix
Tower Holdings in fiscal year 2003 above those from fiscal year 2002, litigation
settlement costs in fiscal year 2003 at Matrix Financial that were not present
in fiscal year 2002, writedown of real estate owned at ABS in 2003, and losses
realized on loans repurchased at Matrix Financial related to the production
platform in 2003 that were not present in 2002.
Income Taxes. Income taxes reflect a benefit of $(2.6) million for fiscal
year 2003 as compared to a benefit of $(7.8) million for fiscal year 2002. Our
effective tax benefit was 72.1% for fiscal year 2003 as compared to an effective
tax benefit of 45.6% for fiscal year 2002. The effective tax rates are affected
by the level of tax-exempt income at ABS and Matrix Bank in proportion to the
level of net loss. The net tax exempt interest income was $3.7 million and $2.9
million for the years ended December 31, 2003 and 2002, respectively.
Comparison of Results of Operations for Fiscal Years 2002 and 2001
Net Income (Loss) from Continuing Operations. A net loss from continuing
operations of $(9.3) million for the fiscal year 2002 was recognized, a $(10.2)
million decrease to the net income of $892 thousand for fiscal year 2001. On a
basic and diluted per share basis, net loss from continuing operations was
$(1.43) for the fiscal year 2002 as compared to net income of $0.14 per basic
and 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 in accordance with SFAS No. 142, and a $700 thousand loss on
subleasing of office space.
Net Interest Income. Net interest income before provision for loan and
valuation losses increased $12.5 million to $42.7 million for fiscal year 2002
as compared to $30.2 million for fiscal year 2001. Our net interest margin
increased 92 basis points (equivalent to 0.0092 percentage points) to 3.06% for
the year ended December 31, 2002 from 2.14% for the year ended December 31,
2001, and interest rate spread increased to 2.72% for the year ended December
31, 2002 from 1.59% 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 FHLBank borrowings and certificates of deposit.
The cost of FHLBank 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 historic 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 6.16% for the year ended December 31,
2002 as compared to 6.85% 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) thouand, 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. Loan administration fees decreased $(900) thousand to
$27.4 million for fiscal year 2002 as compared to $28.3 million for fiscal year
2001. Loan service 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
35
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 0.45% for the year ended December 31, 2002
as compared to 0.50% for the year ended December 31, 2001, excluding for fiscal
2001 a $550 thousand transition adjustment, as well as $275 thousand 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.
Brokerage 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 thousand 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 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
increased $1.3 million, or 31.7%, to $5.5 million for fiscal year 2002 as
compared to $4.2 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 $4.9 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. 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 thousand to approximately $700 thousand for
fiscal year 2002 as compared to $200 thousand 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) thousand, 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. 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.
36
Other Income. Other income decreased $(2.7) million, or 30.6%, to $6.2
million for fiscal year 2002 as compared to $8.9 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.
Noninterest Expense. Noninterest expense increased $33.3 million, or 38.9%,
to $118.9 million for fiscal year 2002 as compared to $85.6 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
thousand in 2001, a $1.0 million charge to write-off the goodwill balance at
ABS, a $700 thousand 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 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.................................................. $ 36,350 $ 30,603
Amortization of mortgage servicing rights .......................................... 24,176 21,862
Occupancy and equipment............................................................. 5,600 4,545
Postage and communication........................................................... 2,676 2,410
Professional fees................................................................... 2,770 2,590
Data processing..................................................................... 2,796 2,370
Impairment of mortgage servicing rights............................................. 14,219 181
Other general and administrative.................................................... 30,261 21,024
--------------- --------------
Total.......................................................................... $ 118,848 $ 85,585
=============== ==============
Compensation and employee benefits increased $5.7 million, or 18.8%, to
$36.3 million for fiscal year 2002 as compared to $30.6 million for fiscal year
2001. This increase was primarily the result of increases in personnel costs at
Matrix Bank, 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 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 9.4%, to 556 employees at December 31, 2002 as compared to 614
employees at December 31, 2001, excluding estimated employees attributable to
the discontinued operations of the production platform. Much of the decrease
occurred in the latter part of 2002. See in "Item 1. Business--Discontinued
Operations".
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 thousand 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 retained by the Company on its originations over the last
year.
37
The remainder of noninterest expense, which includes occupancy and
equipment expense, postage and communication expense, professional fees, data
processing costs and other expenses, increased $11.2 million, or 33.9%, to $44.1
million for fiscal year 2002 as compared to $32.9 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 reflect a benefit of $(7.8) million for fiscal
year 2002 as compared to $(887) thousand for fiscal year 2001. Our effective tax
benefit was 45.6% for fiscal year 2002. The effective tax rate is affected by
the level of tax-exempt income at ABS in proportion to the level of net income
(loss).
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,
----------------------------------------------------------------------------------------
2003 2002 2001
------------------------- --------------------------- ------------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
--------- --------------- ------------------ -------- ------------------------------
(Dollars in thousands)
Assets
Interest-earning assets:
Loans receivable .....................$1,376,723 $ 71,202 5.17% $1,333,390 $82,121 6.16% $1,338,613 $91,731 6.85%
Securities............................ 28,437 1,465 5.15 11,003 594 5.40 17,667 1,335 7.56
Interest-earning deposits............. 14,227 135 0.95 24,285 337 1.39 33,746 1,008 2.99
FHLBank stock......................... 30,611 905 2.96 26,393 936 3.55 23,281 996 4.28
--------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-earning assets.......$1,449,998 73,707 5.08% $1,395,071 $83,988 6.02% $1,413,307 $95,070 6.73%
Noninterest-earning assets:
Cash.................................. 46,451 42,393 24,196
Allowance for loan and valuation (9,008) (9,445) (9,038)
losses..............................
Premises and equipment................ 25,542 22,454 17,838
Other assets.......................... 153,114 178,450 142,914
---------- ---------- ----------
Total noninterest-earning assets.... 216,099 233,852 175,910
---------- ---------- ----------
Total assets........................$1,666,097 $1,628,923 $1,589,217
========== ========== ==========
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Passbook accounts.....................$ 5,706 74 1.30% $ 5,998 117 1.95% 3,467 108 3.12%
Money market and NOW accounts.........
("NOW") accounts.................... 444,468 3,928 0.88 302,479 4,254 1.41 493,354 5,220 2.18
Certificates of deposit............... 336,623 9,336 2.77 469,226 17,125 3.65 493,954 29,544 5.98
FHLBank borrowings.................... 366,627 9,379 2.56 328,057 9,478 2.89 347,807 16,071 4.62
Borrowed money and guaranteed
preferred beneficial interests..... 120,471 9,282 7.70 143,843 10,304 7.16 176,980 13,944 7.88
---------- -------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-bearing liabilities..$1,273,895 31,999 2.51% $1,249,603 41,278 3.30% $1,262,149 64,887 5.14%
Noninterest-bearing liabilities:
Demand deposits (including custodial
escrow balances).................... 317,693 268,957 55,764
Other liabilities..................... 5,510 39,459 55,764
---------- ---------- ----------
Total noninterest-bearing
liabilities.................... 323,203 308,416 260,687
Shareholders' equity.................. 68,999 70,904 66,381
---------- ---------- ----------
Total liabilities and shareholders' $1,666,097 $1,628,923 $1,589,217
equity...........................========== ========== ==========
Net interest income before provision
for loan and valuation losses...........$ 41,708 $ 42,710 $ 30,183
========== ========== ==========
Interest rate spread.................... 2.57% 2.72% 1.59%
====== ====== ======
Net interest margin..................... 2.88% 3.06% 2.14%
====== ====== ======
Ratio of average interest-earning
assets to average interest bearing
liabilities.......................... 113.82% 111.64% 111.98%
====== ======== =======
38
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.
Year Ended December 31, 2003 vs. 2002 Year Ended December 31, 2002 vs. 2001
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...................... $ 2,604 $ (13,523) $ (10,919) $ (357) $ (9,253) $ (9,610)
Securities............................ 900 (29) 871 (422) (319) (741)
Interest-earning deposits............. (114) (88) (202) (231) (440) (671)
FHLBank stock......................... 138 (169) (31) 123 (183) (60)
---------- ---------- --------- -------- -------- ----------
Total interest-earning assets....... 3,528 (13,809) (10,281) (887) (10,195) (11,082)
----------- ---------- --------- -------- -------- ----------
Interest-bearing liabilities:
Passbook accounts..................... (6) (37) (43) 59 (50) 9
Money market and NOW accounts......... 1,599 (1,925) (326) 1,152 (2,118) (966)
Certificates of deposit............... (4,203) (3,586) (7,789) (1,414) (11,005) (12,419)
FHLBank borrowings.................... 1,049 (1,148) (99) (868) (5,725) (6,593)
Borrowed money and guaranteed
preferred beneficial interest...... (1,759) 737 (1,022) (2,448) (1,192) (3,640)
---------- ---------- --------- -------- -------- --------
Total interest-bearing liabilities.. (3,320) (5,959) (9,279) (3,519) (20,090) (23,609)
---------- ---------- --------- -------- -------- --------
Change in net interest income before
provision for loan and
valuation losses................... $ 6,848 $ (7,850) $ (1,002) $ 2,632 $ 9,895 $ 12,527
=========== ========== ========= ======== ======== ==========
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 Increasing focus on lines of business that are less interest rate
sensitive, such as brokerage activities, consulting services,
self-directed trust services, clearing operations and real estate
disposition;
o Purchasing adjustable rate mortgages;
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 longer-term advances from the FHLBank;
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 Focusing on noninterest-bearing custodial escrow balances related to
our mortgage servicing rights;
o Hedging segments of our servicing portfolio;
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; and
o Expanding our trust activities to provide custodial services to Matrix
Settlement & Clearance Services' clients to increase fee income and
low cost deposits.
The strategies outlined have been adhered to over the past several years.
As a result of the strategies, 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 increase, the rising interest rates
should have a positive impact on the net interest income. However, if
39
interest rates remain static or decrease further, we should experience some
compression in our net interest income as certain of our interest-bearing and
noninterest-bearing liabilities cannot re-price any lower. Due to the historic
low interest rate environment, our investment in mortgage servicing rights was
very unprofitable in 2003 and 2002. In the current interest rate environment,
the investment in mortgage servicing rights will cause the amortization of the
investment to remain at higher levels that initially estimated. Due to the sale
of the production platform, as discussed in "Item 1. Business--Discontinued
Operations", we do not anticipate increasing our investment in mortgage
servicing rights. We also face the challenge of managing the servicing costs of
our servicing operation as our investment continues to decrease, as many of the
costs are fixed. The increased cost in relation to the level of investment may
cause the investment to be even less profitable. We may consider several options
related to the servicing operations, including the reduction of expenses, the
potential sale of the operations, and strategic sales of the servicing asset.
During the first quarter of 2004, as dicussed in "Item 1. Business--Sale of
Matrix Capital Bank Branches", we announced the potential sale of our two retail
branch locations in Las Cruces, New Mexico. Included in the sale are
approximately $80.0 million of retail deposits, representing less than 5% of our
interest bearing liabilities, and approximately $20.0 million of loans
originated in the Las Cruces market. The decision to sell the locations will
allow us to focus our efforts on generating institutional depository alliances
which we believe is a less expensive funding strategy.
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,
----------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- -------------------- -------------------- --------------------- --------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------- ------- ------ -------
(Dollars in thousands)
Residential $ 903,186 67.19% $1,001,885 71.88% $1,055,284 78.71% $ 903,955 81.00% $ 954,424 86.49%
Multi-family, commercial
real estate and 379,931 28.26 313,237 22.47 192,225 14.34 123,491 11.07 78,046 7.07
commercial
School Financing 46,765 3.48 49,560 3.56 61,969 4.62 51,909 4.65 31,748 2.88
Construction 21,201 1.58 34,160 2.45 35,158 2.62 36,768 3.29 36,056 3.26
Consumer 2,962 0.22 4,311 0.31 5,403 0.40 8,479 0.76 9,595 0.87
--------- ------ --------- ------ ---------- ------ --------- ------ ---------- -------
Total loans 1,354,045 100.73 1,403,153 100.67 1,350,038 100.70 1,124,602 100.77 1,109,869 100.57
Less allowance for loan
and valuation losses 9,789 0.73 9,343 0.67 9,338 0.70 8,581 0.77 6,354 0.57
--------- ------ --------- ------ ---------- ------ --------- ------ ---------- -------
Loans receivable, net . $1,344,256 100.00% $1,393,810 100.00% $1,340,700 100.00% $1,116,021 100.00% $1,103,515 100.00%
========= ====== ========= ====== ========== ====== ========= ====== ========== =======
The following table presents the aggregate maturities of loans in each
major category of our loan portfolio as of December 31, 2003, excluding the
allowance for loan losses. Loans held for sale are classified as maturing over
five years. Actual maturities may differ from the maturities shown below as a
result of renewals and prepayments or the timing of loan sales.
As of December 31, 2003
------------------------------------------------------
Less than One to Over Five
One Year Five Years Years Total
------------- ------------ ------------ -------------
(In thousands)
Residential.............................................. $ 219,689 $ 658,153 $ 25,344 $ 903,186
Multi-family, commercial real estate and commercial...... 284,445 85,411 10,075 379,931
School financing......................................... 9,353 37,412 - 46,765
Construction............................................. 7,713 12,051 1,437 21,201
Consumer................................................. 1,360 1,544 58 2,962
------------- ------------ ------------ -------------
Total loans ........................................ $ 522,560 $ 794,571 $ 36,914 $ 1,354,045
============= ============ ============ =============
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, 2003
-----------------------------------------------------
Less than One to Over Five
One Year Five Years Years Total
------------- ------------ ------------ ------------
(In thousands)
Fixed ................................................... $ 37,076 $ 50,131 - 87,207
Adjustable............................................... 365,604 551,446 - 917,050
------------- ------------ ------------ ------------
Total loans ........................................ $ 402,680 $ 601,577 - 1,004,257
============= ============ ============ ============
40
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:
As of December 31, 2003
-----------------------------------------------------
Less than One to Over Five
One Year Five Years Years Total
------------- ------------ ------------ ------------
(In thousands)
Fixed ................................................... $ 57,869 $ 95,797 19,588 173,254
Adjustable............................................... 60,331 98,613 17,590 176,534
------------- ------------ ------------ ------------
Total loans ........................................ $ 118,200 $ 194,410 37,178 349,788
============= ============ ============ ============
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,
--------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
Nonaccrual residential mortgage loans............ 19,599 15,123 19,039 22,592 20,185
Nonaccrual commercial real estate, commercial
loans 11,851 15,649 18,172 5,792 5,301
and school financing ........................
Nonaccrual consumer loans........................ - 46 40 132 155
----------- ----------- ----------- ----------- -----------
Total nonperforming loans................... 31,450 30,818 37,251 28,516 25,641
Foreclosed real estate........................... 8,538 8,343 8,355 2,646 800
----------- ----------- ----------- ----------- -----------
Total nonperforming assets.................. 39,988 39,161 45,606 31,162 26,441
=========== =========== =========== =========== ===========
Total nonperforming loans to total loans......... 2.32 % 2.20 2.76 2.54 2.31%
Total nonperforming assets to total assets....... 2.32 % 2.30 2.77 2.20 2.06%
Ratio of allowance for loan and valuation losses
to total nonperforming loans................. 31.13 % 30.32 25.07 30.09 24.78%
Interest on nonperforming loans not included in
interest income.............................. 1,084 916 1,773 1,016 979
We accrue for interest on government-sponsored loans such as FHA insured
and VA 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 $12.2 million, $34.8 million and $55.2 million at
December 31, 2003, 2002 and 2001, respectively.
