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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR (15d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from: _______________________ to
________________________
Commission File No. 0-21341
OCWEN FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
Florida 65-0039856
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
The Forum, Suite 1000
1675 Palm Beach Lakes Boulevard
West Palm Beach, Florida 33401
(Address of principal executive office) (Zip Code)
(561) 681-8000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Not applicable
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.01 par value National Association of Securities Dealers
(Title of each class) Quotations(NASDAQ)
(Name of each exchange on which registered)
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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the this Form 10-K or any
amendment to this Form 10-K ( )
Aggregate market value of the Common Stock, $.01 par value, held by
nonaffiliates of the registrant, computed by reference to the closing price
as reported by NASDAQ as of the close of business on January 31, 1997:
$299,011,170
Number of shares of Common Stock, $.01 par value, outstanding as of January
31, 1997: 26,744,170 shares
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive Proxy Statement for the Annual Meeting of
stockholders to be held on May 27, 1997 are incorporated by reference into
Part III, Items 10-13 of this Form 10K.
OCWEN FINANCIAL CORPORATION
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
-----------
PART I
Item 1. Business...................................................................... 4
General.................................................................... 4
Recent Transaction......................................................... 5
Discounted Loan Acquisition and Resolution Activities...................... 5
Investment in Joint Venture................................................ 9
Lending Activities......................................................... 10
Asset Quality.............................................................. 16
Investment Activities...................................................... 21
Sources of Funds........................................................... 26
Economic Conditions........................................................ 30
Competition................................................................ 30
Employees.................................................................. 31
Computer Systems and Other Equipment....................................... 31
Regulation................................................................. 31
The Company................................................................ 31
The Bank................................................................... 31
Federal Taxation........................................................... 36
State Taxation............................................................. 38
Item 2. Properties.................................................................... 38
Offices.................................................................... 38
Item 3. Legal Proceedings............................................................. 38
Item 4. Submission of Matters to a Vote of Security Holders........................... 38
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters....................................................... 38
Price Range of the Registrants' Common Stock............................... 38
Number of Holders of Common Stock.......................................... 39
Item 6. Selected Consolidated Financial Data.......................................... 39
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 42
Results of Operations...................................................... 42
Changes in Financial Condition............................................. 49
Asset and Liability Management............................................. 52
Liquidity.................................................................. 55
Commitments and Off-Balance Sheet Risks.................................... 56
Regulatory Capital Requirements............................................ 57
Recent Regulatory Developments............................................. 57
Forward-Looking Statements................................................. 58
Item 8. Financial Statements.......................................................... 58
2
OCWEN FINANCIAL CORPORATION
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS (Cont'd)
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 58
PART III
Item 10. Directors and Executive Officers of Registrant................ 59
Item 11. Executive Compensation........................................ 59
Item 12. Security Ownership of Certain Beneficial Owners and Management 59
Item 13. Certain Relationships and Related Transactions................ 59
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K..................................................... 59
Signatures................................................... 59
3
PART I
ITEM 1. BUSINESS
GENERAL
Ocwen Financial Corporation (the "Company") is a financial services
holding company which conducts business primarily through Ocwen Federal Bank
FSB (the "Bank"), a federally-chartered savings bank and a wholly-owned
subsidiary of the Company.
The Company considers itself to be involved in a single business segment
of providing financial services and conducts a wide variety of business
within this segment. The Company's primary business activities currently
consist of its discounted loan acquisition and resolution activities,
multi-family residential and commercial real estate lending activities,
single-family residential activities involving non-conforming borrowers and
various investment activities, including investments in a wide variety of
mortgage-related securities and investments in low-income housing tax credit
interests. The Company obtains funds for investment in the foregoing and
other business activities primarily from brokered and other wholesale
certificates of deposit, as well as retail deposits obtained through its
office in northern New Jersey, Federal Home Loan Bank ("FHLB") advances,
reverse repurchase agreements, maturities and principal repayments on
securities and loans and proceeds from the sale of securities and loans held
for sale.
At December 31, 1996, the only significant subsidiary of the Company,
other than the Bank, was Investors Mortgagee Insurance Holdings Company,
("IMI") which directly and indirectly through subsidiaries currently owns and
manages the Westin Hotel in Columbus, Ohio and residential units in
cooperative buildings.
The Company is a registered savings and loan holding company subject to
regulation by the Office of Thrift Supervision ("OTS"). The Bank is subject to
regulation by the OTS, as its chartering authority, and by the Federal Deposit
Insurance Corporation ("FDIC") as a result of its membership in the Savings
Association Insurance Fund ("SAIF") which insures the Bank's deposits up to
the maximum extent permitted by law. The Bank is also subject to certain
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board") and currently is a member of the FHLB of New York, one of the 12
regional bank's which comprise the FHLB System.
RECENT TRANSACTIONS
On February 2, 1997, the Company was notified by the Department of Housing
and Urban Development ("HUD") that it and a co-investor were the successful
bidder to purchase 13,781 single-family residential loans with an aggregate
unpaid principal balance of $855.7 million and a purchase price of $757.4
million. The loans will be split approximately 50/50 between the
4
Company and its co-investor, each of which hold their respective loans
directly. The Company will act as servicer for all of the
loans and, in this capacity, will receive fees from its co-investor.
This purchase differed from the Company's prior HUD purchases in that
70% of the loans are subject to continued foreclosure relief after the
servicing transfer date (March 31, 1997). During the relief period, borrowers
are required to make a monthly payment which is based on their ability to pay
and may be less than the contractual monthly payment. Once the relief period
is over, the borrower is required to make at least the contractual payment
regardless of ability to pay. The weighted average relief period end date is
July 1997. The prior HUD purchases included only those loans that were beyond
the relief period.
On February 18, 1997 the Company filed a form S-11 registration
statement with the Securities and Exchange Commission to offer to the public
the common stock of Ocwen Asset Investment Corp. ("OAIC"), a newly organized
Virginia Corporation, which will elect to be taxed as a real estate
investment trust under the Internal Revenue Code of 1986. The Company will
manage the day-to-day operations of OAIC. OAIC's investments will include
several categories of real estate and real estate related assets including
subordinated interests in mortgage-backed and related securities and
distressed commercial and multi-family real property. The Company will own
approximately 13% of the common stock of OAIC after completion of the
proposed initial public offering.
On March 27, 1997, the Company, BCBF, LLC (the "LLC") (of which the
Company has a 50% interest) and an unaffiliated entity, completed a
securitization of 2,916 single-family residential mortgage loans with an
unpaid principal balance of $140.7 million and past due interest of $37.1
million. The loans securitized were all acquired from HUD in 1995 and 1996.
The Company expects to record a gain in excess of $15 million on the sale of
the senior classes of securities. The Company continues to service the loans
for a fee and has retained an interest in the related subordinate class
security.
DISCOUNTED LOAN ACQUISITION AND RESOLUTION ACTIVITIES
The Company believes that under appropriate circumstances the acquisition
of non-performing and underperforming mortgage loans at discounts offers
significant opportunities to the Company. Because discounted loans generally
have collateral coverage which is in excess of the purchase price of the loan,
successful resolutions can produce total returns which are in excess of an
equivalent investment in performing mortgage loans.
The Company began its discounted loan operations in 1991 and initially
focused on the acquisition of single-family residential loans. In 1994 the
Company expanded this business through the acquisition and resolution of
discounted multi-family residential and commercial real estate loans (together,
unless the context otherwise requires, "commercial real estate loans"). Prior
to entering the discounted loan business, management of the Company had
substantial loan resolution experience through former subsidiaries of the
Company which had been engaged in the business of providing private mortgage
insurance for residential loans. This experience assisted the Company in
developing the procedures, facilities and systems which are necessary to
appropriately evaluate and acquire discounted loans and to resolve such loans
in a timely and profitable manner. Management of the Company believes that the
resources utilized by the Company in connection with the acquisition, servicing
and resolution of discounted real estate loans, which include proprietary
technology and software, allow the Company to effectively manage an extremely
data-intensive business and that, as discussed below, these resources have
affiliated applications in other areas. See "Business-Computer Systems and
Other Equipment."
COMPOSITION OF THE DISCOUNTED LOAN PORTFOLIO. At December 31, 1996, the
Company's net discounted loan portfolio amounted to $1.06 billion or 44.2% of
the Company's total assets. Substantially all of the Company's discounted loan
portfolio is secured by first mortgage liens on real estate.
The following table sets forth the composition of the Company's discounted
loan portfolio by type of loan at the dates indicated.
DECEMBER 31,
-----------------------------------------------------------------
1996 1995 1994 1993 1992
-------------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Single-family residential loans............ $ 504,049 (1) $ 376,501 $ 382,165 $ 430,355 $ 306,401
Multi-family residential loans............. 341,796 176,259 300,220 -- --
Commercial real estate loans............... 465,801 (2) 388,566 102,138 1,845 2,227
Other loans................................ 2,753 2,203 911 1,316 1,836
---------------- ---------- ---------- ---------- ----------
Total discounted loans.................... 1,314,399 943,529 785,434 433,516 310,464
Unaccreted discount........................ (241,908)(3) (273,758) (255,974) (129,882) (97,426)
Allowance for loan losses.................. (11,538) -- -- -- --
---------------- ---------- ---------- ---------- ----------
Discounted loans, net...................... $ 1,060,953 (1) $ 669,771 $ 529,460 $ 303,634 $ 213,038
---------------- ---------- ---------- ---------- ----------
---------------- ---------- ---------- ---------- ----------
(1) Does not include the Company's 50% ownership interest in the LLC which
held $110.7 million of discounted single-family residential loans, net at
December 31, 1996. See "Business-Investment in
Joint Venture." Inclusive of the Company's pro rata interest in such
loans, the Bank's discounted loans, net would amount to $1.12 billion at
December 31, 1996.
(2) Consists of $202.1 million of loans secured by office buildings, $46.0
million of loans secured by hotels, $138.6 million of loans secured by
retail properties or shopping centers and $79.1 million of loans secured by
other properties.
(3) Consists of $92.2 million on single-family residential loans, $71.8 million
on multi-family residential loans, $77.6 million on commercial real estate
loans and $0.3 million on other loans, respectively.
5
The properties which secure the Company's discounted loans are located
throughout the United States. At December 31, 1996, the five states with the
greatest concentration of properties securing the Company's discounted loans
were California, New Jersey, New York, Pennsylvania and Connecticut, which
had $370.5 million, $134.0 million, $129.2 million, $110.3 million and $104.8
million principal amount of discounted loans (before unaccreted discount),
respectively. For further information about the geographic location of the
properties which secure loans in the Company's discounted loan portfolio, see
Note 10 to the Consolidated Financial Statements included in Item 8 hereof.
The Company believes that the broad geographic distribution of its discounted
loan portfolio reduces the risks associated with concentrating such loans in
limited geographic areas, and that, due to its expertise, technology and
software and procedures, the geographic diversity of its discounted loan
portfolio does not place significantly greater burdens on the Company's
ability to resolve such loans.
At December 31, 1996, the discounted loan portfolio included one loan
with a carrying value greater than $25 million and six loans with a carrying
value of more than $15 million and less than $25 million.
ACQUISITION OF DISCOUNTED LOANS. In the early years of the program, the
Company acquired discounted loans from the FDIC and the Resolution Trust
Corporation, primarily in auctions of pools of loans acquired by them from
the large number of financial institutions which failed during the late 1980s
and early 1990s. Although governmental agencies, such as the FDIC and HUD,
continue to be potential sources of discounted loans, particularly
single-family residential loans, the Company has obtained a
substantial amount discounted loans from various private sector sellers, such
as banks, savings institutions, mortgage companies and insurance companies. At
December 31, 1996, approximately 77.1% of the loans in the Company's
discounted loan portfolio had been acquired from the private sector.
Although the Company believes that a permanent market for the acquisition
of discounted loans has emerged in recent years within the private sector,
there can be no assurance that the Company will be able to acquire the
desired amount and type of discounted loans in future periods or that
there will not be significant inter-period variations in the amount of
such acquisitions.
Discounted real estate loans generally are acquired in pools, although
discounted commercial real estate loans may be acquired individually. These
pools generally are acquired in auctions or competitive bid circumstances in
which the Company faces substantial competition. Although many of the
Company's competitors have access to greater capital and have other
advantages, the Company believes that it has a competitive advantage relative
to many of its competitors as a result of its experience in managing and
resolving discounted loans, its large investment in the computer systems,
technology and other resources which are necessary to conduct this business,
its national reputation and the strategic relationships and contacts which it
has developed in connection with these activities.
The Company generally acquires discounted loans solely for its own
portfolio. From time to time, however, the Company and one or more
co-investors may submit a joint bid to acquire a pool of discounted loans in
order to enhance the prospects of submitting a successful bid. If successful,
the Company and the co-investor generally allocate ownership of the acquired
loans in an agreed upon manner, although in certain instances the Company and
the co-investor may continue to have a joint interest in the acquired loans.
See "Business-Investment in Joint Venture," and "-Recent Transaction."
Prior to making an offer to purchase a portfolio of discounted loans, the
Company conducts an extensive investigation and evaluation of the loans in
the portfolio. Evaluations of potential discounted loans are conducted
primarily by the Company's employees who specialize in the analysis of
non-performing loans, often with further specialization based on geographic
or collateral specific factors. The Company's employees regularly use third
parties, such as brokers, who are familiar with the property's type and
location, to assist them in conducting an evaluation of the value of the
collateral property, and depending on the circumstances, particularly in the
case of commercial real estate loans, may use subcontractors, such as local
counsel and engineering and environmental experts, to assist in the
evaluation and verification of information and the gathering of other
information not previously made available by the potential seller.
The Company determines the amount to be offered by it to acquire
potential discounted loans by using a proprietary modeling system and loan
information database which focuses on the anticipated recovery amount, timing
6
and cost of the resolution of the loans. The amount offered by the Company
generally is at a discount from both the stated value of the loan and the
value of the underlying collateral which the Company estimates is sufficient
to generate an acceptable return on its investment.