Nonaccrual residential mortgage loans as a percentage of total loans were
1.4% at December 31, 2003, 1.1% at December 31, 2002, 1.4% at December 31, 2001,
2.1% at December 31, 2000 and 1.8% at December 1999. The nonaccrual residential
mortgage loans have increased at December 31, 2003 as compared to December 31,
2002. The increase is due to residential portfolios added at Matrix Financial in
the latter part of 2003. The increase at Matrix Financial is related to our
origination activity prior to the sale of the production platform in February
2003, as discussed in "Item 1. Business--Discontinued Operations." The
nonaccrual loans relate to loans that have been repurchased from investors for a
breach of a representation or warranty primarily consisting of not obtaining
mortgage insurance from the FHA. We do not anticipate an increase in 2004
because we have ceased our origination activities.
The decrease in nonaccrual commercial loans and school financing in 2003 is
primarily attributable to the decreased amount of commercial real estate and
construction loans in nonaccrual status, which decreased $1.3 million to $900
thousand at December 31, 2003. In addition, there were decreases in the balance
of SBA originated and purchased loans in nonaccrual status, which decreased $1.3
million to $7.9 million at December 31, 2003. It should be noted that
approximately $5.7 million of the interest and principal of these loans is
guaranteed, and as such, our credit risk is minimized by those guarantees. With
regard to our school financing, a majority of our past origination of tax-exempt
financing for charter schools is for the purchase of real estate and equipment.
The balance of these loans in nonaccrual status decreased $1.2 million to $3.0
million at December 31, 2003. The decrease is due to our success at working with
the schools to either become current on their loans or to have their loans
refinanced with unaffiliated institutions, which results in the pay-off of the
balances outstanding with us. Not included in the 2003 balance is $600 thousand
41
of delinquent school financing 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.
The prior delinquency and anticipated future delinquencies are taken into
consideration in the pricing of the loans acquired. At December 31, 2003, $10.4
million, or 33.2%, 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, 2003, were $1.3 billion, of
which $21.0 million, or 2.15%, 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,
--------------------------------------------------------------------------------
2003 2002 2001 2000 1999
-------------- -------------- ------------- ------------ ------------
(Dollars in thousands)
Allowance for Loan and valuation losses,
beginning of year............................. 9,343 9,338 8,581 6,354 3,710
Charge-offs:
Real estate - mortgage................... 1,998 1,239 872 434 98
Real estate - construction .............. 74 -- 31 320 --
Commercial loans and school financing.... 1,319 1,482 746 819 --
Consumer................................. 139 276 659 476 509
------------ ------------ ------------ ------------ -----------
Total charge-offs................... 3,530 2,997 2,308 2,049 607
Recoveries:
Real estate - mortgage................... 101 97 4 1 2
Commercial loans and school financing.... 110 17 - - -
Consumer................................. 124 67 81 40 69
------------ ------------ ------------ ------------ -----------
Total recoveries.................... 335 181 85 41 71
------------ ------------ ------------ ------------ -----------
Net charge-offs............................... 3,195 2,816 2,223 2,008 536
Provision for loan and valuation losses
charged to operations......................... 3,641 2,821 2,980 4,235 3,180
------------ ------------ ------------ ------------ -----------
Balance at end of year........................ 9,789 9,343 9,338 8,581 6,354
============ ============ ============ ============ ===========
Ratio of net charge-offs to average loans..... 0.23 % 0.2% 0.17 0.18 % 0.06%
============ ============ ============ ============ ===========
Average loans outstanding during the year..... 1,376,723 1,333,390 1,338,613 1,086,041 877,117
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 8.0% for unsecured 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.
42
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,
---------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- --------------------- --------------------- -------------------- -------------------
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
Amount to Amount to Amount to Amount to Amount to
Total Total Total Total Total
Loans Loans Loans Loans Loans
-------- -------- --------- ---------- -------- ----------- -------- ---------- -------- ----------
(Dollars in thousands)
Residential.............. $4,018 66.70% $3,199 71.40% $3,918 78.30% $4,133 80.39% $3,591 86.00%
Multi-family, commercial
real estate and commercial 3,653 28.06 2,768 22.32 2,400 14.15 1,684 11.28 835 7.02
School financing......... 1,766 3.45 2,810 3.53 2,527 4.56 2,329 4.31 1,320 2.86
Construction............. 326 1.57 542 2.44 445 2.59 302 3.27 286 3.25
Consumer................. 26 0.22 24 0.31 48 0.40 133 0.75 322 0.87
------- --------- ------- ----------- ------- ----------- ------- ----------- ------- -----------
$9,789 100.00% $9,343 100.00% $9,338 100.00% $8,581 100.00% $6,354 100.00%
======= ========= ======= =========== ======= =========== ======= =========== ======= ===========
The ratio of the allowance for loan and valuation losses to total loans was
0.73% at December 31, 2003, 0.67% at December 31, 2002, 0.70% at December 31.
2001, 0.77% at December 31, 2000 and 0.57% at December 31, 1999. 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 increased, due to the increase 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 decreased mainly due to the decreased outstanding loan
principal balances in these loan categories. As of December 31, 2003, 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. 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; in an increasing interest rate environment, prepayments tend to
decrease, which increases expected future servicing income.
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.
43
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 to assist us with our asset/liability management. We meet
with this consulting firm quarterly to monitor the interest rate risk position
and to analyze and discuss strategies related to asset/liability management. In
2002, we purchased the software from our third party consultant to be able to
internally model asset/liability and interest rate risk positions and
alternatives as requested by the Asset and Liability Committee. We anticipate
that we will continue to engage this consulting firm on a quarterly basis to
perform quarter end models of interest rate risk and asset/liability positions
and will use our internal modeling to support asset/liability decisions between
quarter end. Part of the modeling is done to comply with the requirements of the
OTS.
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 risk associated with the guaranteed SBA
loans acquired resides with the significant premium paid for the loans. The
other significant asset that in the past we have invested 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 2003 and 2002. The
interest rate environment in 2003 remained at historically low levels. In
response to the low interest rates, we experienced significant runoff in our
servicing portfolio. Due to the volatility of the value of mortgage servicing,
we do not anticipate increasing our investment in 2004. To the contrary, we
expect our overall investment in 2004 to again decrease through normal runoff.
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. During 2003 prior to the sale of the production
platform as discussed in "Item 1. Business--Discontinued Operations", we sold
substantially all of our newly originated servicing rights with the intent of
reducing our overall investment in mortgage servicing rights. We expect in 2004
to attempt to sell portions of our mortgage servicing portfolio as the
opportunity presents itself, and continue to reduce our overall investment in
this asset.
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 custodian, which creates low-cost deposits.
With regards to our interest-sensitive liabilities, in order to take
advantage of the declining and low interest rate environment present in 2002 and
2001, and to extend the average lives of our interest-bearing liabilities,
Matrix Bank entered into short option agreements and other longer term advances
(2 to 10 years) totaling $266.0 million, which have interest rates ranging from
1.27% to 5.63%. It is anticipated that our interest margin will benefit in the
long term as interest rates increase.
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 FHLBank for
Matrix Bank, third party credit facility for ABS, and the revolving portion of
the bank stock loan for Matrix Bancorp. See "Liquidity and Capital Resources."
44
The following table sets forth a summary of our short-term borrowings
during 2003, 2002 and 2001 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, 2003:
FHLBank borrowings(2).................... $ 458,204 $ 366,627 $ 592,211 2.56% 2.17%
Revolving lines of credit................ - 5,883 18,362 4.88 -
School financing......................... 30,439 31,586 32,367 4.03 3.96
At or for the year ended December 31, 2002:
FHLBank borrowings(3).................... 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:
FHLBank borrowings(4).................... 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
__________
(1) Calculations are based on daily averages where available and monthly
averages otherwise.
(2) A total of $266.0 million of the FHLBank borrowings outstanding at December
31, 2003 were borrowed under short option advance agreements with the
FHLBank. The interest rates on the short option advance borrowings ranged
from 1.27% to 5.63% at December 31, 2003 and their possible call dates
varied from January 2004 to November 2006. Additionally, $1.2 million of
the FHLBank borrowings outstanding at December 31, 2003 are fixed-term/rate
advances, which were borrowed from the FHLBank 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 2014.
(3) A total of $266.0 million of the FHLBank borrowings outstanding at December
31, 2002 were borrowed under short option advance agreement with the
FHLBank. The interest rates on the short option advance borrowings ranged
from 1.27% 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 FHLBank borrowings outstanding at December 31, 2002 are fixed-term/rate
advances, which were borrowed from the FHLBank 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 2014.
(4) A total of $136.0 million of the FHLBank borrowings outstanding at December
31, 2001 were borrowed under short option advance agreements with the
FHLBank. 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 2002 to November 2006. Additionally, $1.4 million of
the FHLBank borrowings outstanding at December 31, 2001 are fixed-term/rate
advances, which were borrowed from the FHLBank 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 2014.
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 junior subordinated debentures 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 subordinated debt offering in February 2004;
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, 2003, Matrix Bancorp had $82.1 million in indebtedness
outstanding. The borrowed funds have been used historically as capital
injections to Matrix Bank, Matrix Financial, Matrix Bancorp Trading and ABS.
45
On March 29, 2003, Matrix Bancorp amended its bank stock loan agreement.
The amended bank stock loan agreement has two components, an $8.2 million term
loan and a revolving line of credit of $12.0 million. As of December 31, 2003,
the balance of the term loan was $6.1 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 4% of total assets from January 1, 2003
to and including March 31, 2004, and 3% of total assets thereafter, and must
also earn in excess of $7.5 million over the previous four quarters as of the
end of each fiscal quarter from June 30, 2003 forward. The covenants must be met
quarterly. As of December 31, 2003, we were in compliance with all 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, 2004.
We are in the process of renewing the revolving line of credit and are in
negotiations regarding extending the maturity date of the term loan. However,
there can be no assurances that the bank stock loan will be renewed or any terms
modified.
The Company has sponsored five trusts, Matrix Bancorp Capital Trusts I
through V, of which 100% of the common equity is owned by the Company. The
trusts were formed for the purposes of issuing corporation-obligated mandatorily
redeemable capital securities (the "capital securities") to third-party
investors and investing the proceeds from the sale of such capital securities
solely in junior subordinated debt securities of the Company. The debentures
held by each trust are the sole assets of that trust. Distributions on the
capital securities issued by each trust are payable either quarterly or
semiannually at a rate per annum equal to the interest rate being earned by the
trust on the debentures held by that trust. The capital securities are subject
to mandatory redemption, in whole or in part, upon repayment o the debentures.
The Company has entered into agreements which, taken collectively, fully and
unconditionally guarantee the capital securities subject to the term of each of
the guarantees. See details and further discussion of these trusts included in
Note 11 to the consolidated financial statements.
In February 2004, the Company issued $10.0 million of subordinated debt
with a ten-year maturity. The interest rate adjusts quarterly based on the
90-day LIBOR at a margin of 2.75%. Interest payments are to be made quarterly.
Generally, the debt covenants are no less restrictive than the Capital Trusts
discussed below. The net proceeds will be used to satisfy the full repayment of
the 11.5% senior notes (discussed in the following paragraph) in September 2004.
On September 29, 1997, we completed a registered debt offering of $20.0
million in senior notes due in September 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. 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, 2003, due to repurchases made by the Company
of the senior notes, there remained $9.5 million of the debt issue outstanding.
Through issuances of the subordinated debt in February 2004, we should have
adequate liquidity and intend to payoff the balance of the senior notes in 2004.
Matrix Bancorp has guaranteed the indebtedness of Matrix Settlement &
Clearance Services to U.S. Bank, N.A., in an amount not greater than $6.0
million. The guaranty relates to a $6.0 million line of credit with a third
party that is utilized by Matrix Settlement & Clearance Services in situations
where its clients do not wire funds to settle trades. If the guaranty is
utilized, our joint venture partner guarantees half of any such obligation. 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 $0 outstanding at Matrix Settlement & Clearance Services on such
indebtedness at December 31, 2003.
The trend of net cash used by our operating activities experienced over the
reported periods results primarily from the growth at Matrix Bank, Matrix Asset
Management and First Matrix. We anticipate that in 2004, this trend should in
part reverse as any further growth at Matrix Bank and First Matrix will be
funded through additional revenues at those companies, however, as the growth
initiatives at Matrix Asset Management are still in the early stages for certain
of their new initiatives, cash will be required to fund this growth.
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
payments could significantly impact the Company's liquidity. Historically, the
majority of the dividend payments have been made by Matrix Bank and its
46
consolidated subsidiaries, which include Matrix Financial. Due to the success
experienced by Matrix Bancorp Trading and Matrix Asset Management in 2003,
dividends were also paid by these subsidiaries to the Company. The current
dividend policy approved by Matrix Bank is 75% of the consolidated cumulative
earnings of Matrix Bank. Matrix Bank made dividend payments in 2003, for
earnings through April, 2003, and is anticipating payment of the remaining
calculated dividends for 2003 in 2004. The current dividend policy approved by
Matrix Bancorp Trading and Matrix Asset Management is 90% of the earnings of
those subsidiaries. Absent these dividend payments, the Company intends to
utilize the line of credit on its bank stock loan, as needed, to meet its own
and the other subsidiaries financial obligations. Additionally, it is
anticipated that during 2004, a portion of the capital that was committed to ABS
will be returned through dividends to Matrix Bancorp as the loans receivable at
ABS are liquidated under a strategy adopted in 2003. The timing and amounts of
this liquidation are fluid, but are anticipated to provide liquidity to the
Company during 2004.
Matrix Bank's primary source of funds for use in lending, purchasing bulk
loan portfolios, investing and other general purposes are:
o trust deposits;
o custodial escrow balances;
o brokered deposits;
o FHLBank borrowings;
o retail and wholesale deposits;
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 FHLBank as its primary source for borrowings. At December 31,
2003, Matrix Bank had overnight and term borrowings from the FHLBank of $458.2
million. The availability of FHLBank borrowings is based on the level of
collateral pledged. Generally, the availability will be limited based on
eligible 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 occurs. 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, currently concentrated primarily in Las Cruces and Sun
City, with lesser amounts in Denver. Matrix Bank relies principally on customer
service, marketing programs and its relationships with customers to attract and
retain in-market deposits. As discussed in "in "Item 1. Business--Sale of Matrix
Bank Branches", in February 2004, Matrix Bank announced the potential sale of
its two retail branch locations in Las Cruces. Included in the sale is
approximately $80.0 million of retail deposits, less than 5% of our
interest-bearing liabilities. The sale of the branches is not expected to have a
significant impact on the liquidity at Matrix Bank. Other funding sources
discussed will be utilized to replace the 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:
47
Year Ended December 31,
-------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
-------------- -------------- -------------- -------------- -------------- --------------
(Dollars in thousands)
Passbook accounts........... $ 5,706 1.30 % $ 5,998 1.95 % $ 3,467 3.12 %
NOW accounts................ 159,140 0.21 119,585 0.48 98,872 0.94
Money market accounts....... 444,468 0.81 302,479 1.22 203,757 2.11
Time deposits .............. 114,175 1.92 130,544 4.55 181,535 5.60
Brokered deposits........... 222,448 2.28 338,682 3.30 312,419 6.20
----------- ------------ ----------- ----------- ------------ -----------
Total deposits......... $ 945,937 1.41 % $ 897,288 2.40 % $ 800,050 4.36 %
----------- ------------ ----------- ----------- ------------ -----------
The following table sets forth the amount of Matrix Bank's certificates of
deposit that are greater than $100 thousand by time remaining until maturity as
of December 31, 2003:
Weighted
Amount Average Rate
Paid
--------------- ------------------
(Dollars in thousands)
Three months or less............................ $ 2,025 2.38 %
Over three months through six months............ 857 3.02
Over six months through twelve months........... 4,869 3.21
Over twelve months.............................. 10,203 4.37
--------------- ------------------
Total...................................... $ 17,954 3.77 %
--------------- ------------------
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
dependent upon retention of a portion of its earnings and will be funded through
wholesale deposit growth, brokered deposits, borrowings from the FHLBank and
custodial deposits directed by affiliates.