RESOLUTION OF DISCOUNTED LOANS. After a discounted loan is acquired, the
Company utilizes its computer software system to resolve the loan as
expeditiously as possible in accordance with specified procedures. The
various resolution alternatives generally include the following: (i) the
borrower brings the loan current in accordance with original or modified
terms, (ii) the borrower repays the loan or a negotiated amount of the loan,
(iii) the borrower agrees to deed the property to the Company in lieu of
foreclosure, in which case it is classified as real estate owned and held for
sale by the Company, and (iv) the Company forecloses on the loan and the
property is acquired at the foreclosure sale either by a third party or by
the Company, in which case it is classified as real estate owned and held for
sale by the Company.
The general goal of the Company's asset resolution process is to maximize
in a timely manner cash recovery on each loan in the discounted loan
portfolio. The Company generally anticipates a longer period (approximately
12 to 30 months) to resolve discounted commercial real estate loans than
discounted single-family residential loans, because of their complexity and
the wide variety of issues that may occur in connection with the resolution
of such loans.
The Company's credit manager and the Credit Committee of the Board of
Directors of the Company actively monitor the asset resolution process to
identify discounted loans which have exceeded their expected foreclosure
period and real estate owned which has been held longer than anticipated.
Plans of action are developed for each of these assets to remedy the cause
for delay and are reviewed by the Credit Committee.
ACTIVITY IN THE DISCOUNTED LOAN PORTFOLIO. The following table sets
forth the activity in the Company's gross discounted loan portfolio during
the periods indicated.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
---------------------- --------------------- ------------------- ------------------------ -------------------
NO. OF NO. OF NO. OF NO. OF NO. OF
BALANCE LOANS BALANCE LOANS BALANCE LOANS BALANCE LOANS BALANCE LOANS
------------ --------- ---------- ---------- ---------- --------- ---------- ---------- -------- -------
(DOLLARS IN THOUSANDS)
Balance at
beginning
of period....... $ 943,529 4,543 $ 785,434 3,894 $ 433,516 5,160 $ 310,464 5,358 $ 47,619 590
Acquisitions(1).. 1,110,887 4,812 791,195 2,972 826,391 2,781 294,359 2,412 297,169 5,380
Resolutions and
repayments(2).. (371,228) (2,355) (300,161) (960) (265,292) (2,153) (116,890) (1,430) (28,194) (473)
Loans
transferred
to real estate
owned.......... (138,543) (860) (281,344) (984) (171,300) (1,477) (26,887) (602) (6,130) (139)
Sales(3)......... (230,246) (680) (51,595) (379) (37,881) (417) (27,530) (578) -- --
------------ --------- ---------- ---------- ---------- -------- ----------- ---------- --------- ------
Balance at end
of period...... $1,314,399 5,460 $ 943,529 4,543 $ 785,434 3,894 $ 433,516 5,160 $310,464 5,358
------------ --------- ---------- ---------- ---------- -------- ---------- --------- --------- ------
------------ --------- ---------- ---------- ---------- -------- ---------- --------- --------- ------
(1) In 1996, acquisitions consisted of $365.4 million of single-family
residential loans, $310.4 million of multi-family residential loans, $433.5
million of commercial real estate loans and $1.5 million of other loans.
The 1996 data does not include the Company's pro rata share of the $741.2
million of discounted loans acquired by the LLC (see "Business--Investment
in Joint Venture"). In 1995, acquisitions consisted of $272.8 million of
single-family residential loans, $141.2 million of multi-family
residential loans, $374.9 million of commercial real estate loans and $2.3
million of other loans. In 1994, acquisitions consisted of $395.8 million
of single-family residential loans, $315.5 million of multi-family
residential loans and $115.1 million of commercial real estate loans. In
1993 and 1992, substantially all of the acquisitions were of single-family
residential loans.
(2) Resolutions and repayments consists of loans which were resolved in a manner
which resulted in partial or full repayment of the loan to the Company, as
well as principal payments on loans which have been brought current in
accordance with their original or modified terms or on other loans which
have not been resolved.
(3) The Company realized gains of $7.4 million, $6.0 million and $890,000 from
the sale of discounted loans during 1996, 1995 and 1994, respectively. The
terms of these sales did not provide for any recourse to the Company based
on the subsequent performance of the loans. Also, during 1996 the Company
securitized $136.5 million of commercial discounted loans. The Company
realized a gain of $7.9 million on the sale of its securities and
retained the subordinated security having a carrying value of $9.2 million
and a par value of $26.3 million.
7
For information relating to the activity in the Company's real estate owned
which is attributable to the Company's discounted loan acquisitions, see
"Business--Asset Quality--Real Estate Owned."
PAYMENT STATUS OF DISCOUNTED LOANS. The following table sets forth certain
information relating to the payment status of loans in the Company's discounted
loan portfolio at the dates indicated.
DECEMBER 31,
------------------------------------------------------------
1996 1995 1994 1993 1992
------------ ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Loan status:
Past due less than 31 days........................ $ 579,597 $ 351,630 $ 113,794 $ 23,629 $ 25,463
Past due 31 days to 89 days....................... 22,161 86,838 57,023 15,175 4,063
Past due 90 days or more.......................... 563,077 385,112 413,506 254,413 31,808
Acquired and servicing not yet transferred........ 149,564 119,949 201,111 140,299 249,130
------------ ---------- ---------- ---------- ----------
1,314,399 943,529 785,434 433,516 310,464
Unaccreted discount................................ (241,908) (273,758) (255,974) (129,882) (97,426)
Allowance for loan losses.......................... (11,538) -- -- -- --
------------ ---------- ---------- ---------- ----------
$ 1,060,953 $ 669,771 $ 529,460 $ 303,634 $ 213,038
------------ ---------- ---------- ---------- ----------
------------ ---------- ---------- ---------- ----------
ACCOUNTING FOR DISCOUNTED LOANS. The discount associated with
single-family residential loans is recognized as a yield adjustment and is
accreted into interest income using the interest method applied on a
loan-by-loan basis once foreclosure proceedings are initiated, to the extent
the timing and amount of cash flows can be reasonably determined. The
discount which is associated with a single-family residential loan and
certain multi-family residential and commercial real estate loans which are
current or subsequently brought current by the borrower in accordance with
the loan terms is accreted into the Company's interest income as a yield
adjustment using the interest method over the contractual maturity of the
loan. For all other loans interest is earned as cash is received. During the
years ended December 31, 1996, 1995 and 1994, 94.2%, 93.2% and 92.7%,
respectively, of the Company's income on discounted loans was comprised of
realized discount. For additional information, see Note 10 to the
Consolidated Financial Statements included in Item 8 hereof. Effective
January 1, 1997, the Company ceased accretion of discount on its
nonperforming single-family residential loans. See "Recent Regulatory
Developments" in Item 7 hereof.
Gains on the repayment and discharge of loans are recorded in interest
income on discounted loans. Upon receipt of title to property securing a
discounted loan, the loans are transferred to real estate owned and accretion of
the related discount is discontinued.
Beginning in 1996, adjustments to reduce the carrying value of discounted
loans to the fair value of the property securing the loan are charged against
the allowance for loan losses on the discounted loan portfolio. Prior to 1996,
such adjustments were charged against interest income on discounted loans.
OTHER DISCOUNTED LOAN ACTIVITIES. The Company believes that the
procedures, facilities and systems which it has developed in connection with
the acquisition and resolution of discounted loans may be applied in other
areas. The Company commenced a program in 1995 to utilize this experience by
financing the acquisition of discounted loans by other institutions. During
1996 and 1995, the Company originated $41.7 million and $25.8 million,
respectively, of portfolio finance loans, which had an aggregate balance of
$39.9 million at December 31, 1996. Portfolio finance loans generally have
two-year terms, floating interest rates which adjust in accordance with a
designated reference rate and a loan-to-value ratio which does not exceed the
lesser of 90% of the purchase price or the estimated value of the collateral
as determined by the Company, and may include terms which provide the Company
with a participation interest in the profits from the resolution of the
8
discounted loan collateral. Portfolio finance loans are included in the
Company's non-discounted loan portfolio under the category of loan which is
represented by the properties which secure the discounted loans that
collateralize the Company's portfolio finance loans. See "Business--Lending
Activities."
During 1996, the Company developed a program to provide loan servicing,
including asset management and resolution services, to third party owners of
subprime, subperforming and non-performing assets. Servicing contracts
entered into by the Company provide for the payment to the Company of
specified fees and in some cases may include terms which allow the Company to
participate in the profits resulting from the successful resolution of the
assets. At December 31, 1996, the Company serviced loans for others totaling
$1.92 billion in principal balance as compared to $361.6 million at December
31, 1995.
INVESTMENT IN JOINT VENTURE
GENERAL. In April 1996, the LLC purchased 16,196 single-family
residential loans offered by HUD at an auction ("HUD Loans"). Many of the
loans, which had an aggregate unpaid principal balance of $741.2 million at
the date of acquisition, were not performing in accordance with their original
terms or an applicable forbearance agreement. The aggregate purchase price paid
to HUD amounted to $626.4 million.
In connection with the LLC's acquisition of the HUD Loans the Company
entered into an agreement with the LLC to service the HUD Loans in accordance
with its loan servicing and loan default resolution procedures. In return for
such servicing, the Company receives specific fees which are payable on a
monthly basis.
DESCRIPTION OF HUD LOANS. All of the HUD Loans are secured by first
mortgage liens on single-family residences. Of the $159.4 million gross
principal amount of the HUD Loans remaining as of December 31, 1996, $155.9
million had fixed interest rates and $3.5 million had adjustable rates. As of
the same date, the HUD Loans had a weighted average coupon rate of 10.08% and
a weighted average maturity of 17 years.
The properties which secure the HUD Loans remaining at December 31, 1996
are located throughout 31 states in the U.S., the District of Columbia and
Puerto Rico. As of December 31, 1996, the five jurisdictions with the
greatest concentration of properties securing the remaining HUD Loans were
Texas, California, Connecticut, Maryland and Colorado, which had $30.4
million, $26.6 million, $11.7 million, $9.5 million and $9.0 million gross
principal amount of loans, respectively.
The HUD Loans were acquired by HUD pursuant to various assignment programs
of the FHA. Under programs of the FHA, a lending institution may assign a
FHA-insured loan to HUD because of an economic hardship on the part of the
borrower which precludes the borrower from making the scheduled principal and
interest payment on the loan. FHA-insured loans also are automatically assigned
to HUD upon the 20th anniversary of the mortgage loan. In most cases, loans
assigned to HUD after this 20-year period are performing under the original
terms of the loan. Once a loan is assigned to HUD, the FHA insurance has been
paid and the loan is no longer insured. As a result, none of the HUD Loans are
insured by the FHA.
HUD assistance to borrowers is provided in the form of forbearance
agreements under which the borrower either makes a monthly payment less than or
equal to the original monthly payment or makes a monthly payment more than the
contractual monthly payment to make up for arrearages. Forbearance agreements
are 12 months in duration and the borrower may be granted up to a maximum of
three consecutive 12-month plans. Under the terms of the contract governing the
sale of the HUD Loans, the LLC and the Company, as the servicer of the HUD
Loans, are obligated to comply with the terms of the forbearance agreements,
which may be written or oral in nature, until the term of the forbearance
agreement expires or there is a default under the forbearance agreement.
9
The following table sets forth information relating to the payment status of
the remaining HUD Loans at December 31, 1996:
PRINCIPAL % OF HUD
AMOUNT LOANS
---------- ----------
(DOLLARS IN THOUSANDS)
HUD Loans without Forbearance Agreements:
Past due less than 31 days......................... $ 6,709 4.21
Past due 31 to 89 days............................. 3,011 1.89
Past due 90 days or more........................... 84,509 53.02
----------
Subtotal........................................... 94,229 59.12
----------
HUD Loans with Forbearance Agreements:
Past due less than 31 days......................... 4,867 3.05
Past due 31 to 89 days............................. 5,168 3.24
Past due 90 days or more........................... 55,141 34.59
----------
Subtotal........................................... 65,176 40.88
----------
Total.............................................. $ 159,405 100.00
----------
----------
SECURITIZATION OF THE HUD LOANS. On October 15, 1996, the LLC completed
a securitization of 9,825 of the HUD Loans with an unpaid principal balance
of $419.4 million, past due interest of $86.1 million and a net book value of
$394.2 million. The securitization involved the creation of a special purpose
entity which acquired the HUD Loans which were securitized from the LLC with
payment made from the proceeds of the issuance of the real estate mortgage
investment conduct ("REMIC") securities backed by such loans. The LLC
recognized a $69.8 million gain from the sale of the senior classes of the
mortgage-related security backed by these HUD Loans.The Company has retained
the right to service the HUD Loans which back the REMIC and is paid a
servicing fee. Both the Company and the co-investor each retained 50% of the
first-loss subordinated mortgage-related security issued from the
securitization of the HUD Loans. The par amount of the subordinated security
and the Company's recorded basis in the subordinated security were $35.2
million and $15.3 million, respectively, at December 31, 1996.
ACCOUNTING FOR INVESTMENT IN THE LLC. The Company's investment in the LLC
is accounted for under the equity method of accounting. Under the equity method
of accounting, an investment in the shares or other interests of an investee is
initially recorded at the cost of the shares or interests acquired and
thereafter is periodically increased (decreased) by the investor's proportionate
share of the earnings (losses) of the investee and decreased by all dividends
received by the investor from the investee. At December 31, 1996, the Company's
investment in the LLC amounted to $67.9 million. Because the LLC is a
pass-through entity for federal income tax purposes, provisions for income taxes
are established by each of the Company and its co-investor and not the LLC. The
Company recognized $38.3 million of pre-tax income from its investment in the
LLC during 1996. For additional information, see Note 2 to the Consolidated
Financial Statements included in Item 8 hereof.
LENDING ACTIVITIES
COMPOSITION OF LOAN PORTFOLIO. At December 31, 1996, the Company's net
loan portfolio amounted to $402.6 million or 16.2% of the Company's total
assets. Loans held for investment in the Company's loan portfolio are carried
at amortized cost, less an allowance for loan losses, because the Company has
the ability and presently intends to hold them to maturity.