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. We do not anticipate significantly increasing our
current loan portfolio.
The Company has placed tax-exempt financing of approximately $29.1 million
at December 31, 2003 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 unaffiliated financial institution for one, and the
second one is guaranteed equally by two unaffiliated financial institutions. The
first trust's letter of credit arrangement, which currently holds approximately
$13.0 million of tax-exempt financing, is scheduled to mature September 2004.
The second trust's letter of credit arrangement, which currently holds
approximately $17.0 million of tax-exempt financing, is scheduled to mature
September 2005. Without the letters of credit, ABS will be required to fund the
tax-exempt financings. We are in the process of attempting to refinance several
of the financings with third party lenders. To the extent that we are
unsuccessful, we will attempt to extend the letter of credit arrangements or
seek other borrowing options. The "A" Certificates' interest rate may be
determined weekly, monthly or for a term of 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, 2003 and 2002 was 1.65% and 1.55%,
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 is obligated on a full recourse basis 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
48
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 $10.5 million at
December 31, 2003.
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. We accrue for contingent liabilities with respect to
litigation matters in accordance with the requirements of SFAS 5, which
generally requires the Company to accrue a loss for a litigation matter
involving a contingent liability if the loss is probable and the amount of the
loss is reasonably estimable. 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, and, an adverse decision in certain matters, as
described in "Item 3. Legal Proceedings," may have a material, adverse impact on
our consolidated liquidity or capital.
With regard to the Adderley case at Sterling Trust discussed in "Item 3.
Legal Proceedings," it was noted that the Court of Appeals for the Second
District of Texas (Fort Worth) affirmed a portion of the jury's award for the
plaintiffs and against Sterling Trust for actual damages of $6.2 million, plus
post-judgment interest and conditional attorneys fees for the appeals. We also
noted that we are appealing this decision to the Supreme Court of Texas, but
noted that there are no assurances that the Supreme Court of Texas will agree to
hear the case, or that, if heard, Sterling Trust's appeal will be successful. If
we are unsuccessful in this appeal, and if we elect to contribute the capital to
Sterling Trust to pay the judgment, there would be a significant impact on the
liquidity of the Company.
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, and along with the disclosures presented in the other financial
statement notes, provide information on how significant assets and liabilities
are value in the financial statements and how those values are determined.
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
49
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 currently views the determination of the allowance for loan and
valuation losses as a critical accounting policy that requires the most
significant judgments, assumptions and estimates used in preparation of its
consolidated financial statements. The allowance for loan losses represents
management's estimate of probable credit losses inherent in the loan portfolios,
which represent the largest asset type on the consolidated balance sheet.
Estimating the amount of the allowance for loan losses requires significant
judgment and the use of estimates related to the amount and timing of expected
future cash flows on impaired loans, estimated losses on pools of homogeneous
loans based on historical loss experience, and consideration of current economic
trends and conditions, all of which may be susceptible to significant change.
Loan losses are charged off against the allowance, while recoveries of amounts
previously charged off are credited to the allowance. A provision for loan
losses is charged to operations based on management's periodic evaluation of the
factors previously mentioned, as well as other pertinent factors.
The allowance for loan losses consists of an allocated component and an
unallocated component. The components of the allowance for loan losses represent
an estimation done pursuant to either SFAS 5, "Accounting for Contingencies", or
SFAS 114, "Accounting by Creditors for Impairment of a Loan", as appropriate.
The unallocated portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio due to
uncertainties in economic conditions, delays in obtaining information, including
unfavorable information about a borrower's financial condition, the difficulty
in identifying triggering events that correlate perfectly to subsequent loss
rates, and risk factors that have not yet manifested themselves in loss
allocation factors. The Company has expanded the geographic footprint in which
it operates, and changed its portfolio mix in recent years. As a result,
historical loss experience data used to establish allocation estimates may not
precisely correspond to the current portfolio. Uncertainty surrounding the
strength and timing of economic cycles also affects estimates of loss. The
historical losses used may not be representative of actual unrealized losses
inherent in the portfolio.
The allocated component of the allowance for loan losses reflects expected
losses resulting from analyses developed through specific credit allocations for
individual loans and historical loss experience for each loan category. The
specific credit allocations are based on regular analyses of all loans over a
fixed-dollar amount where the internal credit rating is at or below a
predetermined classification. These analyses involve a high degree of judgment
in estimating the amount of loss associated with specific loans, including
estimating the amount and timing of future cash flows and collateral values. The
historical loan loss element is generally based on historical loss experience,
loss factors are updated as needed based on actual experience. The allocated
component of the allowance for loan losses also includes consideration of
concentrations and changes in portfolio mix and volume.
There are many factors affecting the allowance for loan losses; some are
quantitative while others require qualitative judgment. Although management
believes its process for determining the allowance adequately considers all of
the potential factors that could potentially result in credit losses, the
process includes subjective elements and may be susceptible to significant
change. To the extent actual outcomes differ from management estimates,
additional provision for credit losses could be required that could adversely
affect earnings or financial position in future periods.
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. Our
mortgage servicing portfolio does not trade in an active open market with
readily observable market prices. Although sales of mortgage servicing rights do
occur, the exact terms and conditions may not be readily available. As such,
mortgage servicing rights are established and valued in accordance with SFAS 140
using discounted cash flow modeling techniques which require management to make
estimates regarding future net servicing cash flows, taking into consideration
actual and expected mortgage loan prepayment rates, discount rates, servicing
costs, and other economic factors. The expected and actual rates of mortgage
loan prepayments are the most significant factors driving the value of mortgage
servicing rights asset. Increases in mortgage loan prepayments reduce estimated
future net servicing cash flows because the life of the underlying loan is
reduced. In determining the fair value of the mortgage servicing rights,
mortgage interest rates, which are used to determine prepayment rates, and
discount rates are held constant over the estimated life of the portfolio.
Expected mortgage loan prepayment rates are derived from a third-party model and
may be adjusted to reflect the specific characteristics of the Company's
portfolio. Mortgage servicing rights are carried at the lower of the initial
capitalized amount, net of accumulated amortization, or fair value. Management
compares its fair value estimates and assumptions to observable market data
where available and to recent market activity and believes that the fair values
and related assumptions are comparable to those used by other market
participants. The Company has recorded impairment reserves and recoveries of
50
such reserves based on the market conditions and the valuation analysis.
Although management believes its process for determining the impairment reserve
required adequately considers all of the potential factors that could
potentially result in declines in value of the mortgage servicing rights, the
process includes subjective elements and may be susceptible to significant
change. To the extent actual outcomes differ from management estimates,
additional provision for impairment could be required that could adversely
affect earnings or financial position in future periods. The Company mitigates
risk associated with declines in the estimated fair value of mortgage servicing
rights due to increases in mortgage loan prepayments through the use of
derivative instruments that are expected to increase in value when interest
rates decline.
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. We accrue for contingent
liabilities with respect to litigation matters in accordance with the
requirements of SFAS 5, which generally requires the Company to accrue a loss
for a litigation matter involving a contingent liability if the loss is probable
and the amount of the loss is reasonably estimable. 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.
Any material effect on the consolidated financial statements related to
these critical accounting areas is also discussed in this financial review.
Recent Accounting Pronouncements
Note 2 to the consolidated financial statements discusses new accounting
policies adopted by the Company during 2003 and the expected impact of
accounting policies recently issued or proposed but not yet required to be
adopted. To the extent the adoption of new accounting standards materially
affects financial condition, results of operations, or liquidity, the impacts
are discussed in the applicable section(s) of this discussion and the notes to
the consolidated financial statements.
Contractual Obligations, Commitments, Contingent Liabilities and Off-Balance
Sheet Arrangements
The following table presents, as of December 31, 2003, 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, 2003
------------------------------------------------------------------------------------
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 $ - $ - $ - $762,496 $762,496
Certificate accounts........................ 9 121,003 70,162 20,398 - 211,563
FHLBank borrowings.......................... 12 - - - 458,204 458,204
Borrowed money.............................. 10 31,097 16,873 - - 47,970
Junior subordinated debentures owed
to unconsolidated subsidiary trusts...... 11 - - - 66,525 66,525
Operating leases............................ 16 1,158 2,007 548 525 4,238
A schedule of significant commitments at December 31, 2003 follows:
Commitments (In thousands)
Loans secured by mortgages.................. $ 50,155
Construction loans.......................... 12,833
Commercial lines of credit.................. 1,583
Commercial loans............................ 747
Consumer loans.............................. 848
51
Further discussion of these commitments is included in Note 16 of the
consolidated financial statements. In addition, the Company has contingencies
due to various litigation matters which are also discussed in Note 16 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 16 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
None.
Item 9A. Controls and Procedures
Management of the Company is responsible for establishing and maintaining
effective disclosure controls and procedures, as defined under Rules 13a-15(e)
and 15d-15(b) of the Securities Exchange Act of 1934. As of December 31, 2003,
an evaluation was performed under the supervision and with the participation of
the Company's management, including the Co-Chief Executive Officers and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on that evaluation, the
Company's management concluded that the Company's disclosure controls and
procedures as of December 31, 2003 were effective in ensuring that information
required to be disclosed in this Annual Report on Form 10-K was recorded,
processed, summarized, and reported within the time period required by the SEC's
rules and forms. There have been no significant changes in the Company's
internal controls over financial reporting that occurred during the quarter
ended December 31, 2003 that have significantly affected, or are likely to
materially affect, the Company's internal controls over financial reporting.
52
PART III
Items 10 through 14.
The information for these items is incorporated from the definitive proxy
statement to be filed with the Commission within 120 days of December 31, 2003.
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 4, 2003 (Item 7) which contained a press
release announcing the third quarter 2003 earnings of the Company.
(c) Exhibits
See Exhibit Index, beginning on page II-1.
(d) Financial Statement Schedules
None.
53
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 12th day of
March, 2004.
MATRIX BANCORP, INC.
Dated: March 12, 2004 /s/ D. Mark Spencer
----------------------- ---------------------------------------
D. Mark Spencer
President and Co-Chief Executive
Officer
(Principal Executive Officer)
Dated: March 12, 2004 /s/ Richard V. Schmitz
----------------------- ---------------------------------------
Richard V. Schmitz
Co-Chief Executive Officer
Dated: March 12, 2004 /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 12, 2004
- ---------------------------- Officer and a Director
D. Mark Spencer (Principal Executive Officer)
/s/ Richard V. Schmitz Co-Chief Executive Officer and March 12, 2004
- ---------------------------- Chairman of the Board
Richard V. Schmitz
/s/ Guy A. Gibson Director March 12, 2004
- ----------------------------
Guy A. Gibson
/s/ David A. Frank Director March 12, 2004
- ----------------------------
David A. Frank
/s/ Robert T. Slezak Director March 12, 2004
- ----------------------------
Robert T. Slezak
/s/ Lester Ravitz Director March 12, 2004
- ----------------------------
Lester Ravitz
/s/ Dr. James Bullock Director March 12, 2004
- ----------------------------
Dr. James Bullock
54
INDEX TO EXHIBITS
3.1 ////// Articles of Amendment to the Articles of Incorporation (3.1)
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)
4.32 FH Indenture, dated February 13, 2004, between Registrant and
Wells Fargo Bank, as Trustee, relating to Floating Rate
Subordinated Debt Security due 2014.
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 Matrix Funding Corp. and Nicholson Enterprises,
Inc. (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 //// 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)
10.16 * 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)
10.17 ** 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)
10.18 ///// 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)
10.19 **** 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
10.20 ******* Fifth Amendment to Credit Agreement, dated as of March 29,
2003, by and between Registrant, as borrower, and U.S. Bank
National Association, as agent, and certain lenders, as
lenders (10.1)
10.21 //// Lease dated as of September 1, 1999, by and between Matrix
Financial Services Corporation and Suncor Development
Company (10.22)
10.22 //// Lease with a reference date of 1999, by and between the
Registrant and the Regents of the University of Colorado
(10.23)
10.23 ///// Lease dated as of December 21, 2001 by and between Matrix
Bancorp, Inc. and WXI/SEV Realty, LLC (10.1)
10.24 //// 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)
10.25 //// 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)
10.26 ////o Matrix Bancorp, Inc. Executive Incentive Plan (10.27)
10.27 /////o Matrix Bancorp, Inc. (f/k/a Matrix Capital Corporation)
401(k) Profit Sharing Plan (10.29)
10.28 /////o Amendment No. 1, effective as of January 1, 1994, to the
Registrant's 401(k) Profit Sharing Plan (10.30)
10.29 /////o Amendment No. 2, effective as of May 20, 1996, to the
Registrant's 401(k) Profit Sharing Plan (10.31)
10.30 /////o Amendment No. 3, effective as of April 1, 1997, to the
Registrant's 401(k) Profit Sharing Plan (10.32)
10.31 /////o Amendment No. 4, effective as of December 30, 2001, to the
Registrant's 401(k) Profit Sharing Plan (10.33)
10.32 ***** Warehousing Credit and Security Agreement, dated as of March
29, 2002, by and between Matrix Bancorp Trading, Inc., as
borrower, and Residential Funding Corporation, as agent
(10.1)
10.33 ***** First Amendment to Warehousing Credit and Security
Agreement, dated as of May 24, 2002, by and between Matrix
Bancorp Trading, Inc., as borrower, and Residential Funding
Corporation, as agent (10.2)
10.34 +++o Consulting Agreement, dated as of June 5, 2002, by and
between Guy A. Gibson and Matrix Bancorp, Inc. (10.1)
10.35 +++++ Purchase and Assumption Agreement, dated as of February 28,
2003, by Matrix Financial Services Corporation, as seller,
and AmPro Mortgage Corporation, as purchaser (10.1)
10.36 ******* First Amendment to Purchase and Assumption Agreement, dated
as of April 18, 2003, by and between Matrix Financial
Services Corporation, as seller, Matrix Capital Bank, as
parent, and AmPro Mortgage Corporation, as purchaser (10.2)
10.37 ******** Second Amendment to Purchase and Assumption Agreement, dated
as of July 22, 2003, by and between Matrix Financial
Services Corporation, as seller, Matrix Capital Bank, as
parent, and AmPro Mortgage Corporation, as purchaser (10.1)
10.38 +++++ Third Amendment to Purchase and Assumption Agreement, dated
as of August 31, 2003, by and between Matrix Financial
Services Corporation, as seller, Matrix Capital Bank, as
parent, and AmPro Mortgage Corporation, as purchaser (10.4)
10.39 FHo Change of Control Agreement, dated as of October 28, 2003 by
and between Matrix Bancorp, Inc. and David W. Kloos
10.40 FHo Change of Control Agreement, dated as of October 28, 2003 by
and between Matrix Bancorp, Inc. and T. Allen McConnell
10.41 FH Branch Purchase and Deposit Assumption Agreement, dated as
of January 30, 2004 by and between Matrix Capital Bank and
FirstBank
12 FH Statement Re: Computations of Ratios
21 FH Subsidiaries of the Registrant
23.1 FH Consent of KPMG LLP
31.1 FH Certification by D. Mark Spencer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 FH Certification by Richard V. Schmitz pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
II-3
31.3 FH Certification by David W. Kloos pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 FH 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.
32.2 FH 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.
32.3 FH 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.
__________
FH 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 annual report on Form 10-K for the fiscal year ended
December 31, 2002, 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 report on Form 8-K filed by the Registrant with the
Commission on September 15, 2003.
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
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.
*****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 quarterly report on Form 10-Q for the quarter ended
March 31, 2003, 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, 2003, 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..........................................................................F-2
Consolidated Balance Sheets--December 31, 2003 and 2002...............................................F-3
Consolidated Statements of Operations--for the years ended
December 31, 2003, 2002 and 2001......................................................................F-4
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
for the years ended December 31, 2003, 2002 and 2001..................................................F-6
Consolidated Statements of Cash Flows--for the years ended
December 31, 2003, 2002 and 2001......................................................................F-7
Notes to Consolidated Financial Statements............................................................F-9
F-1
Independent Auditors' Report
The Board of Directors and Shareholders
Matrix Bancorp, Inc.:
We have audited accompanying consolidated balance sheets of Matrix Bancorp, Inc.
and subsidiaries (the Company) as of December 31, 2003 and 2002, and the related
consolidated statements of operations, shareholders' equity and comprehensive
income (loss), and cash flows for each of the years in the three-year period
ended December 31, 2003. 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 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 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, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in note 2 to the consolidated financial statements, the Company
changed its method of accounting for variable interest entities in 2003 and
changed its method of accounting for goodwill and other intangible assets in
2002.
KPMG LLP
Denver, Colorado
March 5, 2004
F-2
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)
December 31,
2003 2002
------------------------------------
Assets
Cash and cash equivalents $ 32,538 $ 58,705
Interest-earning deposits and federal funds sold 1,972 3,707
Investment securities 152,508 29,073
Loans held for sale, net 999,454 1,136,159
Loans held for investment, net 344,802 257,651
Mortgage servicing rights, net 39,744 63,200
Other receivables 43,884 54,818
FHLBank stock, at cost 30,682 30,379
Foreclosed real estate 8,538 8,343
Premises and equipment, net 24,981 27,705
Bank owned life insurance 20,613 -
Other assets, net 24,208 31,665
------------------------------------
Total assets $ 1,723,924 $ 1,701,405
====================================
Liabilities and shareholders' equity
Liabilities:
Deposits $ 974,059 $ 933,957
Custodial escrow balances 85,466 151,790
Draft Payable - 7,097
FHLBank borrowings 458,204 385,785
Borrowed money 47,970 61,403
Junior subordinated debentures owed to unconsolidated subsidiary
trusts 66,525 -
Corporation-obligated mandatorily redeemable capital securities of
subsidiary trusts holding solely debentures of the Company - 64,500
Other liabilities 18,508 23,165
Income taxes payable and deferred income tax liability 3,508 6,772
------------------------------------
Total liabilities 1,654,240 1,634,469
------------------------------------
Commitments and contingencies (Note 16)
Shareholders' equity:
Preferred stock, par value $0.0001; authorized
5,000,000 shares; no shares outstanding - -
Common stock, par value $0.0001; authorized 50,000,000 shares;
issued and outstanding 6,518,981 and 6,489,543 shares at
December 31, 2003 and 2002, respectively 1 1
Additional paid-in capital 20,615 20,375
Retained earnings 48,859 46,534
Accumulated other comprehensive income 209 26
------------------------------------
Total shareholders' equity 69,684 66,936
------------------------------------
Total liabilities and shareholders' equity $ 1,723,924 $ 1,701,405
====================================
See accompanying notes to consolidated financial statements.
F-3
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except share information)
Years Ended December 31,
2003 2002 2001
----------------------------------------------
Interest and dividend income:
Loans and securities $ 72,667 $ 82,715 $ 93,066
Interest-earning deposits 1,040 1,273 2,004
----------------------------------------------
Total interest and dividend income 73,707 83,988 95,070
Interest expense:
Savings and time deposits 9,410 17,242 29,652
Demand and money market deposits 3,928 4,254 5,220
FHLBank borrowings 9,379 9,478 16,071
Borrowed money and junior subordinated debentures 9,282 10,304 13,944
----------------------------------------------
Total interest expense 31,999 41,278 64,887
----------------------------------------------
Net interest income before provision for loan and valuation losses 41,708 42,710 30,183
Provision for loan and valuation losses 3,641 2,821 2,980
----------------------------------------------
Net interest income after provision for loan and valuation losses 38,067 39,889 27,203
Noninterest income:
Loan administration 21,668 27,359 28,273
Brokerage 10,873 8,105 4,815
Trust services 6,781 5,345 4,036
Real estate disposition services 6,624 4,153 2,572
Gain on sale of loans and securities 14,267 5,480 4,163
Gain on sale of mortgage servicing rights, net - 675 167
School services 2,420 4,616 5,427
Other 6,696 6,201 8,934
----------------------------------------------
Total noninterest income 69,329 61,934 58,387
Noninterest expense:
Compensation and employee benefits 34,984 36,350 30,603
Amortization of mortgage servicing rights 32,497 24,176 21,862
Occupancy and equipment 6,172 5,600 4,545
Postage and communication 2,435 2,676 2,410
Professional fees 3,357 2,770 2,590
Data processing 2,860 2,796 2,370
(Recovery of) impairment on mortgage servicing rights (2,950) 14,219 181
Other general and administrative 31,613 30,261 21,024
----------------------------------------------
Total noninterest expense 110,968 118,848 85,585
(Loss) income from continuing operations before income taxes (3,572) (17,025) 5
Income tax benefit (2,575) (7,756) (887)
----------------------------------------------
(Loss) income from continuing operations (997) (9,269) 892
----------------------------------------------
Discontinued operations:
Income from discontinued operations, net of income tax provision of
$2,149, $3,439 and $5,162, respectively 3,322 5,317 7,620
----------------------------------------------
Net income (loss) $ 2,325 $ (3,952) $ 8,512
==============================================
F-4
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except share information)
Years Ended December 31,
2003 2002 2001
----------------------------------------------
----------------------------------------------
(Loss) income from continuing operations per share - basic $ (0.15) $ (1.43) $ 0.14
----------------------------------------------
(Loss) income from continuing operations per share - assuming dilution
$ (0.15) $ (1.43) $ 0.14
----------------------------------------------
Income from discontinued operations per share - basic $ 0.51 $ 0.82 $ 1.17
----------------------------------------------
Income from discontinued operations per share - assuming dilution
$ 0.51 $ 0.82 $ 1.16
----------------------------------------------
Net income (loss) per share - basic $ 0.36 $ (0.61) $ 1.31
==============================================
Net income (loss) per share - assuming dilution $ 0.36 $ (0.61) $ 1.30
==============================================
Weighted average shares - basic 6,494,803 6,462,272 6,495,583
==============================================
Weighted average shares - assuming dilution 6,539,195 6,462,272 6,560,454
==============================================
See accompanying notes to consolidated financial statements.
F-5
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
(Dollars in thousands)
Accumulated
Common Stock Additional Other Comprehensive
------------------ Paid-In Treasury Retained Comprehensive Income
Shares Amount Capital Shares Earnings Income Total (loss)
----------------------------------------------------------------------------------------------
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
plan and options 36,999 - 301 - - - 301
Comprehensive (loss):
Net loss - - - - (3,952) - (3,952) $ (3,952)
Net unrealized holding
gains(1) - - - - - 1 1 1
---------
Comprehensive (loss) $ (3,951)
-------------------------------------------------------------------------------------=========
Balance at December 31, 2002 6,489,543 $ 1 $ 20,375 $ - $ 46,534 $ 26 $ 66,936
-------------------------------------------------------------------------------------
Issuance of stock related to employee
stock purchase 29,438 - 240 - - - 240
plan and options
Comprehensive income:
Net income - - - - 2,325 - 2,325 $ 2,325
Net unrealized holding
gains(1) - - - - - 183 183 183
---------
Comprehensive income $ 2,508
-------------------------------------------------------------------------------------=========
Balance at December 31, 2003 6,518,981 $ 1 $ 20,615 $ - $ 48,859 $ 209 $ 69,684
-------------------------------------------------------------------------------------
(1) Disclosure of reclassification amount
Unrealized holding gain arising during the year ended December 31, 2003 $ 183
Less: reclassification adjustment of gains included in net income (loss) -
---------
Net unrealized holding gain on securities $ 183
=========
See accompanying notes to consolidated financial statements.
F-6
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
Years Ended December 31,
2003 2002 2001
---------------------------------------------
Operating activities
Net (loss) income from continuing operations $ (997) $ (9,269) $ 892
Adjustments to reconcile net (loss) income from
continuing operations to net cash used in operating activities:
Depreciation and amortization 3,652 3,978 2,473
Provision for loan and valuation losses 3,641 2,821 2,980
Amortization of mortgage servicing rights 32,497 24,176 21,862
(Recovery) impairment on mortgage servicing rights (2,950) 14,219 181
Gain on sale of loans and securities (14,267) (5,480) (4,163)
Gain on sale of mortgage servicing rights - (675) (167)
Loss (gain) on sale of building and equipment - 17 (3,425)
Gain on sale of foreclosed real estate (925) (284) (16)
Changes in assets and liabilities:
Loans originated for sale, net of loans sold (16,216) (109,014) (753,783)
Loans purchased for sale (1,636,986) (1,127,632) (97,486)
Principal payments on, and proceeds from sale of loans held 743,713 684,364 261,802
for sale
Originated mortgage servicing rights, net (5,717) (34,511) (30,266)
(Increase) decrease in other receivables and other assets 18,508 10,608 (19,844)
Decrease in payable for purchase of mortgage servicing rights (581) (3,956) (7,791)
(Decrease) increase in other liabilities, income taxes
payable and deferred income tax liability (5,191) 26,964 (29,519)
---------------------------------------------
Net cash used in operating activities from continuing operations (881,819) (523,674) (656,270)
Net cash provided by discontinued operations 353,903 139,964 417,609
---------------------------------------------
Net cash used in operating activities (527,916) (383,710) (238,661)
---------------------------------------------
Investing activities
Loans originated and purchased for investment (236,055) (253,672) (159,619)
Principal repayments on loans held for investment 130,302 137,972 144,002
Purchase of available for sale securities (29,397) (10,994) (1,042)
Proceeds from sale of available for sale securities 653,744 422,685 72,705
Proceeds from maturity and prepayment of available for sale 1,348 1,728 5,912
securities
Purchase of held to maturity securities (40,440) - -
(Purchase) redemption of FHLBank stock, net (303) (12,198) 9,633
Purchase of bank owned life insurance (20,000) - -
Purchases of premises and equipment (4,121) (17,614) (14,415)
Acquisition of mortgage servicing rights (374) - (530)
Proceeds from the sale of building and equipment - 45 14,601
Proceeds from sale of foreclosed real estate 12,306 8,306 1,521
Proceeds from sale of mortgage servicing rights - 9,682 1,600
---------------------------------------------
Net cash provided by investing activities 467,010 285,940 74,368
---------------------------------------------
F-7
Matrix Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
(Dollars in thousands)
Years Ended December 31,
2003 2002 2001
---------------------------------------------
Financing activities
Net increase in deposits $ 40,102 $ 67,722 $ 263,566
Net (decrease) increase in custodial escrow balances (66,324) 22,125 52,018
Increase (decrease) in revolving lines, net 60,530 (18,663) (138,946)
Payments of notes payable (1,515) (1,981) (13,298)
Proceeds from notes payable - 2,000 1,786
Payment of financing arrangements (29) (61) (86)
Proceeds from issuance of capital securities of subsidiary
trusts - 5,000 30,977
Treasury shares repurchased - (726) (746)
Proceeds from issuance of common stock related to employee stock
purchase plan and options 240 301 317
---------------------------------------------
Net cash provided by financing activities 33,004 75,717 195,588
---------------------------------------------
(Decrease) increase in cash and cash equivalents (27,902) (22,053) 31,295
Cash and cash equivalents at beginning of the year 62,412 84,465 53,170
---------------------------------------------
Cash and cash equivalents at end of the year $ 34,510 $ 62,412 $ 84,465
=============================================
Supplemental disclosure of non-cash activity
Loans transferred to foreclosed real estate $ 12,572 $ 8,010 $ 7,214
=============================================
Loans transferred to securities available for sale $ 708,507 $ 435,528 $ 19,196
=============================================
Supplemental disclosure of cash flow information
Cash paid for interest $ 32,592 $ 45,050 $ 62,520
=============================================
Cash paid (received) for income taxes $ 2,879 $ (4,074) $ 4,557
=============================================
See accompanying notes to consolidated financial statements.
F-8
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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 Bancorp Trading, Inc. ("Matrix Bancorp
Trading"), 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 Denver, Colorado, Las Cruces, New Mexico, and Phoenix,
Arizona, by providing personal and business depository services, trust services,
offering residential loans and providing commercial real estate, Small Business
Administration, multi-family and consumer loans. During 2002, Matrix Bank
completed the relocation of its domicile from Las Cruces to Denver. On January
30, 2004, Matrix Bank entered into a definitive agreement to sell its two
branches in Las Cruces to Access Anytime BanCorp, Inc.'s subsidiary, FirstBank.
The sale is subject to regulatory approval and other customary conditions, and
is expected to be completed in the second quarter of 2004. The sale would
include deposits and loans of the Las Cruces branches (approximately $84.1
million and $23.8 million as of December 31, 2003, respectively). The sale of
the branches is not expected to significantly impact the operations or liquidity
of Matrix Bank or the Company.
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. On September 2, 2003, the
Company announced the final closing, and substantial completion of the sale by
Matrix Financial of substantially all of its assets associated with its
wholesale mortgage origination platform, as discussed more fully in Note 3
below. The servicing platform was retained. Servicing mortgage loans involves
the contractual right to receive a fee for processing and administering mortgage
loan payments.
Matrix Bancorp Trading, formerly known as Matrix Capital Markets, Inc., 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.
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.
F-9
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Organization (continued)
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.
ABS, operating under the trade name The GEO Group, provides outsourced business
services and financing primarily to charter schools.
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
Accounting Research Bulletin No. 51 ("ARB 51"), Consolidated Financial
Statements, requires a company's consolidated financial statements to include
subsidiaries in which the company has a controlling financial interest. This
requirement has been applied to subsidiaries in which a company has a majority
voting interest. Investments in companies in which the Company controls
operating and financing decisions (principally defined as owning a voting or
economic interest greater than 50%) are consolidated, and intercompany accounts
and transactions have been eliminated in consolidation. The Company's investment
in Matrix Settlement & Clearance Services, LLC ("MSCS") in which the Company has
significant influence over operating and financing decisions (principally
defined as owning a voting or economic interest of 20% to 50%) is accounted for
by the equity method of accounting. This investment is included in other assets
and the Company's proportionate share of income or loss is included in other
noninterest income.
The voting interest approach defined in ARB 51 is not applicable in identifying
controlling financial interests in entities that are not controllable through
voting interests or in which the equity investors do not bear the residual
economic risks. In such instances, Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", and the reissued FIN 46, indicate
when a company should include in its financial statements the assets,
liabilities and activities of another entity. In general, a variable interest
entity ("VIE") is a corporation, partnership, trust, or any other legal
structure used for business purposes that either does not have equity investors
F-10
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
with voting rights or has equity investors that do not provide sufficient
financial resources for the entity to support its activities. FIN 46 provides
guidance on how to identify a VIE and determine when the assets, liabilities,
noncontrolling interests, and results of operations of a VIE are to be included
in an entity's consolidated financial statements. A VIE exists when either the
total equity investment at risk is not sufficient to permit the entity to
finance its activities by itself, or 2. Significant Accounting Policies
(continued)
the equity investors lack one of three characteristics associated with owning a
controlling financial interest. Those characteristics include the direct or
indirect ability to make decisions about an entity's activities through voting
rights or similar rights, the obligation to absorb the expected losses of an
entity if they occur, or the right to receive the expected residual returns of
the entity if they occur. The Company has 5 VIE's in the form of its
wholly-owned subsidiary trusts that issued capital securities to third-party
investors and to certain direct and indirect interests in investment
partnerships, commonly referred to as Trust Preferred securities. Such VIE's
have been deconsolidated in the financial statements as of December 31, 2003.