10
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
DECEMBER 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
----------- ---------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Single-family residential loans...................... $ 73,186 $ 75,928 $31,926 $30,385 $33,799
Multi-family residential loans....................... 67,842(1) 49,047(1) 1,800 39,352 5,563
Commercial real estate and land loans:
Hotels............................................... 200,311(2) 125,791 19,659 14,237 --
Office buildings..................................... 128,782 61,262 -- -- --
Land................................................. 2,332 24,904 1,315 4,448 --
Other................................................ 25,623 2,494 4,936 4,059 1,908
----------- ---------- --------- --------- ---------
Total................................................ 357,048 214,451 25,910 22,744 1,908
Commercial non-mortgage.............................. 2,614 -- -- -- --
Consumer............................................. 424 3,223 1,558 3,639 2,395
----------- ---------- --------- --------- ---------
Total loans.......................................... 501,114 342,649 61,194 96,120 43,665
Undisbursed loan proceeds............................ (89,840) (39,721) -- -- --
Unaccreted discount.................................. (5,169) (5,376) (3,078) (6,948) (1,898)
Allowance for loan losses............................ (3,523) (1,947) (1,071) (884) (752)
----------- ---------- ---------- --------- ----------
Loans, net..................................... $402,582 $295,605 $57,045 $88,288 $41,015
----------- ---------- --------- --------- ---------
----------- ---------- --------- --------- ---------
(1) At December 31, 1996 and 1995, multi-family residential loans included $36.6
million and $7.7 million of construction loans, respectively.
(2) At December 31, 1996, hotel loans included $26.4 million of construction
loans.
The Company's lending activities are conducted on a nationwide basis and, as
a result, the properties which secure its loan portfolio are geographically
located throughout the United States. At December 31, 1996, the five states in
which the largest amount of properties securing the loans in the Company's loan
portfolio were located were New York, Illinois, California, New Jersey and
Georgia, which had $118.1 million, $81.3 million, $76.6 million, $47.3
million and $30.1 million of principal amount of loans, respectively. For
further information about the geographic location of the properties which secure
loans in the Company's loan portfolio, see Note 9 to the Consolidated
Financial Statements included in Item 8hereof. As noted above, the Company
believes that the broad geographic distribution of its loan portfolio reduces
the risks associated with concentrating such loans in limited geographic areas.
Included in the total loan portfolio at December 31, 1996 and 1995 are
$315.9 million and $180.2 million, respectively, of loans in which the
Company participates in the expected residual profits of the underlying real
estate, of which $233.7 million and $142.5 million, respectively, had been
funded. See Notes 1 and 9 to the Consolidated Financial Statements included
in Item 8 hereof. Management believes that all loans in which the Company
participates in residual profits are properly accounted for under generally
accepted accounting principles as loans and not as investments in real estate,
however, because of concerns raised by the staff of the OTS in this regard, in
December 1996 the Bank sold subordinated, participating interest totaling
$14.6 million to the Company with respect to eight loans. In addition,
subsequent to December 31, 1996, management of the Company decided to cease
origination of loans with expected profit participation features in the
underlying real estate, with the exception of existing commitments. See
"Recent Regulatory Developments" in Item 7 hereof.
CONTRACTUAL PRINCIPAL REPAYMENTS. The following table sets forth certain
information at December 31, 1996 regarding the dollar amount of loans
maturing in the Company's loan portfolio based on scheduled contractual
amortization, as well as the dollar amount of loans which have fixed or
adjustable interest rates. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdrafts are reported as due in one
year or less. Loan balances have not been reduced for (i) undisbursed loan
proceeds, unearned discounts and the allowance for loan losses and (ii)
non-performing loans.
11
MATURING IN
-----------------------------------------------------------------------------
AFTER FIVE YEARS
ONE AFTER ONE YEAR THROUGH TEN AFTER TEN
YEAR OR LESS THROUGH FIVE YEARS YEARS YEARS
------------------- --------------------- ------------------ --------------
(DOLLARS IN THOUSANDS)
Single-family residential loans.............. $ 15,314 $ 6,429 $ 4,446 $ 46,997
Multi-family residential loans............... 37,341 26,921 3,513 67
Commercial real estate and land loans........ 14,484 297,698 40,850 4,016
Consumer and other loans..................... 2,647 323 68 --
----------- -------------- ------------- ------------
Total........................................ $ 69,786 $ 331,371 $48,877 $51,080
----------- -------------- ------------- ------------
----------- -------------- ------------- ------------
Interest rate terms on amounts due:
Fixed........................................ $ 44,744 $ 274,078 $47,777 $ 38,208
Adjustable................................... 25,042 57,293 1,100 12,872
----------- -------------- ------------- ------------
$ 69,786 $ 331,371 $48,877 $ 51,080
----------- -------------- ------------- ------------
----------- -------------- ------------- ------------
Scheduled contractual principal repayments do not reflect the actual
maturities of loans because of prepayments and, in the case of conventional
mortgage loans, due-on-sale clauses. The average life of mortgage loans,
particularly fixed-rate loans, tends to increase when current mortgage loan
rates are substantially higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgages are substantially higher
than current mortgage loan rates.
ACTIVITY IN THE LOAN PORTFOLIO. The following table sets forth the activity
in the Company's loan portfolio during the periods indicated.
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
---------- ---------- ---------
(DOLLARS IN THOUSANDS)
Balance at beginning of period:....... $ 342,649 $ 61,194 $ 96,120
Originations:
Single-family residential loans....... 10,681 14,776 7,119
Multi-family residential loans........ 68,076 48,664 --
Commercial real estate loans.......... 199,017 212,630 22,486
Commercial non-mortgage and
consumer loans...................... 3,366 207 --
---------- ---------- ---------
Total loans originated................ 281,140 276,277 29,605
---------- ---------- ---------
Purchases:
Single-family residential loans....... 305 29,833 --
Commercial real estate loans.......... -- 2,245 --
Consumer loans........................ -- 1,966 --
---------- ---------- ---------
Total loans purchased................. 305 34,044 --
---------- ---------- ---------
Sales................................. -- -- (1,078)
Loans transferred from (to) available
for sale............................. 45 4,353 (24,380)
Principal repayments.................. (121,818) (33,168) (39,073)
Transfer to real estate owned......... (1,207) (51) --
---------- ---------- ---------
Net increase (decrease) in net loans... 158,465 281,455 (34,926)
---------- ---------- ---------
Balance at end of period:.............. $ 501,114 $ 342,649 $ 61,194
---------- ---------- ---------
---------- ---------- ---------
LOANS AVAILABLE FOR SALE. In addition to loans acquired for investment,
the Company also originates and purchases loans which it presently does not
intend to hold to maturity. Such loans are designated as loans available for
sale upon origination or purchase and generally are carried at the lower of
cost or aggregate market value. At December 31, 1996, loans available for
sale amounted to $126.4 million or 5.1% of the Company's total assets.
12
The following table sets forth the composition of the Company's loans
available for sale by type of loan at the dates indicated.
DECEMBER 31,
---------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ---------
(DOLLARS IN THOUSANDS)
Single-family residential loans.......................... $ 111,980 $ 221,927 $ 16,825 $ 30,217 $ 754
Multi-family residential loans........................... 13,657 28,694 83,845 44,919 --
Consumer loans........................................... 729 1,169 1,623 25,930 --
---------- ---------- ---------- ---------- ---------
$ 126,366 $ 251,790 $ 102,293 $ 101,066 $ 754
---------- ---------- ---------- ---------- ---------
---------- ---------- ---------- ---------- ---------
Although the Company's loans available for sale are secured by properties
located nationwide, currently a substantial majority of such loans are
single-family residential loans to non-conforming borrowers originated primarily
in the western states, particularly California. As a result, $ million
or % of the Company's loans available for sale at December 31, 1996 were
secured by properties located in California.
SINGLE-FAMILY RESIDENTIAL LOANS. Since late 1994, the Company's lending
activities have included the origination and purchase of single-family
residential loans to borrowers who because of prior credit problems, the
absence of a credit history or other factors are unable or unwilling to
qualify as borrowers for a single-family residential loan under guidelines of
the Federal National Mortgage Association ("FNMA") and the Federal Home Loan
Mortgage Corporation ("FHLMC) ("conforming loans") and who have substantial
equity in the properties which secure the loans. Loans to non-conforming
borrowers are perceived by the Company as being advantageous
because they generally have higher interest rates and origination and
servicing fees and generally lower loan-to-value ratios than conforming loans
and because the Company's expertise in the servicing and resolution of
non-performing loans can be utilized in underwriting such loans, as well as
to address loans acquired pursuant to this program which become
non-performing after acquisition.
The Company has acquired single-family residential loans to
non-conforming borrowers primarily through a correspondent relationship with
an established mortgage banking firm, Admiral Home Loan ("Admiral"), a
California corporation engaged in the origination of loans to credit-impaired
borrowers secured by first mortgage liens on single family residential real
property, both through the wholesale acquisition of such loans originated by
mortgage brokers and through its retail offices, and to a lesser extent
correspondent relationships with three other financial services companies.
Correspondent institutions originate loans based on guidelines provided by
the Company and promptly sell the loans to the Company on a
servicing-released basis.
The Company's current strategy is to continue to solidify and expand its
wholesale sources, which are subject to a thorough due diligence and approval
process to ensure quality sources of new business. In addition, in order to
diversify its sources, the Company currently is developing the ability to
directly originate loans to non-conforming borrowers on a wholesale basis.
Recently, the Company established loan production offices for this purpose in
California, Illinois, Massachusetts and Utah. Although the Company is
evaluating sites for additional loan production offices, there can be no
assurance that the Company will establish other offices or that its loan
production office or offices will be able to successfully originate
single-family residential loans. In addition, the Company has entered into an
asset purchase agreement (see Note 27) to acquire an 80% interest in the
assets of Admiral. Closing of the acquisition is expected to occur during the
second quarter of 1997.
The Company has adopted policies that set forth the specific lending
requirements of the Company as they relate to the processing, underwriting,
property appraisal, closing, funding and delivery of loans to non-conforming
borrowers. These policies include program descriptions which set forth four
classes of non-conforming loans, designated A, B, C and D. Class A loans
generally relate to borrowers who have no or limited adverse incidents in their
credit histories, whereas Class B, C and D loans relate to increasing degrees of
non-conforming borrowers. Factors which are considered in evaluating a borrower
in this regard are the presence or absence of a credit history, prior
delinquencies in the payment of mortgage and consumer credit and personal
bankruptcies.
The terms of the loan products offered by the Company directly or through
its correspondents to non-conforming borrowers emphasize real estate loans which
generally are underwritten with significant reliance on a borrower's level of
equity in the property securing the loan, which may be an owner-occupied or,
depending on the class of loan and its terms, a non-owner occupied property.
Although the Company's guidelines require information in order to enable the
Company to evaluate a borrower's ability to repay a loan by relating the
borrower's income, assets and liabilities to the proposed
13
indebtedness, because of the significant reliance on the ratio of the principal
amount of the loan to the appraised value of the security property, each of the
four principal classes of loans identified by the Company include products
which permit reduced documentation for verifying a borrower's income and
employment. Loans which permit reduced documentation generally require
documentation of employment and income for the most recent six-month period, as
opposed to the two-year period required in the case of full documentation
loans. Although the Company reserves the right to verify a borrower's
income, assets and liabilities and employment history, other than as set forth
above, it generally does not verify such information through other sources.
The Company's strategy is to offer a broad range of products to its
borrowers and its origination sources. Loans may have principal amounts which
conform to the guidelines set by FHLMC or FNMA for
conforming loans, or principal amounts which significantly exceed these amounts
(so called "jumbo loans"). Loans may have fixed or adjustable interest rates and
terms ranging up to 30 years.
The Company purchased and originated a total of $294.0 million of
single-family residential loans to non-conforming borrowers during 1996 and
$240.3 million of such loans during 1995. At December 31, 1996, the Company had
$99.7 million of single-family residential loans to non-conforming borrowers,
which had a weighted average yield of 10.43%.
The Company generally intends to sell or securitize its single-family
residential loans to non-conforming borrowers and, as a result all of such
loans were classified as available for sale at December 31, 1996. During
1996, the Company sold $161.5 million of single-family residential loans to
non-conforming borrowers for gains of $571,000, and during 1995 the Company
sold $25.3 million of such loans for gains of $188,000. An additional $219.6
million of loans were securitized and sold in two underwritten public
offerings managed by unaffiliated investment banking firms during 1996,
generating gains of $7.2 million upon the sale of the securities. The Company
received residual securities in the REMICs which were formed in connection
with these two transactions as partial payment for the loans sold by it,
which had a carrying value of $20.6 million at December 31, 1996.
Although non-conforming loans generally have higher levels of default than
conforming loans, the Company believes that the borrower's equity in the
security property and its expertise in the area of resolution of non-performing
loans will continue to make its non-conforming borrower loan program a
profitable one notwithstanding such defaults and any resulting losses. There can
be no assurance that this will be the case, however.
In addition to the Company's single-family residential loan programs to
non-conforming borrowers, from time to time the Company purchases pools of
single-family residential loans for investment purposes. During 1995, the
Company purchased $29.8 million of loans which were primarily secured by
properties located in the Company's market area in northern New Jersey.
MULTI-FAMILY RESIDENTIAL LOANS. The Company's lending activities previously
included the acquisition of conventional loans secured by existing multi-family
residences located nationwide. At December 31, 1996, the Company's permanent
multi-family residential loans originated or purchased under this program
amounted to $13.7 million, all of which were classified available for sale.
During 1995 and 1996, the Company originated loans for the construction
of multi-family residences located nationwide, as well as bridge loans to
finance the acquisition and rehabilitation of distressed multi-family
residential properties. At December 31, 1996, the Company's multi-family
residential loan portfolio included $36.6 million of multi-family residential
construction loans, of which $28.9 million had been funded at such date and
$31.2 million of acquisition and rehabilitation loans, of which $24.9 million
had been funded.
Construction loans generally have terms of three to four years and
interest rates which float on a monthly basis in accordance with a designated
reference rate. Payments during the term of the loan may be made to the
Company monthly on an interest-only basis. The loan amount may include an
interest reserve which is maintained by the Company and
14
utilized to pay interest on the loan during a portion of its term. In
addition to stated interest, and in order to compensate the Company for the
greater risk which generally is associated with construction loans, the
Company's multi-family residential construction loans may include provisions
pursuant to which the borrower agrees to pay the Company, as additional
interest on the loan, an amount based on specified percentages (generally
between 10-37.5%) of the net proceeds from the sale of the property or the
net increase in the economic value of the property upon refinancing or
maturity of the loan. Currently, the Company does not intend to originate any
additional loans in which it participates in the residual profits of the
underlying real estate, as discussed above, with the exception of existing
commitments.
Construction loans are secured by a first priority lien on the real
property, all improvements thereon and all fixtures and equipment used in
connection therewith, as well as a first priority assignment of all
revenues and gross receipts generated in connection with the property.
Construction loans are made without pre-leasing requirements or any requirement
of a commitment by another lender to "take-out" the construction loan by making
a permanent loan secured by the property upon completion of construction.
Disbursements on a construction loan are subject to a retainage percentage of
10% and are made only after evidence that available funds have been utilized by
the borrower and are sufficient to pay for all construction costs through the
date of the construction advance and funds remain in the construction budget and
from sources other than the loan to complete construction of the project.
The Company generally requires the general contractor selected by the
borrower, which along with the general construction contract is subject to
the Company's review and approval, to provide payment and performance bonds
issued by a surety approved by the Company in an amount at least equal to the
costs which are estimated to be necessary to complete construction of the
project in accordance with the construction contract. Moreover, the Company
generally conducts site inspections of projects under construction at least
bi-monthly and of completed projects at least semi-annually.
COMMERCIAL REAL ESTATE AND LAND LOANS. The Company's lending activities
include the acquisition of loans secured by commercial real estate, particularly
loans secured by hotels and office buildings, which the Company began
originating in late 1994 and late 1995, respectively. Commercial real estate
loans currently are made to finance the purchase and refinance of properties,
the refurbishment of distressed properties and, recently, the construction of
hotels. At December 31, 1996, the Company's loans secured by commercial real
estate (and land) amounted to $357.0 million and consisted primarily of $200.3
million and $128.8 million of loans secured by hotels and office buildings,
respectively.
Commercial real estate loans are obtained directly by the Company through
its marketing efforts to mortgage brokers, mortgage bankers, developers and
other sources. Such loans generally have terms of four to seven years and are
amortized over 15 to 25 year periods. The maximum loan-to-value ratio generally
does not exceed the lesser of 85% of appraised value or the purchase price of
the property.
Commercial real estate loans generally have fixed rates of interest. In
addition to stated interest, commercial real estate loans may include
provisions pursuant to which the borrower agrees to pay the Company as
additional interest on the loan an amount based on specified percentages
(generally between 20-37.5%) of the net cash flow from the property during the
term of the loan and/or the net proceeds from the sale or refinance of the
property upon maturity of the loan. Alternatively, participating interests
may be obtained in the form of additional fees which must be paid by the
borrower in connection with a prepayment of the loan, generally after an
initial lock-out period during which prepayments are prohibited. The fees
which could be payable by a borrower during specified periods of the loan
consist either of fixed exit fees or yield maintenance payments, which are
required to be paid over a specified number of years after the prepayment and
are intended to increase the yield of the Company on the proceeds from the
loan payoff to a level which is comparable to the yield on the prepaid loan.
Currently, the Company does not intend to originate any additional commercial
real estate loans in which it participates in the residual profits of the
underlying real estate, as discussed above.
15
Commercial real estate loans are secured by a first priority lien on the
real property, all improvements thereon and, in the case of hotel loans, all
fixtures and equipment used in connection therewith, as well as a first priority
assignment of all revenues and gross receipts generated in connection with the
property. The liability of a borrower on a commercial real estate loan
generally is limited to the borrower's interest in the property, except with
respect to certain specified circumstances.
Multi-family residential, commercial real estate and construction lending
generally are considered to involve a higher degree of risk than single-family
residential lending because such loans involve larger loan balances to a single
borrower or group of related borrowers. In addition, the payment experience on
multi-family residential and commercial real estate loans typically is dependent
on the successful operation of the project, and thus such loans may be adversely
affected to a greater extent by adverse conditions in the real estate markets or
in the economy generally. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion of construction or development and the estimated cost (including
interest) of construction, as well as the availability of permanent take-out
financing. During the construction phase, a number of factors could result in
delays and cost overruns. If the estimate of value proves to be inaccurate, the
Company may be confronted, at or prior to the maturity of the loan, with a
project which, when completed, has a value which is insufficient to ensure full
repayment. In addition to the foregoing, multi-family residential and commercial
real estate loans which are not fully amortizing over their maturity and which
have a balloon payment due at their stated maturity, as is generally the case
with the Company's multi-family residential and commercial real estate loans,
involve a greater degree of risk than fully amortizing loans because the ability
of a borrower to make a balloon payment typically will depend on its ability
either to timely refinance the loan or to timely sell the security property. The
ability of a borrower to accomplish these results will be affected by a number
of factors, including the level of available mortgage rates at the time of sale
or refinancing, the financial condition and operating history of the borrower
and the property which secures the loan, tax laws, prevailing economic
conditions and the availability of financing for multi-family residential and
commercial real estate generally.
ASSET QUALITY
The Company, like all financial institutions, is exposed to certain credit
risks related to the value of the collateral that secures its loans and the
ability of borrowers to repay their loans. Management of the Company closely
monitors the Company's loan and investment portfolios and the Company's real
estate owned for potential problems and reports to the Board of Directors at
regularly scheduled meetings.
NON-PERFORMING LOANS. It is the Company's policy to establish an allowance
for uncollectible interest on loans in its loan portfolio and loans available
for sale which are past due 90 days or more and to place such loans on
non-accrual status. As a result, the Company currently does not have any loans
which are accruing interest but are past due 90 days or more. Loans also may
be placed on non-accrual status when, in the judgment of management, the
probability of collection of interest is deemed to be insufficient to warrant
further accrual. When a loan is placed on non-accrual status, previously accrued
but unpaid interest is reversed by a charge to interest income.
The following table sets forth certain information relating to the Company's
non-performing loans in its loan portfolio at the dates indicated. For
information relating to the payment status of loans in the Company's discounted
loan portfolio, see "Business-Discounted Loan Acquisitions and Resolution
Activities, " and for information concerning non-performing loans available for
sale, see "Management Discussion and Analysis of Financial Condition-Changes in
Financial Condition-Loans Available for Sale."
16
DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Non-performing loans (1)
Single-family residential loans.................................. $ 2,123 $ 2,923 $ 2,478 $ 2,347 $ 2,955
Multi-family residential loans................................... 106 731 152 664 269
Consumer and other loans......................................... 55 202 29 556 407
--------- --------- --------- --------- ---------
Total............................................................ $ 2,284 $ 3,856 $ 2,659 $ 3,567 $ 3,631
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Non-performing loans as a percentage of:
Total loans (2).................................................. 0.56% 1.27% 4.35% 3.71% 8.32%
Total assets..................................................... 0.09% 0.20% 0.21% 0.27% 0.44%
Allowance for loan losses as a percentage of:
Total loans(3)................................................... 0.87% 0.65%(4) 1.84% 0.99% 1.80%
Non-performing loans............................................. 154.24% 50.49% 40.28% 24.78% 20.71%
- ------------------------
(1) The Company did not have any non-performing loans in its loan portfolio
which were deemed troubled debt restructuring at the dates indicated.
(2) Total loans is net of undisbursed loan proceeds.
(3) Total loans is net of the undisbursed loan proceeds and unaccreted
discount.
(4) The decrease in the allowance for loan losses as a percentage of total loans
from 1994 was due to the significant increase in the loan portfolio in 1995
as a result of the purchase of single family residential loans and the
origination of multi-family residential and commercial real estate loans.
REAL ESTATE OWNED. Properties acquired through foreclosure or by
deed-in-lieu thereof are valued at the lower of amortized cost or fair value.
Properties included in the Company's real estate owned portfolio are
periodically re-evaluated to determine that they are being carried at the lower
of cost or fair value less estimated costs to sell. Holding and maintenance
costs related to properties are recorded as expenses in the period incurred.
Deficiencies resulting from valuation adjustments to real estate owned
subsequent to acquisition are recognized as a valuation allowance. Subsequent
increases related to the valuation of real estate owned are reflected as a
reduction in the valuation allowance, but not below zero. Increases and
decreases in the valuation allowance are charged or credited to income,
respectively. Accumulated valuation allowances amounted to $11.5 million at
December 31, 1996.
17
The following table sets forth certain information relating to the Company's
real estate owned at the dates indicated.
DECEMBER 31,
-------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Discounted loan portfolio:
Single-family residential................................. $ 49,728 $ 75,144 $ 86,426 $ 33,369 $ 4,390
Multi-family residential.................................. 14,046 59,932 -- -- --
Commercial real estate.................................... 36,264 31,218 8,801 -- --
---------- ---------- --------- --------- ---------
Total..................................................... 100,038 166,294 95,227 33,369 4,390
Loan portfolio............................................ 592 262 1,440 128 320
Loans available for sale.................................. 3,074 -- -- -- --
---------- ---------- --------- --------- ---------
Total..................................................... $ 103,704 $ 166,556 $ 96,667 $ 33,497 $ 4,710
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
The following table sets forth certain geographical information at December
31, 1996 related to the Company's real estate owned.
DECEMBER 31, 1996
-------------------------------------------------------------
SINGLE-FAMILY MULTI-FAMILY RESIDENTIAL
RESIDENTIAL AND COMMERCIAL TOTAL
------------------------ ------------------------ ---------
NO. OF NO. OF NO. OF
AMOUNT PROPERTIES AMOUNT PROPERTIES AMOUNT PROPERTIES
--------- ------------- --------- ------------- --------- ------------
(DOLLARS IN THOUSANDS)
California........................... 12,631 106 40,528 43 53,159 149
New York............................. 14,708 217 2,212 14 16,920 231
New Jersey........................... 7,293 87 3,547 21 10,840 108
Connecticut.......................... 5,433 85 656 9 6,089 94
Florida.............................. 1,429 26 2,104 3 3,533 29
Other................................ 11,900(1) 203 1,263(2) 11 13,163 214
--------- --- --------- --- --------- ---
Total................................ 53,394 724 50,310 101 103,704 825
--------- --- --------- --- --------- ---
--------- --- --------- --- --------- ---
- ------------------------
(1) Consists of properties located in 27 other states, none of which aggregated
over $2.8 million in any one state.
(2) Consists of properties located in 5 other states, none of which aggregated
over $830,000 in any one state.
The following table sets forth the activity in the real estate owned during
the periods indicated.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1996 1995 1994
----------------------- ----------------------- -----------------------
(DOLLARS IN THOUSANDS)
NO. OF NO. OF NO. OF
AMOUNT PROPERTIES AMOUNT PROPERTIES AMOUNT PROPERTIES
---------- ----------- ---------- ----------- ---------- -----------
Balance at beginning of period..................... $ 166,556 1,070 $ 96,667 1,018 $ 33,497 541
Properties acquired through foreclosure or
deed-in-lieu thereof............................. 102,098 918 185,174 970 142,536 1,489
Acquired in connection with acquisitions of
discounted loans................................. 2,529 12 24,417 311 38,071 398
Sales.............................................. (160,592) (1,175) (139,233) (1,229) (115,955) (1,410)
Change in allowance................................ (6,887) -- (669) -- (1,482) --
---------- ----------- ---------- ----------- ---------- -----------
Balance at end of period........................... 103,704 825 $ 166,556 1,070 $ 96,667 1,018
---------- ----------- ---------- ----------- ---------- -----------
---------- ----------- ---------- ----------- ---------- -----------
18
The following table sets forth the amount of time that the Company had held
its real estate owned at the dates indicated.
DECEMBER 31,
----------------------
1996 1995
---------- ----------
(DOLLARS IN THOUSANDS)
One to two months..................................................... $ 17,695 $ 25,398
Three to four months.................................................. 15,291 22,672
Five to six months.................................................... 14,348 25,742
Seven to 12 months.................................................... 13,004 76,782
Over 12 months........................................................ 43,366 15,962
---------- ----------
$ 103,704 $ 166,556
---------- ----------
---------- ----------
The average period during which the Company held the $160.6 million, $139.2
million and $116.0 million of real estate owned which was sold during the years
ended December 31, 1996, 1995 and 1994, respectively, was 11 months, eight
months and seven months , respectively.
Although the Company evaluates the potential for significant environmental
problems prior to acquiring a loan, there is a risk for any mortgage loan,
particularly a multi-family residential and commercial real estate loan, that
hazardous substances or other environmentally restricted substances could be
discovered on the related real estate. In such event, the Company might be
required to remove such substances from the affected properties or to engage in
abatement procedures at its sole cost and expense. There can be no assurance
that the cost of such removal or abatement will not substantially exceed the
value of the affected properties or the loans secured by such properties, that
the Company would have adequate remedies against the prior owners or other
responsible parties or that the Company would be able to resell the affected
properties either prior to or following completion of any such removal or
abatement procedures. If such environmental problems are discovered prior to
foreclosure, the Company generally will not foreclose on the related loan;
however, the value of such property as collateral will generally be
substantially reduced and the Company may suffer a loss upon collection of the
loan as a result.
From time to time the Company makes loans to finance the sale of real estate
owned. At December 31, 1996, such loans amounted to $12.8 million and consisted
of $6.4 million of single-family residential loans, $3.7 million of multi-family
residential loans, $2.3 million of land loan and $0.4 million of commercial
loans. All of the Company's loans to finance the sale of real estate owned were
performing in accordance with their terms at December 31, 1996.
CLASSIFIED ASSETS. OTS regulations require that each insured savings
association classify its assets on a regular basis. In addition, in connection
with examinations of insured associations, OTS examiners have authority to
identify problem assets and, if appropriate, require them to be classified.
There are three classifications for problem assets: "substandard," "doubtful"
and "loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified loss is considered uncollectible and of
such little value that continuance as an asset of the institution is not
warranted. Another category designated "special mention" also must be
established and maintained for assets which do not currently expose an insured
institution to a sufficient degree of risk to warrant classification as
substandard, doubtful or loss but do possess credit deficiencies or potential
weaknesses deserving management's close attention. Assets classified as
substandard or doubtful require the institution to establish general allowances
for loan losses. If an asset or portion thereof is classified loss, the insured
institution must either establish specific allowances for loan losses in the
amount of 100% of the portion of the asset classified loss or charge off such
amount. In this regard, the Company establishes required reserves and charges
off loss assets as soon as administratively practicable. General loss allowances
established to cover possible losses related to assets classified substandard or
doubtful may be included in determining an institution's regulatory capital,
while specific valuation allowances for loan losses do not qualify as regulatory
capital.