Further discussion regarding these securitization trusts is included below and
in Note 11.
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 16.
Most of these cases involve ordinary and routine claims incidental to our
business. We accrue for contingent liabilities with respect to litigation
matters in accordance with the requirements of Statement of Financial Accounting
Standards ("SFAS") No. 5, "Accounting for Contingencies," which generally
requires the Company to accrue a loss for a litigation matter involving a
contingent liability if the loss is probable and the amount of the loss is
reasonably estimable. In order to determine whether the two conditions
F-11
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
necessary for accrual are met, management makes a number of judgments and
assumptions. Because the outcome of most litigation matters is inherently
uncertain, the Company will generally only a accrue a loss for a pending
litigation matter if, for example, the parties to the matter have entered into
definitive settlement agreements or a final judgment adverse to the Company has
been entered. 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.
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 years' 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 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. 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.
F-12
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
At December 31, 2003, the Company has no hedge that meets the hedge accounting
provisions provided under SFAS 133. However, the Company does have contracts and
commitments that meet the definition of a derivative as well as economic hedges
outstanding. SFAS 133 requires the Company to record its best effort commitments
associated with its mortgage loan origination activities on the consolidated
balance sheets.
2. Significant Accounting Policies (continued)
The Company also utilizes derivative instruments to hedge a portion of its
investment in mortgage servicing rights. The Company's hedge is an economic
hedge to offset changes in fair value of mortgage servicing rights caused by
changes in interest rates with changes in hedge instruments that consist of
futures contracts and options on futures. The change in the fair value of the
derivative instruments is recorded with a corresponding charge or credit to
earnings.
Investment Securities
Securities available for sale include mortgage-backed securities and SBA
securities available for sale. Securities available for sale are carried at
estimated fair value with the change in unrealized gains and losses reported in
other comprehensive income, net of tax, which is included as a separate
component in shareholders' equity. Realized gains and losses on the sale of, and
other-than-temporary impairment charges on, available for sale securities are
recorded in gains on sale of loans and securities using the
specific-identification method. Securities held to maturity include
mortgage-backed securities. Securities are classified as held to maturity when
management has the positive intent and ability to hold the securities to
maturity. Securities held to maturity are carried at amortized cost.
Loans Held for Sale
Loans purchased or originated 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.
F-13
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
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.
2. Significant Accounting Policies (continued)
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 include residential mortgage loans, commercial loans,
multi-family, and SBA loans, and are primarily secured by real estate. Loan
origination fees, net of certain direct origination costs, are deferred and
amortized into interest income as an adjustment to the yield over the term of
the loan.
Allowance for Loan and Valuation Losses
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 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 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 delinquency such as 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, trends in portfolio growth and historical loss experience.
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.
F-14
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
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.
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 91 PSA (Public Securities Association prepayment speed
measurement) to 1,316 PSA; discount rates ranging from 9.00% to 22.00%; 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, 2003 and 2002, a valuation allowance
of $6,450,000 and $14,400,000, respectively, was required, and the fair value of
the aggregate MSRs was approximately $39,744,000 and $63,200,000, respectively.
F-15
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
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.
2. Significant Accounting Policies (continued)
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 40 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.
Bank Owned Life Insurance
Bank owned life insurance represents the cash surrender value of life insurance
policies purchased to insure the lives of certain officers and directors of
Matrix Bank. Earnings are credited to the balance and recorded as part of other
income in the consolidated statements of operations.
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.
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. 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.
F-16
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
Brokerage Income
Brokerage income represents fees earned related to consulting services performed
pertaining to mortgage servicing rights, as well as brokerage income from whole
loan activities, retail and fixed income activities, SBA trading fees and fees
earned related to third party servicing brokerage. 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.
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
At December 31, 2003, the Company has one stock-based employee compensation
plan, which is described more fully in Note 15. 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 and SFAS 148
"Accounting for Stock Based Compensation - Transition and Disclosure, an
Amendment to FASB Statement No. 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 income (loss) and income (loss) per share would have been
reduced to the pro forma amounts indicated below:
F-17
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
Year ended December 31,
2003 2002 2001
------------------------------------------------------
(Dollars in thousands except per share data)
Net income (loss):
Net income (loss) as reported $ 2,325 $ (3,952) $ 8,512
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for awards, net of related tax effects (262) (358) (307)
------------------------------------------------------
Pro forma $ 2,063 $ (4,310) $ 8,205
======================================================
Income (loss) per share:
Basic, as reported $ 0.36 $ (0.61) $ 1.31
======================================================
Basic, pro forma $ 0.32 $ (0.67) $ 1.26
======================================================
Diluted, as reported $ 0.36 $ (0.61) $ 1.30
======================================================
Diluted, pro forma $ 0.32 $ (0.67) $ 1.25
======================================================
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.
Income (Loss) Per Common Share
Basic income (loss) per common share from continuing operations is computed by
dividing (loss) income from continuing operations by the weighted average number
of common shares outstanding for the period. Basic and diluted income per common
share from discontinued operations is computed by dividing net income from
discontinued operations by the weighted average number of common shares for the
period, and the effect of potentially dilutive securities, such as stock options
and warrants outstanding for the year ("dilutive securities"). 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. Due to the net loss in 2002, the potentially
dilutive securities were not used in the calculation of diluted loss per share
for the year ended December 31, 2002.
F-18
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Restructuring Charges
Associated with the purchase of Matrix Financial Center by Matrix Bank in 2002,
Matrix Bancorp and certain subsidiaries with various leased office space
throughout the Denver metropolitan area have moved 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 for the year
ended December 31, 2002. The charge represents the excess of costs to be 2.
Significant Accounting Policies (continued)
incurred on original leased space in excess of expected revenues on subleasing
of the space or terminating original lease commitments. Moving expenses
associated with the final relocation are included in other general and
administrative expenses for the years ended December 31, 2003 and 2002.
Investment in Joint Venture
The Company has a 45%-owned investment in 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 $1,737,000 and $802,000 as of December 31, 2003 and 2002,
respectively. For the years ended December 31, 2003, 2002 and 2001, the Company
recorded income (losses) of $1,158,000, $213,000, and $(175,000), respectively,
in other income related to MSCS consolidated operations.
As of December 31, 2003 and 2002, MSCS had total assets of $5,192,000 and
$3,362,000; total liabilities of $1,949,000 and $1,709,000; and equity of
$3,243,000 and $1,653,000, respectively. For the years ended December 31, 2003,
2002 and 2001, MSCS had revenues of $9,061,000, $7,714,000, and $3,517,000; and
pre-tax income (loss) of $2,573,000, $475,000, and $(388,000), 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
On December 11, 2003, the SEC staff announced its intention to release a Staff
Accounting Bulletin that would require all registrants to account for mortgage
loan interest rate lock commitments related to loans held for sale as written
options, effective no later than for commitments entered into after March 31,
2004. The Company enters into such commitments with customers in connection with
residential mortgage loan applications, however, the amount of these commitments
is not material to the Company's consolidated financial statements. This
guidance, if issued, would require the Company to recognize a liability on its
consolidated balance sheet equal to the fair value of the commitment at the time
the loan commitment is issued. As a result, this guidance would delay the
recognition of any revenue related to these commitments until such time as the
loan is sold, however, it would have no effect on the ultimate amount of revenue
or cash flows recognized over time. The Company is currently assessing the
impact of this pending guidance on its consolidated results of operations and
financial position,
F-19
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
but does not expect the implementation to have a significant impact on the
consolidated financial statements.
In May 2003, the Financial Accounting Standards Board (FASB) issued SFAS 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity". This Statement establishes standards for classifying
and measuring certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity. The provisions
of SFAS 150 became effective June 1, 2003, for all financial instruments created
or modified after May 31, 2003, and otherwise became effective as of July 1,
2003. The adoption of this standard did not have a material impact on
consolidated financial statements.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities", which amends and clarifies
financial accounting and reporting for derivative instruments and hedging
activities under SFAS 133, as well as amends certain other existing FASB
pronouncements. In general, SFAS 149 is effective for derivative transactions
entered into or modified and for hedging relationships designated after June 30,
2003. The adoption of this standard did not have a material impact on
consolidated financial statements.
In January 2003, the FASB issued FIN 46, which provides guidance on how to
identify a variable interest entity (VIE) and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a VIE are to
be included in an entity's consolidated financial statements. A VIE exists when
either the total equity investment at risk is not sufficient to permit the
entity to finance its activities by itself, or the equity investors lack one of
three characteristics associated with owning a controlling financial interest.
Those characteristics include the direct or indirect ability to make decisions
about an entity's activities through voting rights or similar rights, the
obligation to absorb the expected losses of an entity if they occur, or the
right to receive the expected residual returns of the entity if they occur. In
December 2003, the FASB revised FIN 46 with certain modifications and
clarifications. Application of this guidance was effective for interests in
certain VIEs commonly referred to as special-purpose entities (SPEs) as of
December 31, 2003. Application for all other types of entities is required for
periods ending after March 15, 2004, unless previously applied.
During the fourth quarter of 2003, the Company applied the provisions of FIN 46
and the revised FIN 46 to its wholly-owned subsidiary trusts that issued capital
securities to third-party investors and to certain direct and indirect interests
in investment partnerships. The application of FIN 46, and early adoption of the
reissued FIN 46, resulted in the deconsolidation of the 5 wholly-owned
subsidiary trusts. The assets and liabilities of the subsidiary trusts that were
deconsolidated totaled $64,500,000 and $66,525,000, respectively. See Note 11
for further discussion of these trusts and the Company's related obligations.
F-20
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
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.
During the fourth 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 an impairment of goodwill was
present, and the entire goodwill balance of $1,004,000 was written off. The
consolidated balance of goodwill is $0 at both December 31, 2003 and 2002.
3. Discontinued Operations
On September 2, 2003, the Company announced the final closing, and substantial
completion of the sale by Matrix Financial Services Corporation of substantially
all of its assets associated with its wholesale mortgage origination platform.
On February 23, 2003, the Company announced that its subsidiaries, Matrix
Financial and Matrix Bank, entered into a Purchase and Assumption Agreement, as
amended ("Purchase Agreement"), to sell substantially all of Matrix Financial's
assets associated with its wholesale mortgage origination platform ("Platform")
to AmPro Mortgage Corporation ("AmPro" or the "Buyer"). After the sale, our
remaining operations at Matrix Financial consist of our mortgage servicing
platform, where we service loans for third parties and ourselves. Included in
the sale were 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 at Matrix
Financial consist primarily of the mortgage servicing platform and a limited
amount of corporate personnel and operations.
Upon signing of the Purchase Agreement, the Buyer was not yet licensed to engage
in any mortgage banking activities under state or federal law. It was
anticipated that it would take approximately six months from execution of the
Purchase Agreement 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, contemplated a
two-staged closing. The first closing ("Initial Closing Date") occurred on the
date the Purchase Agreement was signed and was the effective date for
F-21
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Discontinued Operations (continued)
the sale of the fixed assets, and the final or second closing ("Final Closing
Date") occurred six months following the Initial Closing Date, or August 31,
2003. The effective sale date for accounting purposes was considered to be the
Final 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."
On the Initial Closing Date, the Buyer purchased substantially all of the
tangible personal property and intangible property associated with the Platform.
There was no gain or loss on the sale of the assets. The Buyer additionally has
taken the transfer and assignment of certain contract rights, real property
leases and equipment leases from Matrix Financial at or about the Final Closing
Date.
At the Final Closing Date, the Buyer purchased any tangible and intangible
personal property of the Platform that was 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.
The purchase price was determined as follows:
o The asset payment amount, which was $3,342,000 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, which was $577,000 in
payment for the book value of the Subsequently Acquired Assets as of
the Final Closing Date; plus
o The production premium, 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 Matrix Financial loan
production offices purchased by Buyer. The production premium is
"capped" at $9,100,000. Through December 31, 2003, the production
premium earned and reflected in discontinued operations loss on sale
is $6,836,000 before tax; plus
o The aggregate locked loan profitability amount, which pays Matrix
Financial one-half of the profit over a specified threshold amount
(the threshold being generally 30 basis points) on loans that funded
during the first two months after the Initial Closing Date which
resulted from its locked pipeline as of the Initial Closing Date and
which was $160,000 before tax; plus or minus
o The transition period gain or loss, which 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. Because
the Platform generated a profit during the transition period of
$11,594,000 before tax, Matrix Financial was required to pay such
profit into an escrow account, and has reflected the amount as a
component of the loss on sale of discontinued operations.
F-22
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Discontinued Operations (continued)
As a result of the sale, the Company recorded an after tax loss on the sale of
the platform of $2,792,000, or $(0.43) per diluted share, which is included in
income from discontinued operations in the consolidated statements of
operations. The operating income of the discontinued production platform is
reflected in discontinued operations beginning in the first quarter of 2001, and
the consolidated statements of operations have been restated to reflect the
production platform as a discontinued operation. Operating results of the
discontinued operations, previously included in our mortgage banking segment,
were as follows:
Years Ended December 31,
2003 2002 2001
------------------------------------------------------------
(Dollars in thousands, except share information)
Net interest income after provision for loan
and valuation losses $ 3,477 $ 6,490 $ 10,327
Noninterest income 38,309 35,476 33,130
Noninterest expense 31,717 33,210 30,865
------------- --------------- ---------------
Operating income before taxes from
discontinued operations 10,069 8,756 12,592
Income tax provision 3,955 3,439 4,972
------------- --------------- ---------------
Operating income from discontinued
operations 6,114 5,317 7,620
Loss on sale of production platform, net of
income tax benefit of $1,806 (2,792) - -
------------- --------------- ---------------
Income from discontinued operations, net of
income taxes $ 3,322 $ 5,317 $ 7,620
============= =============== ===============
Income from discontinued operations per share -
basic $ 0.51 $ 0.82 $ 1.17
============= =============== ===============
Income from discontinued operations per share -
diluted $ 0.51 $ 0.82 $ 1.16
============= =============== ===============
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 its affiliates from engaging in such business in order to comply
with applicable law, rules, regulations, directives, agreements or orders from
the Office of Thrift Supervision ("OTS") or other parties 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.
F-23
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
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.
4. Net Income (Loss) 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,
2003 2002 2001
-------------------------------------------------------
(Dollars in thousands)
Numerator:
(Loss) income from continuing operations, net
of tax effects $ (997) $ (9,269) $ 892
=======================================================
Income from discontinued operations, net of tax
effects $ 3,322 $ 5,317 $ 7,620
=======================================================
Net income (loss) $ 2,325 $ (3,952) $ 8,512
=======================================================
Denominator:
Weighted average shares outstanding 6,494,803 6,462,272 6,495,583
Effect of dilutive securities:
Common stock options 44,392 - 64,871
-------------------------------------------------------
Denominator for net (loss) income per share,
assuming dilution 6,539,195 6,462,272 6,560,454
=======================================================
For the year ended December 31, 2002, there were 90,702 stock options and
warrants outstanding which were potentially convertible to common stock.