19
In 1996, based upon discussions with the OTS and a result of an OTS
bulletin issued on December 13, 1996 entitled "Guidance on the Classification
and Regulatory Reporting of Certain Delinquent Loans and Other Credit Impaired
Assets,'' the Company has classified all discounted loans that are 90 or more
days contractually past due, not otherwise classified, as special mention and
all real state owned, not otherwise classified, as special mention. The
Company also modified its policy for classifying non-performing discounted
loans and real state owned related to its discounted loan portfolio
("non-performing discounted assets") to take into account both the holding
period of such assets from the date of acquisition and the ratio of book
value to market value of such assets. All non-performing discounted assets
which are held 15 months or more after the date of acquisition are classified
substandard; non-performing discounted assets held 12 months to less than 15
months from the date of acquisition are classified as substandard if a ratio
of book value to market value is 80% or more; and non-performing discounted
assets held less than 12 months from the date of acquisition are classified
as substandard if they have a ratio of book value to market value of more than
85%. In addition, non-performing discounted assets which are performing for a
period of time subsequent to acquisition by the Company are classified as
substandard at the time such loans become non-performing. The Company also
modified its classified assets policy to classify all real state owned which
is not cash flowing and which has been held for more than 15 months as
substandard. The Company's past experience indicates that the resulting
classified discounted assets do not necessarily correlate to probability or
severity of loss.
Excluding assets which have been classified loss and fully reserved by the
Company, the Company's classified assets at December 31, 1996 under the above
policy consisted of $204.9 million of assets classified as substandard and $5.4
million of assets classified as doubtful. In addition, at the same date $435.3
million of assets were designated as special mention.
Substandard assets at December 31, 1996 under the above policy consisted
primarily of $108.1 million of loans and real estate owned related to the
Company's discounted single-family residential loan, $78.9 million of
loans and real estate owned related to the Company's discounted commercial real
estate loan program and $16.2 million of single-family residential loans to
non-conforming borrowers. Special mention assets at December 31, 1996 under the
policy consisted primarily of $276.6 million and $144.7 million of loans and
real estate owned related to the Company's discounted single-family residential
and discounted commercial real estate loan programs, respectively.
ALLOWANCES FOR LOSSES. The Company maintains an allowance for loan losses
for each of its loan portfolio and discounted loan portfolio at a level which
management considers adequate to provide for potential losses in each portfolio
based upon an evaluation of known and inherent risks in such portfolios.
The following table sets forth the breakdown of the allowance for loan
losses on the Company's loan portfolio and discounted loan portfolio by loan
category and the percentage of loans in each category to total loans in the
respective portfolios at the dates indicated.
DECEMBER 31,
----------------------------------------------------------------------------------------
1996 1995 AMOUNT 1993
-------------------- -------------------- -------------------- ----------------------
AMOUNT % AMOUNT % 1994 % AMOUNT %
--------- --------- --------- --------- --------- --------- ----------- ---------
(DOLLARS IN THOUSANDS)
Loan portfolio:
Single-family residential loans.......... $ 520 14.6% $ 346 22.2% $ 615 52.2% $ 174 31.6%
Multi-family residential loans........... 673 13.5 683 14.3 -- 2.9 333 40.9
Commercial real estate loans............. 2,299 71.3 875 62.6 218 42.3 218 23.7
Commercial non-mortgage.................. 11 0.5 -- -- -- -- -- --
Consumer loans........................... 20 0.1 43 0.9 238 2.6 159 3.8
--------- --------- --------- --------- --------- ------- ----- -------
Total.................................... $ 3,523 100.0% $ 1,947 100.0% $ 1,071 100.0% $ 884 100.0%
--------- --------- --------- --------- --------- ------- ----- -------
--------- --------- --------- --------- --------- ------- ----- -------
Discounted loan portfolio(1):
Single-family residential loans.......... $ 3,528 38.4% $ -- -% $ -- -% $ -- -%
Multi-family residential loans........... 3,124 26.0 -- -- -- -- -- --
Commercial real estate loans............. 4,886 35.4 -- -- -- -- -- --
Other.................................... -- 0.2 -- -- -- -- -- --
--------- --------- --------- --------- --------- --------- ----- -------
Total.................................... $ 11,538 100.0% $ -- -- $ -- -- $ -- --
--------- --------- --------- --------- --------- --------- ----- -------
--------- --------- --------- --------- --------- --------- ----- -------
1992
----------------------
AMOUNT %
----------- ---------
Loan portfolio:
Single-family residential loans.......... $ 20 77.3%
Multi-family residential loans........... 281 12.7
Commercial real estate loans............. 220 4.6
Commercial non-mortgage.................. -- --
Consumer loans........................... 231 5.4
----- ---------
Total.................................... $ 752 100.0%
----- ---------
----- ---------
Discounted loan portfolio(1):
Single-family residential loans.......... $ -- -%
Multi-family residential loans........... -- --
Commercial real estate loans............. -- --
Consumer loans........................... -- --
----- ---------
Total.................................... $ -- --
----- ---------
----- ---------
- ------------------------
(1) The Company did not maintain an allowance for loan losses on its
discounted loan portfolio prior to 1996.
20
The allocation of the allowance to each category is not necessarily
indicative of future losses and does not restrict the use of the allowance to
absorb losses in any other category.
The following table sets forth an analysis of activity in the allowance for
loan losses relating to the Company's loan portfolio during the periods
indicated.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Balance, beginning of period......................................... $ 1,947 $ 1,071 $ 884 $ 752 $ 934
Provision for loan losses............................................ 1,872 1,121 -- -- --
Charge-offs:
Single-family residential loans...................................... (261) (131) (302) (150) (138)
Multi-family residential loans....................................... (7) -- -- (170) (3)
Commercial real estate loans......................................... -- (40) -- -- --
Consumer loans....................................................... (296) (92) (170) (16) (88)
--------- --------- --------- --------- ----
Total charge-offs.................................................... (263) (472) (336) (229)
Recoveries:.......................................................... --
Single-family residential loans...................................... -- 3 410 346 29
Multi-family residential loans....................................... -- -- -- -- --
Commercial real estate loans......................................... -- 15 -- -- --
Consumer loans....................................................... -- -- 249 122 18
--------- --------- --------- --------- ---
Total recoveries..................................................... -- 18 659 468 47
--------- --------- --------- --------- ---
Net (charge-offs) recoveries......................................... (296) (245) 187 132 (182)
--------- --------- --------- --------- ---
Balance, end of period............................................... 3,523 $ 1,947 $ 1,071 $ 884 $ 752
--------- --------- --------- --------- ---
Net charge-offs (recoveries) as a percentage of average loan
portfolio, net..................................................... 0.09% 0.19% (0.28% (0.10% 0.37%
During 1996, the activity in the allowance for loan losses related to the
discounted loan portfolio consisted of $206 million of general provisions for
losses, $9.2 million of charge-offs (consisting of $7.0 million, $0.7 million
and $1.5 million related to single-family residential loans, multi-family
residential loans and commercial real estate loans, respectively) and $0.2
million of recoveries.
INVESTMENT ACTIVITIES
GENERAL. The investment activities of the Company currently include
investments in mortgage-related securities, investment securities, and
low-income housing tax credit interests. The investment policy of the
Company, which is established by the Investment Committee and approved by the
Board of Directors, is designed primarily to provide a portfolio of
diversified instruments while seeking to optimize net interest income within
acceptable limits of interest rate risk, credit risk and liquidity.
MORTGAGE-BACKED AND RELATED SECURITIES. From time to time the Company
invests in mortgage-backed and related securities. Although mortgage-backed
and mortgage-related securities generally yield less than the loans that back
such securities because of costs associated with their payment guarantees or
credit enhancements, such securities are more liquid than individual loans
and may be used to collateralize borrowings of the Company. Other
mortgage-backed and mortgage-related securities bear the distilled risks of
the underlying loans, such as prepayment risk (interest-only securities) and
credit risk (subordinated interests), and are generally less liquid than
individual loans. See Note 6 to the Consolidated Financial Statements
included in Item 8 hereof.
Mortgage-related securities include senior and subordinate regular
interests and residual interests in collateralized mortgage obligations
("CMOs"), including CMOs which have qualified as REMICs. The regular interests
of some CMOs are like traditional debt instruments because they have stated
principal amounts and traditionally defined interest-rate terms. Purchasers
of certain other interests in REMICs are entitled to the excess, if any, of the
issuer's cash inflows, including reinvestment earnings, over the cash
outflows for debt service and administrative
21
expenses. These interests may include instruments designated as residual
interests, which represent an equity ownership interest in the underlying
collateral, subject to the first lien of the investors in the other classes of
the REMIC.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the Government National Mortgage
Association ("GNMA"). These structures divide mortgage pools into two risk
classes: a senior class and one or more subordinated classes. The
subordinated classes provide protection to the senior class. When cash flow
is impaired, debt service goes first to the holders of senior classes. In
addition, incoming cash flows also may be held in a reserve fund to meet any
future shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any principal repayments until the
holders of senior classes have been paid and, when appropriate, until a
specified level of funds has been contributed to the reserve fund.
Interest-only and principal-only securities are so-called stripped
mortgage-related securities, in which interest coupons may be stripped from a
mortgage-related security to create an interest-only ("IO") strip, where the
investor receives all of the interest cash flows and none of the principal, and
a principal-only ("PO") strip, where the investor receives all of the principal
cash flows and none of the interest. Inverse floating rate interest-only
("Inverse IO") securities also have coupons which are stripped from a
mortgage-related security. However, Inverse IOs have coupons whose interest
rates change inversely with, and often as a multiple of, a specialized index
such as the one-month London Interbank Offered Rate.
The following table sets forth the fair value of the Company's
mortgage-backed and related securities available for sale at the dates
indicated.
DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Mortgage-backed securities:
Single-family residential.................................................... $ -- $ -- $ 19,099
Mortgage-related securities:
Single-family residential:
Privately issued CMOs--AAA-rated............................................. 73,935 138,831 75,032
Interest only--AAA-rated..................................................... 98,124 11,774 1,996
Principal only............................................................... -- 8,218 11,490
Subordinates................................................................. 19,164 27,310 --
PAC securities............................................................... -- 574 --
REMIC residuals.............................................................. 20,560 472 --
Futures contracts and Swaps.................................................. (1,921) (1,598) 1,143
---------- ---------- ----------
Total........................................................................ 209,862 185,881 89,661
---------- ---------- ----------
Multi-family residential and commercial:
Privately issued CMOs........................................................ -- -- 53,939
Interest only................................................................ 87,389 109,193 --
Subordinates................................................................. 57,534 42,954 22,095
Futures contracts............................................................ (780) (248) (609)
---------- ---------- ----------
Total........................................................................ 144,143 151,899 75,425
---------- ---------- ----------
Total........................................................................ $ 354,005 $ 337,480 $ 184,185
---------- ---------- ----------
---------- ---------- ----------
22
At December 31, 1996, $115.9 million of the Company's securities available
for sale were issued by FHLMC or FNMA and $238.1 million of such securities were
privately issued. Of the $238.1 million of securities available for sale which
were privately issued at December 31, 1996, $155.6 million were rated AAA by
national rating agencies, $11.1 million were rated investment grade below this
level and $71.4 million (amortized cost of $69.3 million) were unrated.
At December 31, 1996, the carrying value of the Company's investment in
IO strips amounted to $185.5 million. At December 31, 1996 the Company had no
investments in PO strips. The Company invests in IO strips and PO strips from
time to time based on its capital position, interest rate risk profile and
the market for such securities. IO strips and PO strips exhibit considerably
more price volatility than mortgages or ordinary mortgage pass-through
securities, due in part to the uncertain cash flows that result from changes
in the prepayment rates of the underlying mortgages. In the case of IO strips
in particular, increased prepayments of the underlying mortgages as a result
of a decrease in market interest rates or other factors can result in a loss
of all or part of the purchase price of such security, although IO strips
relating to mortgage-related securities backed by multi-family residential
and commercial real estate loans (which amounted to $87.4 million of the
$185.5 million of IO strips owned by the Company at December 31, 1996)
generally have provisions which prohibit and/or provide economic
disincentives to prepayments for specified periods. The Company generally
attempts to offset the interest rate risk associated with a particular IO
strip or PO strip by purchasing other securities. At December 31, 1996, all
of the Company's IO strips were either issued by FHLMC or FNMA or rated AAA
by national rating agencies, with the exception of seven IO securities with
an aggregate carrying value of $3.9 million, which were rated investment
grade below this level.
At December 31, 1996, the carrying value of the Company's investment in
subordinate classes of mortgage-related securities amounted to $76.7 million.
The Company invests in subordinate classes of mortgage-related securities
from time to time based on its capital position, interest rate risk profile,
the market for such securities and other factors. In recent periods,
acquisitions of subordinated classes of mortgage-related securities have been
attributable primarily to the retention of such classes in connection with
the securitization activities of the Company. During 1996, the Company
acquired $51.0 million of subordinate classes of mortgage-related securities,
of which $9.2 million were acquired in connection with the Company's
securitization of commercial discounted loans and $18.9 million were acquired
from the LLC in connection with the LLC's securitization of a portion of the
HUD Loans. For additional information see "Business--Discounted Loan
Acquisition and Resolution Activities--Activity in the Discounted Loan
Portfolio" and "Business -Investment in Joint Venture--Securitization of HUD
Loans." At December 31, 1996, the Company's subordinate securities supported
senior classes of securities having an outstanding principal balance of $1.27
billion. Because of their subordinate position, subordinate classes of
mortgage-related securities involve more risk than the other classes.
During 1996 the Company retained residual securities in REMICs which were
formed in connection with the securitization and sale of $219.6 million of
single-family residential loans to non-conforming borrowers in two
underwritten public offerings as partial payment for the loans sold by it.
These REMIC residual securities had a carrying value of $20.6 million at
December 31, 1996 and supported senior classes of securities having an
outstanding principal balance of $183.6 million. These REMIC residuals
provide credit support similar to the senior-subordinated structure, however,
the cash flows supporting the REMIC residuals are generated by the amount by
which the interest collected on the mortgage loan exceeds the interest due on
the senior securities. See "Business - Lending Activities - Single-Family
Residential Loans."
Under a regulatory bulletin issued by the OTS, a federally-charted savings
institution such as the Bank generally may invest in "high risk" mortgage
securities only to reduce its overall interest rate risk and after it has
adopted various policies and procedures, although under specified circumstances
such securities also may be acquired for trading purposes. A "high risk"
mortgage security for this purpose generally is any mortgage-related security
which meets one of three tests which are intended to measure the average life or
price volatility of the security in relation to a benchmark fixed rate, 30-year
mortgage-backed pass-through security. At December 31, 1996, the Bank held
mortgage-related
23
securities with a carrying value of $159.8 million (amortized cost of $150.7
million) which were classified as "high-risk" mortgage securities by the OTS.
The expected actual maturity of a mortgage-backed and related security is
shorter than its stated maturity due to prepayments of the underlying mortgages.
Prepayments that are faster than anticipated may shorten the life of the
security and adversely affect its yield to maturity. The yield is based upon the
interest income and the amortization of any premium or accretion of any discount
related to the mortgage-backed and related security. Prepayments on
mortgage-backed and related securities have the effect of accelerating the
amortization of premiums and accretion of discounts, which decrease and increase
interest income, respectively. Although prepayments of underlying mortgages
depend on many factors, including the type of mortgages, the coupon rate, the
age of mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates generally is the most significant
determinant of the rate of prepayments. During periods of falling mortgage
interest rates, if the coupon rate of the underlying mortgages exceeds the
prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related security. Similarly, during periods of increasing interest
rates, refinancing generally decreases, thus lengthening the estimated
maturity of mortgage loans.
For additional information relating to the Company's mortgage-related
securities, see Note 6 to the Consolidated Financial Statements included in
Item 8 hereof.
INVESTMENT SECURITIES. Investment securities currently consist primarily
of required investment in FHLB stock. The following table sets forth the
Company's investment securities available for sale and held for investment at
the dates indicated.
DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Available for sale:
U.S. Government securities........................................................ $ -- $ -- $ 3,532
Held for investment:
U.S. Government securities........................................................ -- 10,036 10,325
FHLB stock(1)..................................................................... 8,798 8,520 6,555
Limited partnership interests..................................................... 103 109 131
--------- --------- ---------
Total............................................................................. 8,901 18,665 17,011
--------- --------- ---------
Total investment securities....................................................... $ 8,901 $ 18,665 $ 20,543
--------- --------- ---------
--------- --------- ---------
- ------------------------
(1) As a member of the FHLB of New York, the Bank is required to purchase and
maintain stock in the FHLB of New York in an amount equal to at least 1% of
its aggregate unpaid residential mortgage loans, home purchase contracts and
similar obligations at the beginning of each year or 5% of borrowings,
whichever is greater.
TRADING SECURITIES. When securities are purchased with the intent to resell
in the near term, they are classified as trading securities and reported on the
Company's consolidated balance sheet as a separately identified trading account.
Securities in this account are carried at current market value. All trading
securities are marked-to-market, and any increase or decrease in unrealized
appreciation or depreciation is included in the Company's consolidated
statements of operations.
Under guidelines approved by the Board of Directors of the Company, the
Company is authorized to hold a wide variety of securities as trading
securities, including U.S. Government and agency securities and
mortgage-backed and mortgage-related securities. The Company also is
authorized by such guidelines to use various hedging techniques in connection
with its trading activities, as well as to effect short sales of securities,
pursuant to which the Company sells securities which are to be acquired by it
at a future date. Under current guidelines, the amount of securities held by
the Company in a trading account may not exceed on a gross basis the greater
of $200 million or 15% of the Company's total assets, and the
24
total net amount of securities (taking into account any related hedge or
buy/sell agreement relating to similar securities) may not exceed the greater
of $150 million or 10% of total assets.
The Company's securities held for trading at December 31, 1996 amounted to
$75.6 million and represented one AAA-rated CMO which was sold in January 1997.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. The Company
invests in low-income housing tax credit interests primarily through limited
partnerships for the purpose of obtaining Federal income tax credits pursuant
to Section 42 of the Code, which provides a tax credit to investors in
qualified low-income rental housing that is constructed, rehabilitated or
acquired after December 31, 1986. To be eligible for housing tax credits, a
property generally must first be allocated an amount of tax credits by the
tax credit allocating agency, which in most cases also serves as the housing
finance agency, of the state in which the property is located. If the
property is to be constructed or rehabilitated, it must be completed and
placed in service within a specified time, generally within two years after
the year in which the tax credit allocation is received. A specified portion
of the apartment units in a qualifying project may only be rented to
qualified tenants for a period of 15 years, or a portion of any previously
claimed tax credits will be subject to recapture, as discussed below.
At December 31, 1996, the Company's investment in low-income housing tax
credit interests amounted to $93.3 million, as compared to $81.4 million at
December 31, 1995. The Company's investments in low-income housing tax credit
interests are made by the Company indirectly through subsidiaries of the
Company, which may be a general partner and/or a limited partner in the
partnership.
In accordance with a 1995 pronouncement of the Emerging Issues Task Force,
the Company's accounting for investments in low-income housing tax credit
partnerships in which it acts solely as a limited partner, which amounted to
$68.5 million in the aggregate at December 31, 1996, depends on whether the
investment was made on or after May 18, 1995. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Changes in Financial
Condition--Investments in Low-Income Housing Tax Credit Interests."
Low-income housing tax credit partnerships in which the Company, through
a subsidiary, acts as a general partner, are presented on a consolidated
basis. At December 31, 1996, the Company's investment in low-income housing
tax credit interests included $24.8 million of assets related to low-income
housing tax credit partnerships in which a subsidiary of the Company acts as
a general partner. The Company had commitments to make $17.3 million of
additional investments in such partnerships.
The Company also makes loans to low-income housing tax credit
partnerships in which it has invested to construct the affordable housing
project owned by the partnership. At December 31, 1996, the Company had $25.4
million of construction loans outstanding to low-income housing tax credit
partnerships and commitments to fund an additional $17.3 million of such
loans. Approximately $12.2 million of such funded construction loans at
December 31, 1996 were made to partnerships in which subsidiaries of the
Company acted as a general partner and thus were consolidated with the
Company for financial reporting purposes. The risks associated with these
construction loans generally are the same as those made by the Company to
unaffiliated third parties. See "Business-Lending Activities".
The affordable housing projects owned by the low-income housing tax credit
partnerships in which the Company had invested at December 31, 1996 are
geographically located throughout the United States. At December 31, 1996, the
Company's largest funded investment in a low-income housing tax credit interest
was a $15.4 million investment in a partnership which owned a 408-unit
qualifying project in Fort Lauderdale, Florida, and the Company's largest
unfunded investment in such a partnership was a $27.9 million commitment to fund
equity and debt investments in a partnership which will construct a 240-unit
qualifying project in Greece, New York, of which $236,000 of equity and $13.2
million of debt was funded as of such date.
25
At December 31, 1996, the Company had invested in or had commitments to
invest in 30 low-income housing tax credit partnerships, of which 12 had been
allocated tax credits. The Company estimates that its investment in low-income
housing tax credit interests at December 31, 1996 will provide approximately
$218.0 million of tax credits.
During 1996, the Company sold $19.8 million of its investments in
low-income housing credit interests for gain of $4.9 million. Depending on
available prices, its ability to utilize tax credits and other factors, the
Company may seek to sell other of its low-income housing tax credit interests
in the future.
The ownership of low-income housing tax credit interests produces two
types of tax benefits. The primary tax benefit flows from the low-income
housing tax credits under the Code which are generated by the ownership and
operation of the real property in the manner required to obtain such tax
credits These credits may be used to offset Federal income tax on a dollar
for dollar basis but may not offset the alternative minimum tax; tax credits
thus may reduce the overall federal income tax to an effective rate of 20%.
At December 31, 1996, the Company could recover $8.7 million and $700,000 of
taxes paid in 1994 and 1993, respectively, through the carryback of tax
credits realized in the current year. In addition, the operation of the
rental properties produces losses for financial statement and tax purposes in
the early years and sometimes throughout the anticipated ownership period.
These tax losses may be used to offset taxable income from other operations
and thereby reduce income tax which would otherwise be paid on such taxable
income.
Tax credits may be claimed over a ten-year period on a straight-line
basis once the underlying multi-family residential properties are placed in
service. Tax credits claimed reduce the tax payments computed based upon
taxable income to not less than the alternative minimum tax computed for that
year or any year not more than three years before or 15 years after the year
the tax credit is earned. Tax credits are realized regardless of whether
units in the project continue to be occupied once the units in the project
have been initially rented to a qualifying tenant, and tax credits are not
dependent on a project's operating income or appreciation. Tax credits can be
claimed over a ten-year period and generally can be lost or recaptured only
if non-qualifying tenants are placed in units, ownership of the project is
transferred or the project is destroyed and not rebuilt during a 15-year
compliance period for the project. The Company has established specific
investment criteria for investment in multi-family residential projects which
have been allocated tax credits, which require, among other things, a third
party developer of the project and/or the seller of the interest therein to
provide a guarantee against loss or recapture of tax credits and to maintain
appropriate insurance to fund rebuilding in case of destruction of the
project. Notwithstanding the Company's efforts, there can be no assurance
that the multi-family residential projects owned by the low-income housing
tax credit partnerships in which it has invested will satisfy applicable
criteria during the 15-year compliance period and that there will not be loss
or recapture of the tax credits associated therewith.
Investments made pursuant to the affordable housing tax credit program of
the Code are subject to numerous risks resulting from changes in the Code.
For example, the Balanced Budget Act of 1995, which was vetoed by the
President of the United States in December 1995 for reasons which were
unrelated to the tax credit program, generally would have established a
sunset date for the affordable housing tax credit program of the Code for
housing placed in service after December 31, 1997 and would have required a
favorable vote by Congress to extend the credit program. Although this change
would not have impacted the Company's existing investments, other potential
changes in the Code which have been discussed from time to time could reduce
the benefits associated with the Company's existing investments in low-income
housing tax credit interests, including the replacement of the current
graduated income taxation provisions in the Code with a "flat tax" based
system and increases in the alternative minimum tax, which cannot be reduced
by tax credits. Management of the Company is unable to predict whether any of
the foregoing or other changes to the Code will be subject to future
legislation and, if so, what the contents of such legislation will be and its
effects, if any, on the Company.
SOURCES OF FUNDS
GENERAL. Deposits, FHLB advances, reverse repurchase agreements,
maturities, resolutions and principal repayments on securities and
loans and proceeds from the sale of securities, loans and real estate owned
held for sale currently are the principal sources of funds for use in the
Company's investment and lending activities and for other general business
purposes. Management of the Company closely monitors rates and terms of
competing sources of funds on a regular basis and generally utilizes the
sources which are the most cost effective.
26
DEPOSITS. The primary source of deposits for the Company currently is
brokered certificates of deposit obtained through national investment banking
firms which, pursuant to agreements with the Company, solicit funds from
their customers for deposit with the Company ("brokered deposits"). Such
deposits amounted to $1.22 billion or 63.6% of the Company's total deposits
at December 31, 1996. In addition, during 1995 the Company commenced a
program to obtain certificates of deposit from customers of regional and
local investment banking firms which are made aware of the Company's products
by the Company's direct solicitation and marketing efforts. At December 31,
1996, $344.5 million or 17.9% of the Company's deposits were obtained in this
manner through over 100 regional and local investment banking firms. The
Company also solicits certificates of deposit from institutional investors
and high net worth individuals identified by the Company. At December 31,
1996, $196.1 million or 10.2% of the Company's total deposits consisted of
deposits obtained by the Company from such efforts.
The Company's brokered deposits at December 31, 1996 were net of $10.9
million of unamortized deferred fees. The amortization of deferred fees is
computed using the interest method and is included in interest expense on
certificates of deposit.
The Company believes that the effective cost of brokered and other wholesale
deposits is more attractive to the Company than deposits obtained on a retail
basis from branch offices after the general and administrative expense
associated with the maintenance of branch offices is taken into account.
Moreover, brokered and other wholesale deposits generally give the Company more
flexibility than retail sources of funds in structuring the maturities of its
deposits and in matching liabilities with comparably maturing assets. At
December 31, 1996, approximately 50.9% of the Company's certificates of deposits
were scheduled to mature within one year.
Although management of the Company believes that brokered and other
wholesale deposits are advantageous in certain respects, such funding
sources, when compared to retail deposits attracted through a branch network,
are generally more sensitive to changes in interest rates and volatility in
the capital markets and are more likely to be compared by the investor to
competing investments. In addition, such funding sources may be more
sensitive to significant changes in the financial condition of the Company.
There are also various regulatory limitations on the ability of all but
well-capitalized insured financial institutions to obtain brokered deposits.
See "Regulation -Brokered Deposits." These limitations currently are not
applicable to the Company because the Bank is a well-capitalized financial
institution under applicable laws and regulations. See
"Business--Regulation--Regulatory Capital Requirements." There can be no
assurances, however, that the Company will not become subject to such
limitations in the future. See "Recent Regulatory Developments" in Item 7
hereof.
As a result of the Company's reliance on brokered and other wholesale
deposits, significant changes in the prevailing interest rate environment, in
the availability of alternative investments for individual and institutional
investors or in the Company's financial condition, among other factors, could
affect the Company's liquidity and results of operations much more
significantly than might be the case with an institution that obtained a
greater portion of its funds from retail or core deposits attracted through a
branch network.
In addition to brokered and other wholesale deposits, the Company obtains
deposits from its office located in Bergen County, New Jersey. These deposits
include non-interest bearing checking accounts, NOW and money market checking
accounts, savings accounts and certificates of deposit and are obtained through
advertising, walk-ins and other traditional means. At December 31, 1996, the
deposits which were allocated to this office amounted to $54.1 million or 2.8%
of the Company's deposits.
27
The following table sets forth information related to the Company's
deposits at the dates indicated.