Assuming conversion at the beginning of the year, the aggregate weighted average
shares would have been 6,552,974 at December 31, 2002. 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. Investment Securities
Investment securities available for sale were as follows:
December 31, 2003 December 31, 2002
-------------------------------------------------- ------------------------------------
Gross Gross Gross
Amortized Unrealized Unrealized Carrying Amortized Unrealized Carrying
Cost Gains Losses Value Cost Gains Value
------------ ------------ ------------ ----------- ----------- ------------- ----------
(In thousands)
Mortgage-backed securities,
available for sale $ 29,562 $ 223 $ - $ 29,785 $ 1,046 $ 40 $ 1,086
SBA Securities, available for
sale 82,515 124 (22) 82,617 27,987 - 27,987
------------ ------------ ------------ ----------- ----------- ------------- ----------
Total $ 112,077 $ 347 $ (22) $ 112,402 $ 29,033 $ 40 $ 29,073
============ ============ ============ =========== =========== ============= ==========
F-24
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. Investment Securities (continued)
The Company expects to receive payments on investment securities available for
sale 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 as determined by specific
identification, were approximately $0, $78,000, and $1,198,000 for the years
ended December 31, 2003, 2002 and 2001, respectively. Carrying value of held for
sale securities equals the estimated fair value.
Investment securities held to maturity were as follows:
December 31, 2003 December 31, 2002
--------------------------------------- ------------------------------------------
Amortized Amortized
Cost and Gross Cost and Gross
Carrying Unrealized Estimated Carrying Unrealized Estimated
Value Gains Fair Value Value Gains Fair Value
------------- ------------ ------------ ------------- ------------ ---------------
(In thousands)
Mortgage-backed securities, held to
maturity $ 40,106 $ 66 $ 40,172 $ - $ - $ -
------------- ------------ ------------ ------------- ------------ ---------------
Total $ 40,106 $ 66 $ 40,172 $ - $ - $ -
============= ============ ============ ============= ============ ===============
The amortized cost and estimated fair value of investment securities by
contractual maturity at December 31, 2003 is as follows:
Available for Sale Held to Maturity
Amortized Cost Estimated Fair Amortized Cost Estimated Fair
Value Value
(In thousands)
Within 1 year $ $ $ $
- - - -
Over 1 year through 5 years 193 193 - -
After 5 years through 10 years 5,364 5,381 - -
Over 10 years 76,958 77,043 - -
----------------- ------------------- ------------------- -----------------
82,515 82,617 - -
Mortgage-backed securities 29,562 29,785 40,106 40,172
----------------- ------------------- ------------------- -----------------
Total $ 112,077 $ 112,402 $ 40,106 $ 40,172
================= =================== =================== =================
At December 31, 2003 and 2002, mortgage backed securities and SBA securities
with a carrying value of $1,166,000 and $926,000, respectively, were pledged to
secure public deposits and for other purposes required or permitted by law.
F-25
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,
2003 2002
----------------------------------
(In thousands)
Residential loans $ 178,463 $ 54,420
Multi-family, commercial real estate, SBA commercial 148,842 168,316
Construction loans 21,304 34,175
Consumer loans and other 2,977 4,313
(Discounts) premium, net (1,000) 570
Unearned fees (798) (699)
----------------------------------
349,788 261,095
Less:
Allowance for loan and valuation losses 4,986 3,444
----------------------------------
Loans held for investment, net $ 344,802 $ 257,651
==================================
Activity in the allowance for loan and valuation losses on loans held for
investment is summarized as follows:
Years Ended December 31,
2003 2002 2001
-----------------------------------------------------
(In thousands)
Balance at beginning of year $ $ 2,776 $ 2,107
3,444
Provision for loan and valuation losses 2,248 1,700 1,821
Charge-offs (1,035) (1,127) (1,235)
Recoveries 329 95 83
-----------------------------------------------------
Balance at end of year $ 4,986 $ 3,444 $ 2,776
=====================================================
Loans Held for Sale
Loans held for sale consist of the following:
December 31,
2003 2002
-----------------------------------
(In thousands)
Residential loans $ 722,192 $ 941,249
SBA guaranteed commercial loans, school financing and other 267,705 191,400
Purchase premiums, net 14,360 9,409
-----------------------------------
1,004,257 1,142,058
Less:
Allowance for loan and valuation losses 4,803 5,899
-----------------------------------
Loans held for sale, net $ 999,454 $ 1,136,159
===================================
F-26
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Loans Held for Sale and Investment (continued)
Activity in the allowance for loan and valuation losses on loans held for sale
is summarized as follows:
Years Ended December 31,
2003 2002 2001
------------------------------------------------------
(In thousands)
Balance at beginning of year $ 5,899 $ 6,562 $ 6,474
Provision for loan losses 1,393 1,121 1,159
Charge-offs (2,515) (1,871) (1,075)
Recoveries 26 87 4
------------------------------------------------------
Balance at end of year $ 4,803 $ 5,899 $ 6,562
======================================================
The following lists information related to nonperforming loans held for
investment and held for sale:
December 31,
2003 2002
---------------------------------
(In thousands)
Loans on nonaccrual status in the held for investment portfolio $ 21,006 $ 11,604
Loans on nonaccrual status in the held for sale portfolio 10,444 19,214
---------------------------------
Total nonperforming loans $ 31,450 $ 30,818
=================================
Interest income that would have been recognized at
original contract terms $ 1,084 $ 916
=================================
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 $12,164,000 and $34,791,000 as of December 31,
2003 and 2002, respectively.
F-27
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Premises and Equipment
Premises and equipment consist of the following:
December 31,
2003 2002
------------------------------------
(In thousands)
Land $ 3,450 $ 3,520
Buildings 14,069 13,987
Leasehold improvements 4,377 2,992
Office furniture and equipment 15,152 20,513
------------------------------------
37,048 41,012
Less accumulated depreciation 12,067 13,307
------------------------------------
Premises and equipment, net $ 24,981 $ 27,705
====================================
7. Premises and Equipment
Included in premises and equipment, net at December 31, 2002 was $3,492,000 of
assets sold under the Purchase Agreement with the sale of the production
platform as discussed in Note 3 above. There was no gain or loss on the sale.
Included in occupancy and equipment expense is depreciation expense of premises
and equipment of approximately $3,552,000, $3,478,000 and $2,797,000 for the
years ended December 31, 2003, 2002 and 2001, respectively.
8. Mortgage Servicing Rights
The activity in the MSRs is summarized as follows:
Years Ended December 31,
2003 2002 2001
------------------------------------------------------
(In thousands)
Mortgage servicing rights
Balance at beginning of year $ 79,234 $ 78,893 $ 71,529
Purchases 375 - 530
Originations 5,082 34,511 30,129
Amortization (32,497) (24,176) (21,862)
Sales - (9,994) (1,433)
Application of valuation allowance to write down
impaired MSRs (5,000) - -
------------------------------------------------------
Balance before valuation allowance at
end of year 47,194 79,234 78,893
------------------------------------------------------
Valuation allowance for impairment of mortgage
servicing rights
Balance at beginning of year (14,400) (181) -
Additions (2,400) (14,219) (181)
Application of valuation allowance to write down
impaired MSRs 5,000 - -
Recovery 5,350 - -
------------------------------------------------------
Balance at end of year (6,450) (14,400) (181)
------------------------------------------------------
Valuation allowance for foreclosure costs (1,000) (1,634) -
------------------------------------------------------
Mortgage servicing rights, net $ 39,744 $ 63,200 $ 78,712
======================================================
The Company's servicing activity is diversified throughout 50 states with
concentrations at December 31, 2003, in Missouri, Texas, California, Arizona,
New Mexico and Florida of approximately 14.5%, 14.3%, 13.9%, 9.0%, 8.2% and
5.0%, respectively, based on aggregate outstanding unpaid principal balances of
the mortgage loans serviced. As of December 31, 2003, 2002 and 2001, the Company
subserviced loans for others of approximately $176,921,000, $26,613,000 and
$889,000,000, respectively.
F-28
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. Mortgage Servicing Rights (continued)
The Company's servicing portfolio (excluding subserviced loans) is comprised of
the following:
December 31,
2003 2002
--------------------------------------------------------------
Principal Principal
Number Balance Number Balance
of Loans Outstanding of Loans Outstanding
--------------------------------------------------------------
(Dollars in thousands)
Freddie Mac 6,194 $ 253,245 9,027 $ 417,583
Fannie Mae 19,257 1,164,589 27,678 1,832,276
Ginnie Mae 16,370 1,068,975 24,453 1,823,706
VA, FHA, conventional and other
loans 9,034 696,727 13,489 1,260,062
--------------------------------------------------------------
Total servicing portfolio 50,855 $ 3,183,536 75,647 $ 5,333,627
==============================================================
The Company's custodial escrow balances shown in the accompanying consolidated
balance sheets at December 31, 2003 and 2002, 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, 2004, 2005, 2006, 2007 and 2008 is $9,158,000,
$6,929,000, $5,249,000, $4,032,000, $3,118,000, respectively. The estimated
amortization is based on several assumptions as of December 31, 2003 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-29
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Deposits
Deposit account balances are summarized as follows:
December 31,
2003 2002
---------------------------------------------------------------------------
Percent of Weighted Percent of Weighted
Total Average Rate Total Average Rate
Amount Deposits Amount Deposits
---------------------------------------------------------------------------
(Dollars in thousands)
Passbook accounts $ 5,675 0.58% 1.28% $ 5,514 0.59% 1.31%
NOW accounts 180,733 18.55 0.15 145,465 15.57 0.20
Money market accounts 576,088 59.14 0.71 334,508 35.82 0.91
---------------------------------------------------------------------------
762,496 78.28 0.58 485,487 51.98 0.69
Certificate accounts 211,563 21.72 2.89 448,470 48.02 2.63
---------------------------------------------------------------------------
Deposits $ 974,059 100.00% 1.07% $ 933,957 100.00% 1.62%
===========================================================================
Included in NOW accounts are noninterest-bearing DDA accounts of $136,146,000
and $96,289,000 at December 31, 2003 and 2002, respectively.
Contractual maturities of certificate accounts as of December 31, 2003 are as
follows:
Under 12 12 to 36 36 to 60
months months months Total
------------------------------------------------------------------
(In thousands)
0.00-0.99% $ 7,468 $ $ $
- - 7,468
1.00-1.99% 86,254 3,171 - 89,425
2.00-2.99% 6,925 10,372 596 17,893
3.00-3.99% 5,958 3,989 5,623 15,570
4.00-4.99% 9,257 39,940 9,553 58,750
5.00-5.99% 3,750 3,659 4,626 12,035
6.00-6.99% 616 9,031 - 9,647
7.00-7.99% 775 - - 775
------------------------------------------------------------------
$ 121,003 $ 70,162 $ 20,398 $ 211,563
==================================================================
Approximately $178,991,000 and $141,278,000 of fiduciary assets under
administration by Sterling are included in NOW and money market accounts as of
December 31, 2003 and 2002, respectively. Approximately $85,338,000 and
$60,870,000 of MSCS customer assets under administration by MSCS are included in
NOW and money market accounts as of December 31, 2003 and 2002, respectively.
Included in certificate accounts are $104,608,000 and $327,335,000 of brokered
deposits as of December 31, 2003 and 2002, respectively.
F-30
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Deposits (continued)
Interest expense on deposits is summarized as follows:
Years Ended December 31,
2003 2002 2001
------------------------------------------------------
(In thousands)
Passbook accounts $ 74 $ 117 $ 108
NOW accounts 327 570 929
Money market 3,602 3,684 4,291
Certificates of deposit 9,335 17,125 29,544
------------------------------------------------------
Interest expense on deposits $ 13,338 $ 21,496 $ 34,872
======================================================
The aggregate amount of deposit accounts with a balance greater than $100,000
(excluding brokered deposits) was approximately $17,954,000 and $17,769,000 at
December 31, 2003 and 2002, respectively.
10. Borrowed Money
Borrowed money is summarized as follows:
December 31,
2003 2002
---------------------------------
(In thousands)
Borrowed Money
Senior notes, interest at 11.50% payable semiannually, unsecured and
maturing September 30, 2004 $ 9,545 $ 9,545
$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% (3.87% at December 31,
2003) 6,073 7,501
$12,000,000 revolving line of credit to a third party financial
institution, through March 31, 2004, renewable annually,
collateralized by the common stock of Matrix Bank; interest at
LIBOR plus 2.65% (3.87% at December 31, 2003); $12,000,000
available at December 31, 2003 - -
Note payable with a bank, secured by real estate, interest only at
7% at December 31, 2002, maturing September 30, 2004 1,913 2,000
School financing agreements, maturing September 2004 and September
2005, collateralized by school financing; interest rates are
variable based on the BMA mini-swap index. Future financing
commitment is at the discretion of the third-party lenders
30,439 32,328
$50,000,000 at December 31, 2002, through August 30, 2003,
secured by mortgage loans held for sale, interest at LIBOR plus
1.20% at December 31, 2002 - 10,000
Other financing agreements - 29
----------------------------------
Total $ 47,970 $ 61,403
==================================
F-31
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. Borrowed Money (continued)
As of December 31, 2003, the maturities of borrowed money are as follows:
(In thousands)
2004 $ 31,097
2005 16,873
------------------
$ 47,970
==================
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 less than 4% of
total assets from January 1, 2003 to and including March 31, 2004, and 3% of
total assets thereafter, Matrix Bank to earn not less than $7,500,000 over the
prior four quarters as of and for the end of each fiscal quarter, and maintain
the requirements necessary such that Matrix Bank will not be classified as other
than "well capitalized," all as defined in the regulations. At December 31,
2003, the Company was in compliance with the covenants described above. We are
in the process of renewing the revolving line of credit, and anticipate it will
be renewed with similar terms and conditions as those currently in effect.
However, there can be no assurances that the bank stock loan will be renewed.
School Financing Agreement
The Company had approximately $29,119,000 and $31,100,000 at December 31, 2003
and 2002, 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.
The "A" Certificates, under the two grantor trusts, are guaranteed by a letter
of credit issued by a an 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 an investment bank for one trust 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, 2003 and 2002 was 1.54% and 1.55%,
respectively. The interest that the Company receives through its ownership of
the "B" Certificates is tax-exempt.
F-32
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. Borrowed Money (continued)
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 $10,534,000
at December 31, 2003.
11. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trusts and
Corporation-Obligated Mandatorily Redeemable Capital Securities of Subsidiary
Trusts Holding Solely Debentures of the Company
The Company has sponsored five trusts, Matrix Bancorp Capital Trust I, Matrix
Bancorp Capital Trust II, Matrix Bancorp Capital Trust III, Matrix Bancorp
Capital Trust IV and Matrix Bancorp Capital Trust V, of which 100% of the common
equity is owned by the Company. The trusts were formed for the purpose of
issuing corporation-obligated mandatorily redeemable capital securities (the
"capital securities") to third-party investors and investing the proceeds from
the sale of such capital securities solely in junior subordinated debt
securities of the Company (the "debentures"). The debentures held by each trust
are the sole assets of that trust. Distributions on the capital securities
issued by each trust are payable at either quarterly or semiannually at a rate
per annum equal to the interest rate being earned by the trust on the debentures
held by that trust. The capital securities are subject to mandatory redemption,
in whole or in part, upon repayment of the debentures. The Company has entered
into agreements which, taken collectively, fully and unconditionally guarantee
the capital securities subject to the terms of each of the guarantees. The
debentures held by the trusts are redeemable as noted below.
In the fourth quarter of 2003, as a result of applying the provisions of FIN 46
and early application of revised FIN 46, governing when an equity interest
should be consolidated, the Company was required to deconsolidate these
subsidiary trusts from its consolidated financial statements. The
deconsolidation of the net assets and results of operations of the trusts had
virtually no impact on the Company's consolidated financial statements or
liquidity position because the Company continues to be obligated to repay the
debentures held by the trusts and guarantees repayment of the capital securities
issued by the trusts. The consolidated debt obligation related to the trusts
increased from $64,500,000 to $66,525,000 upon deconsolidation with the
difference representing the Company's common ownership interests in the trusts.
Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trusts and
Corporation-Obligated Mandatorily Redeemable Capital Securities of Subsidiary
Trusts Holding Solely Debentures of the Company are summarized as follows:
F-33
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trusts and
Corporation-Obligated Mandatorily Redeemable Capital Securities of Subsidiary
Trusts Holding Solely Debentures of the Company (continued)
December 31,
2003 2002
----------------------------------
(In thousands)
Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trusts
Junior subordinated debentures owed to Matrix Bancorp Capital Trust I,
10% junior subordinated debentures payable quarterly, unsecured and
maturing September 30, 2029 $ 28,351 $
-
Junior subordinated debentures owed to Matrix Bancorp Capital
Trust II, 10.18% junior subordinated debentures payable semi-annually,
unsecured and maturing June 8, 2031 12,400 -
Junior subordinated debentures owed to Matrix Bancorp Capital Trust
III, 10.25% junior subordinated debentures payable semi-annually,
unsecured and maturing July 25, 2031 15,464 -
Junior subordinated debentures owed to Matrix Bancorp Capital Trust IV,
LIBOR plus 3.75% (4.97% at December 31, 2003) junior subordinated
debentures payable semi-annually, unsecured and maturing December 8, -
2031 5,155
Junior subordinated debentures owed to Matrix Bancorp Capital Trust V,
LIBOR plus 3.625% (4.845% at December 31, 2003) junior subordinated
debentures payable semi-annually, unsecured and maturing January 25, -
2032 5,155
Capital Securities of Matrix Bancorp Capital Trust I, 10% junior
subordinated debentures payable quarterly, unsecured and maturing
September 30, 2029 - 27,500
Capital Securities of Matrix Bancorp Capital Trust II, 10.18% junior
subordinated debentures payable semi-annually, unsecured and
maturing June 8, 2031 - 12,000
Capital Securities of Matrix Bancorp Capital Trust III, 10.25% junior
subordinated debentures payable semi-annually, unsecured and
maturing July 25, 2031 - 15,000
Capital Securities of 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
Capital Securities of 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 $ 66,525 $64,500
==================================
F-34
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trusts and
Corporation-Obligated Mandatorily Redeemable Capital Securities of Subsidiary
Trusts Holding Solely Debentures of the Company (continued)
Following is a description of each of the trusts:
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 $28,351,000 in principal amount of
10% junior subordinated debentures of the Company due September 30, 2029. 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 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 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 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.
F-35
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trusts and
Corporation-Obligated Mandatorily Redeemable Capital Securities of Subsidiary
Trusts Holding Solely Debentures of the Company (continued)
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
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 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
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 the offerings of approximately $2,348,000
were included in other assets at December 31, 2002. These costs have also been
deconsolidated as of December 31, 2003.
12. FHLBank Borrowings
In connection with Matrix Bank's change in domicile in 2002, Matrix Bank obtains
FHLBank advances from FHLBank of Topeka, which is the FHLBank that serves
Denver, Colorado, and utilizes FHLBank of Topeka as its primary correspondent
bank. This change was approved March 25, 2002. Long-term advances that existed
at March 25, 2002 with FHLBank of Dallas are still outstanding under their
original terms.
F-36
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. FHLBank Borrowings (continued)
The balances of FHLBank borrowings are as follows:
December 31,
2003 2002
------------------------------------
(In thousands)
FHLBank of Topeka borrowings $ 311,000 $ 238,500
FHLBank of Dallas borrowings 147,204 147,285
------------------------------------
$ 458,204 $ 385,785
====================================
Advances of $266,000,000 at both December 31, 2003 and 2002, were borrowed under
Convertible Advance and Short Option Advance (SOA) Agreements with the FHLBank.
These SOA borrowings have a term of up to ten years, but are callable by the
FHLBank 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 FHLBank exercises its
call option on a SOA borrowing, the FHLBank 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, 2003, the interest rates on
the SOA borrowings ranged from 1.27% to 5.63%, and their possible call dates
varied from January 2004 to November 2006. Community investment advances of
$1,204,000 and $1,285,000 at December 31, 2003 and 2002, respectively, were
borrowed under a fixed term and rate. At December 31, 2003, 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 FHLBank stock.
Matrix Bank is on full custody status at FHLBank of Dallas, which requires
Matrix Bank to place loan collateral at the FHLBank of Dallas. At December 31,
2003, loans collateralized by first lien mortgages of $251,107,000 and
securities held for sale of $36,295,000 were pledged for FHLBank of Dallas
advances. Matrix Bank is on blanket collateral status at FHLBank of Topeka,
which requires Matrix Bank to identify, yet maintain in its possession, loan
collateral pledged at FHLBank of Topeka. At December 31, 2003, loans
collateralized by first lien mortgages of $483,000,000 and guaranteed SBA loans
of $159,834,000 were pledged for the FHLBank of Topeka advances. As of December
31, 2003, Matrix Bank had available unused borrowings from the FHLBank of Topeka
for advances of approximately $208,000,000.
F-37
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Income Taxes
The income tax (benefit) provision consists of the following:
Years ended December 31,
2003 2002 2001
------------------------------------------------------
(In thousands)
Current:
Federal $ 2,586 $ 832 $ (7,713)
State 366 - (15)
Deferred:
Federal (2,941) (4,306) 11,162
State (437) (843) 841
------------------------------------------------------
(Benefit) provision $ (426) $ (4,317) $ 4,275
======================================================
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,
2003 2002 2001
------------------------------------------------------
(In thousands)
Expected income tax (benefit) provision $ 646 $ (2,811) $ 4,348
State income tax (benefit) provision, net
of federal benefit 100 (556) 545
Other (1,172) (950) (618)
------------------------------------------------------
(Benefit) provision for income taxes $ (426) $ (4,317) $ 4,275
======================================================
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 2003, 2002 and 2001). 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.
F-38
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Income Taxes (continued)
December 31,
2003 2002
------------------------------------
(In thousands)
Deferred tax assets:
Allowance for loan and valuation losses $ 5,401 $
6,481
Deferred fees 1,367 1,270
Delinquent interest - 552
Net operating loss carry-forwards - 1,082
Other 201 393
------------------------------------
Total deferred tax assets 6,969 9,778
Deferred tax liabilities:
Mortgage servicing rights $ (6,435) $ (12,992)
Gain on sale of building (1,318) (1,368)
Other (1,775) (1,355)
------------------------------------
Total deferred tax liabilities (9,528) (15,715)
------------------------------------
Net deferred tax liability $ (2,559) $ (5,937)
====================================
The net deferred tax liability is recorded in the accompanying consolidated
balance sheets in income taxes payable and deferred income tax liability. The
current and other income tax payable of $949,000 and $835,000 as of December 31,
2003 and 2002, respectively, 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,
2003 or 2002. 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.
14. Regulatory
The Company is a unitary thrift holding company and, as such, is subject to the
regulation, examination and supervision of the OTS.
F-39
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
14. Regulatory (continued)
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
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 in the regulations), and of Tier I capital (as
defined in the regulations) to total assets (as defined in the regulations).
Management believes, as of December 31, 2003 and 2002, that Matrix Bank met all
applicable capital adequacy requirements.
As of December 31, 2003, 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
Under Prompt Corrective
For Capital Action Provisions
Actual Adequacy Purposes
--------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------
(Dollars in thousands)
As of December 31, 2003
Total Capital
(to Risk Weighted Assets) $ 108,689 12.1% $ 72,104 8.0% $ 90,129 10.0%
Core Capital
(to Adjusted Tangible Assets) 101,293 6.2 65,715 4.0 82,143 5.0
Tier I Capital
(to Risk Weighted Assets) 101,293 11.2 N/A N/A 54,078 6.0
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 64,852 4.0 81,605 5.0
Tier I Capital
(to Risk Weighted Assets) 94,349 10.8 N/A N/A 52,634 6.0
F-40
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
14. Regulatory (continued)
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 a noninterest-earning account based on a
percentage of deposit liabilities. The required reserve balance was $35,301,000
and $6,989,000 at December 31, 2003 and 2002, 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 $2,492,000 at December 31, 2003 and
$5,561,000 at December 31, 2002. At December 31, 2003 and 2002, Matrix Financial
was in compliance with these regulatory requirements.
First Matrix, headquartered in Denver, Colorado, a wholly owned subsidiary of
Matrix Bancorp Trading, 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 that requires the maintenance of minimum net
capital and requires that the ratio of aggregate indebtedness to net capital,
both as defined by the regulations, shall not exceed 15 to 1. At December 31,
2003, First Matrix had a net capital deficiency of $(211,000), which was
$281,000 under its required net capital of $69,000. The deficiency was
calculated after two technical exceptions noted in connection with a routine
examination of First Matrix's books and records by the NASD. The exceptions
related to cash on hand at an affiliate bank, and deductible limits on fiduciary
bond coverage. Upon receipt of the NASD's calculation of net capital deficiency,
cash was transferred from First Matrix's account at Matrix Bank to First
Matrix's clearing firm, which cured the capital deficiency.
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, 2003,
Sterling was in compliance with capital requirements under Texas law.
F-41
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
15. 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 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 950,000 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
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 2003, 2002 and 2001,
respectively: risk-free interest rates of 4.2%, 4.5% and 5.0%; a dividend yield
of zero percent; volatility factors of the expected market price of the
Company's common stock of 0.49, 0.52 and 0.57; 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
F-42
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
15. Shareholders' Equity (continued)
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:
Years ended December 31,
2003 2002 2001
------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------------------------------------------------------------------------
Outstanding, beginning of
year 678,125 $ 10.11 611,825 $ 9.99 496,700 $ 10.54
Granted 35,000 9.29 86,500 11.12 250,000 9.32
Exercised (9,000) 9.00 (1,700) 9.11 (16,250) 8.55
Forfeited (94,375) 10.07 (18,500) 10.44 (118,625) 11.09
------------- ------------- -------------
Outstanding, end of year 609,750 10.10 678,125 10.11 611,825 9.99
============= ============= =============
Exercisable end of year 436,900 $ 10.24 397,655 $ 10.31 306,683 $ 10.34
Weighted average fair value
of options granted during
the year $ 2.72 $ 6.20 $ 5.79
============= ============= =============
Options outstanding at December 31, 2003, have exercise prices ranging from
$5.13 to $26.50 per share as outlined in the following table:
Weighted Average
Weighted Average Remaining Weighted Average
Number of Options Exercise Price Contractual Life Number of Exercise Price
Range of Exercise Outstanding Per Share Options Per Share
Prices Exercisable
- -----------------------------------------------------------------------------------------------------------
$ 5.13 79,500 $ 5.13 1.00 79,500 $ 5.13
7.00 - 7.88 7,500 7.29 7.50 3,000 7.29
8.00 - 8.69 88,750 8.55 6.77 49,950 8.52
9.15 - 9.86 134,000 9.71 8.20 46,250 9.80
10.00 - 10.37 155,000 10.34 5.03 120,600 10.18
11.50 - 13.88 69,500 12.47 5.02 62,100 12.46
14.25 - 17.25 73,500 15.13 3.51 73,500 15.13
26.50 2,000 26.50 5.33 2,000 26.50
-----------------------------------------------------------------------------------------
609,750 $10.10 6.27 436,900 $10.31
=========================================================================================
F-43
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
15. Shareholders' Equity (continued)
Employee Stock Purchase Plan
In 1996, the board of directors and shareholders adopted an Employee Stock
Purchase Plan (Purchase Plan) and authorized, as amended, 250,000 shares of
common stock (ESPP Shares) for issuance there under. 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.
As of December 31, 2003, there were 59,866 ESPP Shares available for future
issuance.
16. 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, 2003 are approximately as follows:
(In thousands)
2004 $ 1,158
2005 1,065
2006 942
2007 363
2008 185
Thereafter 525
-------------------
$ 4,238
===================
Total rent expense aggregated approximately $1,050,000, $1,534,000 and
$1,674,000 for the years ended December 31, 2003, 2002 and 2001, 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, 2003 are approximately:
(In thousands)
2004 $ 1,927
2005 1,888
2006 1,533
2007 1,083
2008 316
Thereafter 20
-------------------
-------------------
$ 6,767
===================
F-44
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Commitments, Contingencies and Related Party Transactions (continued)
Total rental income for the years ended December 31, 2003, 2002 and 2001
aggregated approximately $2,050,000, $1,172,000 and $0, respectively.
Included in the expected future office rents are the following amounts under an
operating lease with MSCS: $129,000, $135,000, $136,000, $113,000 and $0 for
2004, 2005, 2006, 2007 and 2008, respectively.
Off-Balance Sheet Risk and Concentration of Commitments
A summary of the contractual amount of significant commitments follows:
December 31,
2003 2002
----------------------------------
(In thousands)
Loans secured by mortgages $ 50,155 $ 31,154
Construction loans 12,833 10,991
Commercial lines of credit 1,583 8,338
Commercial loans 747 4,858
Consumer loans 848 581
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 a 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.
F-45
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Commitments, Contingencies and Related Party Transactions (continued)
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 $6,000,000 at December 31, 2003. There was no balance
outstanding at MSCS on such indebtedness at December 31, 2003.
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 impairment in
the associated basis in the MSRs may occur. In 2001 through mid-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, as well as an increased level of repayment activity.
Due to the interest rate environment and capital constraints, in late 2002 the
Company began to sell the majority of its newly originated servicing, and
continued in that strategy during 2003. The strategy is to reduce the Company's
overall investment in mortgage servicing rights.
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. 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. At December 31, 2003, the
Company hedged approximately $530,000,000 notional balance of its servicing
portfolio, or 18.8%. During 2003, the Company recorded gains on sale of the
derivatives of $708,000, which is recorded in other income. 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 on 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 current servicing portfolio.
F-46
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Commitments, Contingencies and Related Party Transactions (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. Because the outcome of most litigation matters is inherently uncertain,
the Company will generally only accrue a loss for a pending litigation matter
if, for example, the parties to the matter have entered into definitive
settlement agreements or a final judgment adverse to the Company has been
entered. 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, 2003 unless otherwise noted, 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 has appealed the decision
of the arbitration panel, and the ultimate legal and financial liability of the
Company, if any, in this matter cannot be estimated with certainty at this time.
Sterling Trust Company has been named a defendant in an action filed in 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 a judgment was entered
against Sterling Trust in the amount of approximately $6,400,000, plus
post-judgment interest and conditional attorneys' fees for the plaintiffs in
connection with any appeals. Sterling Trust appealed the judgment to the Court
of Appeals for the Second District of
F-47
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Commitments, Contingencies and Related Party Transactions (continued)
Texas (Fort Worth). On July 31, 2003, the Court of Appeals affirmed and reversed
in part the jury's verdict. The Court of Appeals affirmed the jury's award for
actual damages of approximately $6,200,000 (plus post-judgment interest and
attorneys' fees currently estimated to be approximately $2,800,000) but denied
the punitive damage award of approximately $250,000. Sterling Trust continues to
believe that it has meritorious points of appeal to the decision. On October 31,
2003, Sterling Trust filed its Petition for Review with the Supreme Court of
Texas. On January 29, 2004, the Supreme Court of Texas notified the parties that
it was requesting full briefing from the parties on the matter. However, an
appeal to the Supreme Court of Texas is discretionary in nature, meaning that
the Supreme Court of Texas does not automatically have to hear the case.
Notwithstanding the request by the Supreme Court of Texas for full briefing on
the matter, there can be no assurances that the Supreme Court of Texas will
agree to hear the case or that, if heard, Sterling Trust's appeal will be
successful. Because management has determined that the loss in this matter is
not probable, no accrual for loss has been recorded in these financial
statements. The ultimate legal and financial liability, if any, of the Company
cannot be estimated with certainty at this time.
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. Each of these arbitration actions has been abated pending the
outcome of the matter pending in the Superior Court of the State of California
discussed in the following paragraph. 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.