DECEMBER 31,
------------------------------------------------------------------------------
1996 1995 1994
------------------------ ------------------------- -------------------------
AMOUNT AVG. RATE AMOUNT AVG. RATE AMOUNT AVG. RATE
------------ ---------- ------------ ----------- ------------ -----------
(DOLLARS IN THOUSANDS)
Non-interest bearing checking accounts....... $ 96,563 -% $ 48,482 -% $ 35,943 -%
NOW and money market checking accounts....... 22,208 2.99 17,147 3.37 18,944 2.17
Savings accounts............................. 2,761 2.30 3,471 2.30 24,007 2.30
----------- ------------ ------------
121,532 69,100 78,884
------------ ------------ ------------
Certificates of deposit(1)................... 1,809,098 1,440,240 950,817
Unamortized deferred fees.................... (10,888) (7,694) (6,433)
------------ ------------ ------------
Total certificates of deposit................ 1,798,210 5.80 1,432,546 5.68 944,384 5.50
------------ ------------ ------------
Total deposits............................... $ 1,919,742 5.47 $ 1,501,646 5.46 $ 1,023,268 5.17
------------ ------------ ------------
------------ ------------ ------------
- ------------------------
(1) At December 31, 1996, 1995 and 1994, certificates of deposit issued on an
uninsured basis amounted to $147.5 million, $80.0 million and $21.1 million,
respectively.
The following table sets forth by various interest rate categories the
certificates of deposit in the Company at the dates indicated.
DECEMBER 31,
-----------------------------------
1996 1995 1994
------------ ------------ -----------
(DOLLARS IN THOUSANDS)
2.99% or less.. $ 1,442 $ 222 $ 3,613
3.00-3.50%..... 4 39 642
3.51-4.50...... 1,149 42,751 221,459
4.51-5.50...... 595,730 454,653 242,383
5.51-6.50...... 990,621 660,745 310,898
6.51-7.50...... 208,774 273,655 165,197
7.51-8.50...... 490 481 192
----------- ---------- ---------
$ 1,798,210 $1,432,546 $ 944,384
----------- ---------- ---------
----------- ---------- ---------
The following table sets forth the amount and maturities of the certificates
of deposit in the Company at December 31, 1996.
OVER SIX
MONTHS AND
SIX MONTHS LESS THAN ONE YEAR
AND LESS ONE YEAR THROUGH TWO YEARS OVER TWO YEARS TOTAL
----------- ----------- ----------------- -------------- ---------
(DOLLARS IN THOUSANDS)
2.99% or less.. $ 39 $ 1,199 $ -- $ 204 $ 1,442
3.00-3.50%..... -- 4 -- -- 4
3.51-4.50...... 1,020 86 23 20 1,149
4.51-5.50...... 297,480 140,393 70,991 86,866 595,730
5.51-6.50...... 215,205 204,011 245,662 325,743 990,621
6.51-7.50...... 17,620 38,999 58,610 93,545 208,774
7.51-8.50...... -- -- -- 490 490
----------- ----------- --------- ------------ ----------
$ 531,364 $ 384,692 $ 375,286 $ 506,868 $1,798,210
----------- ----------- --------- ------------ ----------
----------- ----------- --------- ------------ ----------
At December 31, 1996, the Company had $219.5 million of certificates of
deposit in amounts of $100,000 or more outstanding maturing as follows:
$101.6 million within three months; $38.9 million over three months through
six months; $40.7 million over six months through 12 months; and $38.3
million thereafter.
For additional information related to the Company's deposits, see Note 16
to the Consolidated Financial Statements included in Item 8 hereof.
28
BORROWINGS. Through the Bank the Company obtains advances from the FHLB
of New York upon the security of certain of its residential first mortgage
loans, mortgage-backed and mortgage-related securities and other assets,
including FHLB stock, provided certain standards related to the
creditworthiness of the Bank have been met. FHLB advances are available to
member financial institutions such as the Bank for investment and lending
activities and other general business purposes. FHLB advances are made
pursuant to several different credit programs, each of which has its own
interest rate, which may be fixed or adjustable, and range of maturities.
The Company also obtains funds pursuant to securities sold under reverse
repurchase agreements. Under these agreements, the Company sells securities
(generally mortgage-backed and mortgage-related securities) under an
agreement to repurchase such securities at a specified price at a later date.
Reverse repurchase agreements have short-term maturities (typically 90 days
or less) and are deemed to be financing transactions. All securities
underlying reverse repurchase agreements are reflected as assets in the
Company's Consolidated Financial Statements and are held in safekeeping by
broker-dealers.
The Company's borrowings also include notes, subordinated debentures and
other interest-bearing obligations. At December 31, 1996 this category of
borrowings consisted primarily of $100.0 million of 12% Subordinated
Debentures issued by the Bank in June 1995 and due 2005 (the "Debentures"),
and $125.0 million of 11.875% Notes (the "Notes") issued by the Company
through a public offering on September 25, 1996 and due 2003. In November
1996, the Company acquired the first mortgage payable on the hotel located in
Columbus, Ohio which the Company owns. From time to time, the Company
privately raises funds by issuing short-term notes to certain executives and
stockholders of the Company. Such notes were repaid during 1996 and amounted
to $8.6 million and $1.0 million at December 31, 1995 and 1994, respectively.
The following table sets forth information relating to the Company's
borrowings and other interest-bearing obligations at the dates indicated.
DECEMBER 31,
---------------------------------
1996 1995 1994
---------- ---------- ---------
(DOLLARS IN THOUSANDS)
FHLB advances.................................................................. $ 399 $ 70,399 $ 5,399
Reverse repurchase agreements.................................................. 74,546 84,761 --
Notes, debentures and other interest bearing obligations:
Notes........................................................................ 125,000 -- --
Debentures................................................................... 100,000 100,000 --
Hotel mortgage payable....................................................... 573 8,427 19,099
Short-term notes............................................................. -- 8,627 1,012
---------- ---------- ---------
225,573 117,054 20,111
---------- ---------- ---------
$ 300,518 $ 272,214 $ 25,510
---------- ---------- ---------
---------- ---------- ---------
29
The following table sets forth certain information relating to the Company's
short term borrowings having average balances during the period of greater than
30% of stockholders' equity at the end of the period. During each reported
period, FHLB advances and reverse repurchase agreements are the only categories
of borrowings meeting this criteria.
AT OR FOR THE YEAR ENDED
DECEMBER 31,
---------------------------------
1996 1995 1994
--------- ---------- ----------
(DOLLARS IN THOUSANDS)
FHLB advances:
Average amount outstanding during the period................................. $ 71,221 $ 14,866 $ 26,476
Maximum month-end balance outstanding during the period...................... $ 81,399 $ 100,399 $ 57,399
Weighted average rate:
During the period.......................................................... 5.69% 7.57% 4.65%
At end of period........................................................... 7.02% 5.84% 9.59%
Reverse repurchase agreements:
Average amount outstanding during the period................................. $ 19,581 $ 16,754 $ 254,052
Maximum month-end balance outstanding during the period........................ $ 84,321 $ 84,761 $ 537,457
Weighted average rate:
During the period............................................................ 5.62% 5.68% 4.09%
At end of period............................................................. 5.46% 5.70% -%
For additional information relating to the Company's borrowings, see
Notes 17, 18 and 19 to the Consolidated Financial Statements included in
Item 8 hereof.
ECONOMIC CONDITIONS
The success of the Company is dependent to a certain extent upon the
general economic conditions in the geographic areas in which it conducts
substantial business activities. Adverse changes in national economic
conditions or in the economic conditions of regions in which the Company
conducts substantial business likely would impair the ability of the Company
to collect on outstanding loans and would otherwise have an adverse effect on
its business, including the demand for new loans, the ability of customers to
repay loans and the value of both the collateral pledged to the Company to
secure its loans and its real estate owned. Moreover, earthquakes and other
natural disasters could have similar effects. Although such disasters have
not significantly adversely affected the Company to date, the availability of
insurance for such disasters in California, in which the Company conducts
substantial business activities is severely limited. At December 31, 1996,
the Company had loans with an unpaid balance aggregating $498.8 million
(including loans available for sale) secured by properties located in
California and $53.2 million of the Company's real estate owned was located
in California.
COMPETITION
Although there currently is no single competitor which competes directly
with the Company in all aspects of its activities, the activities in
which the Company is engaged generally are highly competitive. The
acquisition of discounted loans is particularly competitive, as acquisitions
of such loans are often based on competitive bidding. In addition,
competitors of the Company may seek to establish relationships with the
correspondent mortgage banking firms which currently are a primary source of
the Company's loans to non-conforming borrowers and, from time to time, other
loans, and which generally are not obligated to continue to do business with
the Company. The Company also encounters significant competition in
connection with its other lending activities, its investment activities and
in its deposit-gathering activities. Many of the Company's competitors are
significantly larger than the Company and have access to greater capital and
30
other resources. In addition, many of the Company's competitors are not
subject to the same extensive federal regulation that govern
federally-insured institutions such as the Company. As a result, many of the
Company's competitors have advantages over the Company in conducting certain
businesses and providing certain services.
EMPLOYEES
At December 31, 1996, the Company had 560 full-time equivalent employees
excluding employees of the hotel the Company owns and operates. The employees
are not represented by a collective bargaining agreement. Management
considers the Company's employee relations to be satisfactory.
COMPUTER SYSTEMS AND OTHER EQUIPMENT
The Company believes that its use of information technology is a key
factor in achieving competitive advantage in the servicing of servicing
intensive assets such as nonperforming loans, improving servicing
efficiencies to minimize operating costs and increasing overall
profitability. The Company has invested in a state-of-the-art computer
infrastructure, and uses an IBM RISC AS400 and NetFRAME file servers as its
primary hardware platforms. In addition to its standard industry software
applications, the Company has internally developed fully integrated
proprietary applications designed to provide decision support, automation of
decision execution, tracking and exception reporting. The Company's
systems have significant capacity for expansion and upgrade.
The proprietary software packages developed for asset resolution use
advanced financial models to predict the resolution strategy with the highest
returns and to route the loan or property through the resolution process, as
well as track performance against specified timelines for each event. These
activities are linked with automated communications, including FAX, e-mail or
letter with the borrower or outside vendors, such as attorneys and brokers. The
systems also are integrated with a document imaging system which currently
stores twelve million images on magnetic media with a 165 gigabyte optical
juke box for additional storage. This system permits immediate access
to pertinent loan documents and the automatic preparation of foreclosure
packages. The Company also has implemented a data warehouse strategy which
provides corporate data on a centralized basis for decision support.
REGULATION
Financial institutions and their holding companies are extensively
regulated under federal and state laws. As a result, the business, financial
condition and prospects of the Company can be materially affected not only by
management decisions and general economic conditions, but also by applicable
statutes and regulations and other regulatory pronouncements and policies
promulgated by regulatory agencies with jurisdiction over the Company and the
Bank, such as the OTS and the FDIC. The effect of such statutes, regulations
and other pronouncements and policies can be significant, cannot be predicted
with a high degree of certainty and can change over time. Moreover, such
statutes, regulations and other pronouncements and policies are intended to
protect depositors and the insurance funds administered by the FDIC, and not
stockholders or holders of indebtedness which are not insured by the FDIC.
The enforcement powers available to Federal banking regulators is
substantial and includes, among other things, the ability to assess civil
monetary penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, these enforcement actions must be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities.
The following discussion and other references to and descriptions of the
regulation of financial institutions contained herein constitute brief summaries
thereof as currently in effect. This discussion is not intended to constitute
and does not purport to be a complete statement of all legal restrictions and
requirements applicable to the Company and the Bank and all such descriptions
are qualified in their entirety by reference to applicable statutes,
regulations and other regulatory pronouncements.
The Company
General. The Company is a registered savings and loan holding company
under the Home Owners Loan Act ("HOLA"). As such, the Company is subject to
regulation, supervision and examination by the OTS.
Activities Restriction. There are generally no restriction on the
activities of a savings and loan holding company such as the Company which
holds only one subsidiary savings institution. However, if the Director of
the OTS determines that there is reasonable cause to believe that the
continuation by a savings and loan holding company of an activity constitutes
a serious risk to the financial safety, soundness or stability of its
subsidiary savings institution, the Director may impose such restrictions as
deemed necessary to address such risk, including limiting (i) payment of
dividends by the savings institution; (ii) transactions between the saving
institution and its affiliates; and (iii) any activities of the savings
institution that might create a serious risk that the liabilities of the
holding company and its affiliates may be imposed on the savings institution.
Notwithstanding the above rules as to permissible business activities of
unitary savings and loan holding companies, if the savings institution
subsidiary of such a holding company fails to meet a qualified thrift lender
("QTL") test set forth in OTS regulations, then such unitary holding company
shall become subject to the activities and restrictions applicable to multiple
savings and loan holding companies and, unless the savings institution
requalifies as a OTL within one year thereafter, shall register as, and
become subject to the restriction applicable to, a bank holding company. See
"-The Bank-Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve
emergency thrift acquisition and where each subsidiary savings institution
meets the QTL test, as set forth below, the activities of the Company and any
of its subsidiaries (other than the Bank or other subsidiary savings
institutions) would thereafter be subject to further restrictions. Among
other things, no multiple savings and loan holding company or subsidiary
thereof which is not a savings institution generally shall commence or
continue for a limited period of time after becoming a multiple savings and
loan holding company or subsidiary thereof any business activity, other than:
(i) furnishing or performing management services for a subsidiary savings
institution; (ii) conducting an insurance agency or escrow business; (iii)
holding, managing or liquidating assets owned by or acquired from a
subsidiary savings institution; (iv) holding or managing properties used or
occupied by a subsidiary savings institution; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding companies; or
(vii) unless the Director of the OTS by regulation prohibits or limits such
activities for savings and loan holding companies, those activities
authorized by the Federal Reserve Board as permissible for bank holding
companies. Those activities described in clause (vii) above also must be
approved by the Director of the OTS prior to being engaged in by a multiple
savings and loan holding company.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS (i) control of any other savings
institution or savings and loan holding company or substantially all the
assets thereof or (ii) more than 5% of the voting shares of a savings
institution or holding company thereof which is not a subsidiary. Except with
the prior approval of the Director of the OTS, no director or officers of a
savings and loan holding company or person owning or controlling by proxy or
otherwise more than 25% of such company's stock may acquire control of any
savings institution, other than a subsidiary savings institution, or of any
other savings and loan holding company.