F-48
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Commitments, Contingencies and Related Party Transactions (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. 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 either provided company checks with insufficient funds or had
inappropriately placed a stop payment on the checks. To date, the Company has
reached settlements or prevailed on the merits in connection with all of these
loans, with the exception of third parties claiming ownership of, or an interest
in seven loans having an original principal balance of approximately $830,000.
The Company intends to continue to vigorously defend the claims of these third
parties with respect to the
F-49
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Commitments, Contingencies and Related Party Transactions (continued)
remaining seven loans in this category to which there continues to be a dispute.
The ultimate legal and financial liability of the Company, if any, in any of the
matters involving these seven loans cannot be estimated with certainty at this
time.
Additionally, certain parties in the chain of title to property securing
approximately $2,700,000 of loans (approximately 20 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
settlements with respect to all of these loans, with the exception of third
parties claiming ownership of, or an interest in seven of these properties. The
Company intends to continue to vigorously defend the claims of these third
parties with respect to the remaining seven loans in this category. The ultimate
legal and financial liability of the Company, if any, in any of the matters
involving these seven loans cannot be estimated with certainty at this time.
In connection with the review of the relationship between the Company and the
debtor, the trustee for the debtor claimed an interest in each of the loans that
had been purchased by the Company from the debtor. The trustee's claims included
theories that, with respect to certain other loans, the Company was a secured
creditor (as opposed to a purchaser), and with respect to certain other loans,
that the Company was and unsecured creditor (as opposed to a purchaser).
Accordingly, the trustee concluded, depending on which of the above theories a
particular loan fit into, that the trustee was either entitled to a surcharge
with respect to the loans or that the estate in fact continued to own the loans.
During 2003, the Company and the trustee reached an agreement to settle these
claims, and this matter has now been closed.
The trustee has also initiated an adversarial action against the Company seeking
to recover as an avoidable preference approximately $6,100,000 payments by the
debtor to the Company during the 90 days proceeding the filing of bankruptcy.
The Company believes that it will successfully demonstrate to the Bankruptcy
Court that the amount claimed was purchase money belonging to the Company
returned by the debtor for loans that did not close and were not sold to the
Company. The Company believes it has adequate defenses and intends to vigorously
defend this action. 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.
F-50
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
16. Commitments, Contingencies and Related Party Transactions (continued)
Related Party Transactions
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 $500,000 in 2003 for
his consulting services. The expense is recorded in compensation and employee
benefits expense in the consolidated statements of operations.
17. 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 $12,000 in 2003. 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 $643,000, $716,000 and $298,000
during the years ended December 31, 2003, 2002 and 2001, respectively, which and
was recorded in compensation and employee benefits expense in the consolidated
statements of operations.
18. Fair Value of Financial Instruments
The carrying amounts and estimated fair value of financial instruments are as
follows:
December 31,
2003 2002
------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------------------
(In thousands)
Financial assets:
Cash and cash equivalents $ 34,510 $ 34,510 $ 62,412 $ 62,412
Investment securities - available for
sale 112,402 112,402 29,073 29,073
Investment securities - held to maturity
40,106 40,172 - -
Loans held for sale, net 999,454 1,003,092 1,107,919 1,112,841
Loans held for investment, net 344,802 341,937 285,891 290,084
FHLBank stock 30,682 30,682 30,379 30,379
F-51
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
18. Fair Value of Financial Instruments (continued)
December 31,
2003 2002
------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------------------
(In thousands)
Financial liabilities:
Deposits $ 974,059 $ 977,280 $ 933,957 $ 936,809
Custodial escrow balances 85,466 85,466 151,790 151,790
Payable for purchase of MSRs 201 201 782 782
FHLBank borrowings 458,204 469,415 385,785 400,418
Borrowed money and junior subordinated
debentures 114,495 115,018 125,903 126,849
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, FHLBank 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 FHLBank borrowings is estimated using a discounted
cash flow calculation that applies interest rates currently being offered on
FHLBank 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.
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, 2003 and 2002, 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).
F-52
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
19. Parent Company Condensed Financial Information
Condensed financial information of Matrix Bancorp, Inc. (Parent) is as follows:
December 31,
2003 2002
------------------------------------
(In thousands)
Condensed Balance Sheets
Assets:
Cash $ 3,192 $ 854
Loans receivable - 2,430
Other receivables - 491
Premises and equipment, net 696 915
Other assets 5,311 3,046
Investment in and advances to subsidiaries 157,146 157,480
------------------------------------
Total assets $ 166,345 $ 165,216
====================================
Liabilities and shareholders' equity:
Borrowed money and junior subordinated debentures
owed to unconsolidated subsidiary trusts and
corporation-obligated mandatorily redeemable
capital securities of subsidiary trusts holding
solely debentures of the Company (a) $ 82,143 $ 86,046
Other liabilities 14,518 12,234
------------------------------------
Total liabilities 96,661 98,280
Shareholders' equity:
Common stock 1 1
Treasury shares - -
Additional paid-in capital 20,615 20,375
Retained earnings 48,859 46,534
Accumulated other comprehensive income 209 26
------------------------------------
Total shareholders' equity 69,684 66,936
------------------------------------
Total liabilities and shareholders' equity $ 166,345 $ 165,216
====================================
(a) The Parent's debt is set forth in a table following the condensed
statements of cash flows. The Parent also guarantees a portion the
financing related to charter schools. See Note 10 and Note 11 for
additional information regarding the debt.
F-53
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
19. Parent Company Condensed Financial Information (continued)
Years ended December 31,
2003 2002 2001
----------------------------------------------------
(In thousands)
Condensed Statements of Operations
Income:
Interest income on inter-company
advances $ 52 $ 1,232 $ 2,395
Other 46 57 1,230
----------------------------------------------------
Total income 98 1,289 3,625
Expenses:
Compensation and employee benefits 4,468 4,584 3,529
Occupancy and equipment 745 817 748
Interest on borrowed money 7,628 7,766 8,511
Professional fees 947 299 437
Other general and administrative 731 943 2,553
----------------------------------------------------
Total expenses 14,519 14,409 15,778
----------------------------------------------------
Loss before income taxes and equity income of
subsidiaries (14,421) (13,120) (12,153)
Income taxes (b) - - -
----------------------------------------------------
Loss before equity income of subsidiaries (14,421) (13,120) (12,153)
Equity income of subsidiaries 16,746 9,168 20,665
----------------------------------------------------
Net income (loss) $ 2,325 $ (3,952) $ 8,512
====================================================
(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-54
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
19. Parent Company Condensed Financial Information (continued)
Years ended December 31,
2003 2002 2001
------------------------------------------------------
(In thousands)
Condensed Statements of Cash Flows
Operating activities:
Net income (loss) $ 2,325 $ (3,952) $ 8,512
Adjustments to reconcile net income (loss)
to net cash (used) provided by operating
activities:
Equity income of subsidiaries (16,746) (9,168) (20,665)
Dividends from subsidiaries 6,593 8,485 11,996
Depreciation and amortization 566 757 703
Unrealized gain (loss) on securities
available for sale 183 1 (794)
Loss on sublease - 700 -
Increase (decrease) in other
liabilities 2,284 4,647 (888)
Decrease (increase) in other
receivables and other assets 2,527 534 (3,133)
------------------------------------------------------
Net cash (used in) provided by operating
activities (2,268) 2,004 (4,269)
Investing activities:
Purchases of premises and equipment (193) (274) (606)
Investment in and advances to subsidiaries
5,987 (5,042) (19,331)
------------------------------------------------------
Net cash provided by (used in) investing
activities 5,794 (5,316) (19,937)
Financing activities:
Repayments of notes payable and revolving
line of credit (11,778) (34,877) (49,437)
Proceeds from notes payable and revolving
line of credit 10,350 34,396 43,250
Shares repurchased - (726) (746)
Proceeds from capital securities of
subsidiary trusts - 4,917 30,977
Proceeds from issuance of common stock
240 301 317
------------------------------------------------------
Net cash (used in) provided by financing
activities (1,188) 4,011 24,361
------------------------------------------------------
Increase in cash 2,338 699 155
Cash at beginning of year 854 155 -
------------------------------------------------------
Cash at end of year $ 3,192 $ 854 $ 155
======================================================
F-55
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
19. Parent Company Condensed Financial Information (continued)
Parent Company Debt is set forth below:
December
2003 2002
------------------------------------
(In thousands)
Senior notes $ 9,545 $ 9,545
Bank stock loan 6,073 7,501
------------------------------------
Total term notes 15,618 17,046
Bank stock revolving line of credit - -
Junior subordinated debentures owed to unconsolidated
subsidiary trusts 66,445 -
Capital securities of subsidiary trusts - 64,500
Other - 4,500
------------------------------------
Total debt $ 82,063 $ 86,046
====================================
As of December 31, 2003, the maturities of debt are as follows:
(In thousands)
2004 $ 15,618
Thereafter 66,445
----------------------
$ 82,063
======================
20. Selected Quarterly Financial Data (Unaudited)
2003
-----------------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------------------
(In thousands except share data)
Operations:
Net interest income before provision
for loan and valuation losses $ 9,966 $ 10,295 $ 10,710 $ 10,737
Provision for loan and valuation
losses 990 1,114 842 695
Noninterest income 15,675 14,782 21,047 17,825
Noninterest expense 24,185 23,932 34,101 28,750
-----------------------------------------------------------------
Income (loss) from continuing
operations before income taxes 466 31 (3,186) (883)
Income tax benefit (185) (289) (1,558) (543)
Income (loss) from continuing
operations 651 320 (1,628) (340)
Discontinued operations:
Income (loss) from discontinued
operations, net of income taxes 373 (2,360) 3,057 2,252
-----------------------------------------------------------------
Net income (loss) $ 1,024 $ (2,040) $ 1,429 $ 1,912
=================================================================
F-56
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
20. Selected Quarterly Financial Data (Unaudited) (continued)
2003
-----------------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
-----------------------------------------------------------------
(In thousands except share data)
Net income (loss) per share data
-----------------------------------------------------------------
Basic $ 0.16 $ (0.31) $ 0.22 $ 0.30
=================================================================
Diluted $ 0.16 $ (0.31) $ 0.22 $ 0.29
=================================================================
Balance Sheet:
Total assets $ 1,723,924 $ 1,601,340 $ 1,744,670 $ 1,697,475
Total loans, net 1,344,256 1,282,838 1,384,642 1,376,386
Shareholders' equity 69,684 68,299 70,324 68,856
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 $ 11,472 $ 11,337 $ 11,028 $ 8,873
Provision for loan and valuation
losses 357 895 532 1,037
Noninterest income 14,530 16,034 15,859 15,511
Noninterest expense 32,167 37,342 26,312 23,027
-----------------------------------------------------------------
(Loss) income from continuing
operations before income taxes (6,522) (10,866) 43 320
Income tax benefit (2,741) (4,675) (309) (31)
Income (loss) from continuing
operations (3,781) (6,191) 352 351
Discontinued operations:
Income from discontinued operations,
net of income taxes 2,088 990 552 1,687
-----------------------------------------------------------------
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 $ 1,701,405 $ 1,778,046 $ 1,623,223 $ 1,570,227
Total loans, net 1,393,810 1,449,773 1,303,835 1,210,458
Shareholders' equity 66,936 68,337 73,540 72,625
21. 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
F-57
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
21. Segments of the Company and Related Information (continued)
subsidiary, two 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 owns residential MSRs and services the
mortgage loans underlying those MSRs, and has some minimal mortgage origination
activity. The 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. Accordingly, the information presented in
this table is from continuing operations, which excludes the financial results
of the wholesale production platform for all of the years presented. The
platform was sold in 2003 as discussed in Note 3. 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)
2003
Revenues from external
customers:
Interest income $ 62,286 $ 5,132 $ 285 $ 5,607 $ 397 $ 73,707
Noninterest income 8,345 32,538 10,707 2,240 15,499 69,329
Intersegment revenues 3,059 3,236 2,028 11 1,814 10,148
Interest expense 22,773 3,082 47 5 6,092 31,999
Depreciation/amortization 702 32,758 123 778 1,622 35,983
Segment income (loss) from
continuing operations
before income taxes
23,355 (12,608) 4,028 (4,616) (13,731) (3,572)
Segment assets (a) 1,647,833 114,743 9,244 62,768 182,925 2,017,573
F-58
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
21. Segments of the Company and Related Information (continued)
Servicing
Traditional Mortgage Brokerage and School
Banking Banking Consulting Services All Others Total
----------------------------------------------------------------------------------
(In thousands)
2002
Revenues from external
customers:
Interest income $ 71,320 $ 5,220 $ 123 $ 6,823 $ 501 $ 83,988
Noninterest income 4,677 31,499 9,273 6,445 10,040 61,934
Intersegment revenues 3,019 3,694 1,192 11 2,260 10,176
Interest expense 31,037 3,019 154 2,771 4,297 41,278
Depreciation/amortization 602 25,433 109 1,405 1,383 28,932
Segment income (loss) from
continuing operations
before income taxes
20,081 (19,377) 2,311 (6,736) (13,304) (17,025)
Segment assets (a) 1,556,268 527,328 7,209 70,237 50,842 2,211,884
2001
Revenues from external
customers:
Interest income $ 87,188 $ 839 $ 14 $ 6,854 $ 175 $ 95,070
Noninterest income 9,652 30,889 3,658 7,252 6,936 58,387
Intersegment revenues 1,385 4,418 2,345 - 3,346 11,494
Interest expense 51,008 4,113 85 4,931 4,750 64,887
Depreciation/amortization 489 23,013 124 360 992 24,978
Segment income (loss) from
continuing operations
before income taxes
21,529 (5,529) (1,406) (1,177) (13,412) 5
Segment assets (a) 1,410,072 669,317 6,506 78,131 57,367 2,221,393
(a) See reconciliation to total consolidated assets in the following table.
2003 2002 2001
-------------------------------------------------------
(In thousands)
Revenues for year ended December 31:
Interest income for reportable segments $ 73,310 $ 83,486 $ 94,895
Noninterest income for reportable segments 53,830 51,894 51,451
Intersegment revenues for reportable segments 8,334 7,916 8,148
Other revenues 17,710 12,802 10,457
Elimination of intersegment revenues (10,148) (10,176) (11,494)
-------------------------------------------------------
Total consolidated revenues $ 143,036 $ 145,922 $ 153,457
=======================================================
F-59
Matrix Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
21. Segments of the Company and Related Information (continued)
2003 2002 2001
-------------------------------------------------------
(In thousands)
(Loss) income for year ended December 31:
Total profit for reportable segments $ 10,159 $ (3,721) $ 13,417
Other loss (13,117) (12,664) (13,339)
Elimination of intersegment profit (loss) (614) (640) (73)
-------------------------------------------------------
(Loss) income before income taxes $ (3,572) $ (17,025) $ 5
=======================================================
Assets as of December 31:
Total assets for reportable segments $ 1,834,588 $ 2,161,042 $ 2,164,026
Other assets 182,925 50,842 57,367
Elimination of intersegment receivables (282,574) (497,514) (563,304)
Other intersegment eliminations (11,015) (12,965) (11,149)
-------------------------------------------------------
Total consolidated assets $ 1,723,924 $ 1,701,405 $ 1,646,940
=======================================================
Other Significant Items for the year ended December 31:
Depreciation/amortization expense:
Segment totals $ 34,361 $ 27,549 $ 23,986
Intersegment adjustments 1,622 1,383 992
-------------------------------------------------------
Consolidated totals $ 35,983 $ 28,932 $ 24,978
=======================================================
Interest expense:
Segment totals $ 25,907 $ 36,981 $ 60,137
Intersegment adjustments 6,092 4,297 4,750
-------------------------------------------------------
Consolidated totals $ 31,999 $ 41,278 $ 64,887
=======================================================
F-60