The Director of the OTS may approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls
savings institutions in more than one state only if (i) the multiple savings
and loan holding company involved controls a savings institution which
operated a home or branch office located in the state of the institution to
be acquired as of March 5, 1987; (ii) the acquiror is authorized to acquire
control of the savings institution pursuant to the emergency acquisition
provision of the Federal Deposit Insurance Act ("FDIA"); or (iii) the
statutes of the state in which the institution to be acquired is located
specifically permit institutions to be acquired by state-chartered savings
institutions located in the state where the acquiring entity is located (or
by a holding company that controls such state-chartered savings institutions).
Restrictions on Transactions with Affiliates. Transactions between the
Company or any of its non-bank subsidiaries and the Bank are subject to
various restrictions, which are described below under "-The Bank-Affiliate
Transactions".
The Bank
GENERAL. The Bank is a federally-chartered savings bank organized under
the HOLA. As such, the Bank is subject to regulation, supervision and
examination by the OTS. The deposit accounts
31
of the Bank are insured up to applicable limits by the SAIF administered
by the FDIC and, as a result, the Bank also is subject to regulation,
supervision and examination by the FDIC.
The business and affairs of the Bank are regulated in a variety of ways.
Regulations apply to, among other things, insurance of deposit accounts, capital
ratios, payment of dividends, liquidity requirements, the nature and amount of
the investments that the Bank may make, transactions with affiliates,
community and consumer lending laws, internal policies and controls, reporting
by and examination of the Bank and changes in control of the Bank.
INSURANCE OF ACCOUNTS. Pursuant to legislation enacted in September 1996, a
fee was paid by all SAIF-insured institutions at the rate of $0.657 per
$100 of deposits held by such institutions at March 31, 1995. The money
collected recapitalized the SAIF reserve to the level of 1.25% of insured
deposits as required by law. In September 1996, the Bank recorded a pre-tax
accrual of $7.1 million for this assessment, which was subsequently paid in
November 1996.
The new legislation also provides for the merger, subject to certain
conditions, of the SAIF into the Bank Insurance Fund ("BIF") by 1999 and also
requires BIF-Insured institutions to share in the payment of interest on the
bonds issued by a specially created government entity ("FICO"), the proceeds
of which were applied toward resolution of the thrift industry crisis in the
1980s. Beginning on January 1, 1997, in addition to the insurance premiums
that will be paid by SAIF-insured institutions to maintain the SAIF reserve
at its required level pursuant to the current risk classification system,
SAIF-insured institutions will pay deposit insurance premiums at the annual
rate of 6.4 basis points of their insured deposits and BIF-insured
institutions will pay deposit insurance premiums at the annual rate of 1.3
basis points of their insured deposits towards the payment of interest on the
FICO bonds. Under the current risk classification system, institutions are
assigned to one of three capital groups which are based solely on the level
of an institution's capital--'well capitalized," "adequately capitalized" and
"undercapitalized'--which are defined in the same manner as the regulations
establishing the prompt corrective action system under Section 38 of the
FDIA, as discussed below. These three groups are then divided into three
subgroups which are based on supervisory evaluations by the institution's
primary federal regulator, resulting in nine assessment classifications.
Assessment rates currently range from 0 basis points for well capitalized,
healthy institutions to 27 basis points for undercapitalized institutions
with substantial supervisory concerns.
The recapitalization of the SAIF is expected to result in lower deposit
insurance premiums in the future for most SAIF-insured financial institutions,
including the Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Bank's deposit insurance.
REGULATORY CAPITAL REQUIREMENTS. Federally-insured savings associations
are required to maintain minimum levels of regulatory capital. These
standards generally must be as stringent as the comparable capital
requirements imposed on national bank's. The OTS also is authorized to impose
capital requirements in excess of these standards on individual associations
on a case-by-case basis. At December 31, 1996, the Bank's regulatory capital
substantially exceeded applicable requirements. See "Regulatory Capital
Requirements" and "Recent Regulatory Developments" in Item 7 hereof.
Federally-insured savings associations are subject to three capital
requirements: a tangible capital requirement, a core or leverage capital
requirement and a risk-based capital requirement. All savings associations
currently are required to maintain tangible capital of at least 1.5% of adjusted
total assets (as defined in the regulations), core capital equal to 3% of
adjusted total assets and total capital (a combination of core and supplementary
capital) equal to 8% of risk-weighted assets (as defined in the regulations).
For purposes of the regulation, tangible capital is core capital less all
intangibles other than
32
qualifying purchased mortgage servicing rights, of which
the Bank had $3.8 million at December 31, 1996. Core capital includes common
stockholders' equity, non-cumulative perpetual preferred stock and related
surplus, minority interests in the equity accounts of fully consolidated
subsidiaries and certain nonwithdrawable accounts and pledged deposits. Core
capital generally is reduced by the amount of a savings association's intangible
assets, other than qualifying mortgage servicing rights.
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain capital instruments that do not
qualify as core capital, including subordinated debt (such as the Debentures)
which meets specified requirements, and general valuation loan and lease loss
allowances up to a maximum of 1.25% of risk-weighted assets. In determining the
required amount of risk-based capital, total assets, including certain
off-balance sheet items, are multiplied by a risk weight based on the risks
inherent in the type of assets. The risk weights assigned by the OTS for
principal categories of assets currently range from 0% to 100%, depending on the
type of asset.
OTS policy imposes a limitation on the amount of net deferred tax assets
under Statement of Financial Accounting Standards ("SFAS") No. 109 that may
be included in regulatory capital. (Net deferred tax assets represent
deferred tax assets, reduced by any valuation allowances, in excess of
deferred tax liabilities.) Application of the limit depends on the possible
sources of taxable income available to an institution to realize deferred tax
assets. Deferred tax assets that can be realized from the following generally
are not limited: taxes paid in prior carryback years and future reversals of
existing taxable temporary differences. To the extent that the realization of
deferred tax assets depends on an institution's future taxable income
(exclusive of reversing temporary differences and carryforwards), or its
tax-planning strategies, such deferred tax assets are limited for regulatory
capital purposes to the lesser of the amount that can be realized within one
year of the quarter-end report date or 10% of core capital. The foregoing
considerations did not affect the calculation of the Bank's regulatory
capital at December 31, 1996.
In August 1993, the OTS adopted a final rule incorporating an interest-rate
risk component into the risk-based capital regulation. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating the risk-based capital requirement. As a result,
such an institution will be required to maintain additional capital in order to
comply with the risk-based capital requirement. Although the final rule was
originally scheduled to be effective as of January 1994, the OTS has indicated
that it will delay invoking its interest rate risk rule requiring institutions
with above normal interest rate risk exposure to adjust their regulatory capital
requirement until appeal procedures are implemented and evaluated. The OTS has
not yet established an effective date for the capital deduction. Management of
the Company does not believe that the OTS' adoption of an interest rate risk
component to the risk-based capital requirement will adversely affect the
Bank if it becomes effective in its current form.
In April 1991, the OTS proposed to modify the 3% of adjusted total assets
core capital requirement in the same manner as was done by the Comptroller of
the Currency for national Bank's. Under the OTS proposal, only savings
associations rated composite 1 under the CAMEL rating system will be permitted
to operate at the regulatory minimum core capital ratio of 3%. For all other
savings associations, the minimum core capital ratio will be 3% plus at least an
additional 100 to 200 basis points, which thus will increase the core capital
ratio requirement to 4% to 5% of adjusted total assets or more. In determining
the amount of additional capital, the OTS will assess both the quality of risk
management systems and the level of overall risk in each individual savings
association through the supervisory process on a case-by-case basis.
PROMPT CORRECTIVE ACTION. Federal law provides the Federal Banking
regulators with broad power to take "prompt corrective action" to resolve the
problems of undercapitalized institutions. The extent of the regulators' powers
depends on whether the institution in question is "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
or "critically undercapitalized." Under regulations adopted by the federal
banking regulators, an institution shall be deemed to be (i) "well capitalized"
if it has a total risk-based capital ratio of 10.0% or more, has a Tier I
risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of
5.0% or more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital
33
ratio of 4.0% or more (3.0% under certain circumstances) and does not
meet the definition of "well capitalized," (iii) "undercapitalized" if it has
a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based
capital ratio that is less than 4.0% or a Tier I leverage capital ratio that
is less than 4.0% (3.0% under certain circumstances), (iv) "significantly
undercapitalized" if it has a total risk-based capital ratio that is less
than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier
I leverage capital ratio that is less than 3.0%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to adjusted total
assets that is equal to or less than 2.0%. The regulations also permit the
appropriate federal Banking regulator to downgrade an institution to the next
lower category (provided that a significantly undercapitalized institution
may not be downgraded to critically undercapitalized) if the regulator
determines (i) after notice and opportunity for hearing or response, that the
institution is in an unsafe or unsound condition or (ii) that the institution
has received (and not corrected) a less-than-satisfactory rating for any of
the categories of asset quality, management, earnings or liquidity in its
most recent exam. At December 31, 1996, the Bank was a "well capitalized"
institution under the prompt corrective action regulations of the OTS.
Depending upon the capital category to which an institution is assigned,
the regulators' corrective powers, many of which are mandatory in certain
circumstances, include prohibition on capital distributions; prohibition on
payment of management fees to controlling persons; requiring the submission
of a capital restoration plan; placing limits on asset growth; limiting
acquisitions, branching or new lines of business; requiring the institution
to issue additional capital stock (including additional voting stock) or to
be acquired; restricting transactions with affiliates; restricting the
interest rates that the institution may pay on deposits; ordering a new
election of directors of the institution; requiring that senior executive
officers or directors be dismissed; prohibiting the institution from
accepting deposits from correspondent banks; requiring the institution to
divest certain subsidiaries; prohibiting the payment of principal or interest
on subordinated debt; and, ultimately, appointing a receiver for the
institution.
QUALIFIED THRIFT LENDER TEST. All savings associations are required to
meet QTL test set forth in the HOLA and regulations of the OTS thereunder to
avoid certain restrictions on their operations. A savings association that
does not meet the QTL Test set forth in the HOLA and implementing regulations
must either convert to a bank charter or comply with the following
restrictions on its operations: (i) the association may not engage in any new
activity or make any new investment, directly or indirectly, unless such
activity or investment is permissible for a national bank; (ii) the branching
powers of the association shall be restricted to those of a national bank;
(iii) the association shall not be eligible to obtain any advances from its
FHLB; and (iv) payment of dividends by the association shall be subject to
the rules regarding payment of dividends by a national bank. Upon the
expiration of three years from the date the association ceases to be a QTL,
it must cease any activity and not retain any investment not permissible for
a national bank and immediately repay any outstanding FHLB advances (subject
to safety and soundness considerations). The Bank met the QTL test throughout
1996.
RESTRICTIONS ON CAPITAL DISTRIBUTIONS. The OTS has promulgated a regulation
governing capital distributions by savings associations, which include cash
dividends, stock redemptions or repurchases, cash-out mergers, interest
payments on certain convertible debt and other transactions charged to the
capital account of a savings association as a capital distribution. Generally,
the regulation creates three tiers of associations based on regulatory capital,
with the top two tiers providing a safe harbor for specified levels of capital
distributions from associations so long as such associations notify the OTS and
receive no objection to the distribution from the OTS. Associations that do not
qualify for the safe harbor provided for the top two tiers of associations are
required to obtain prior OTS approval before making any capital distributions.
Tier 1 associations may make the highest amount of capital distributions,
and are defined as savings associations that before and after the proposed
distribution meet or exceed their fully phased-in regulatory capital
requirements. Tier 1 associations may make capital distributions during any
calendar year equal to the greater of (i) 100% of net income for the calendar
year-to-date plus 50% of its "surplus capital ratio" at the beginning of the
calendar year and (ii) 75% of its net income over the most recent four-quarter
period. The "surplus capital ratio" is defined to mean the percentage by which
the association's ratio of total capital to assets exceeds the ratio of its
fully phased-in capital requirement to assets, and "fully phased-in capital
requirement" is defined to mean an association's capital requirement under the
statutory and regulatory standards applicable on December 31, 1994, as modified
to reflect any applicable individual minimum capital requirement imposed upon
the association. At December 31, 1996, the Bank was a Tier 1 association
under the OTS capital distribution regulation.
34
In December 1994, the OTS published a notice of proposed rulemaking to amend
its capital distribution regulation. Under the proposal, the three tiered
approach contained in existing regulations would be replaced and institutions
would be permitted to make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized," as defined above under "--Prompt Corrective Action."
LOAN-TO-ONE BORROWER Under applicable laws and regulations the amount of
loans and extensions of credit which may be extended by a savings institution
such as the Bank to any one borrower, including related entities,
generally may not exceed the greater of $500,000 or 15% of the unimpaired
capital and unimpaired surplus of the institution. Loans in an amount equal
to an additional 10% of unimpaired capital and unimpaired surplus also may be
made to a borrower if the loans are fully secured by readily marketable
securities. An institution's "unimpaired capital and unimpaired surplus"
includes, among other things, the amount of its core capital and
supplementary capital included in its total capital under OTS regulations.
At December 31, 1996, the Bank's unimpaired capital and surplus amounted
to $340.4 million, resulting in a general loans-to-one borrower limitation of
$51.1 million under applicable laws and regulations. See "Business-Discounted
Loan Acquisition and Resolution Activities-Composition of the Discounted Loan
Portfolio" and "-Lending Activities-Composition of Loan Portfolio."
BROKERED DEPOSITS. Under applicable laws and regulations, an insured
depository institution may be restricted in obtaining, directly or
indirectly, funds by or through any "deposit broker," as defined, for deposit
into one or more deposit accounts at the institution. The term "deposit
broker" generally includes any person engaged in the business of placing
deposits, or facilitating the placement of deposits, of third parties with
insured depository institutions or the business of placing deposits with
insured depository institutions for the purpose of selling interests in those
deposits to third parties. In addition, the term "deposit broker" includes
any insured depository institution, and any employee of any insured
depository institution, which engages, directly or indirectly , in the
solicitation of deposits by offering rates of interest (with respect to such
deposits) which are significantly higher than the prevailing rates of
interest on deposits offered by other insured depository institutions having
the same type of charter in such depository institution's normal mareket
area. As a result of the definition of "deposit broker," all of the Bank's
brokered deposits, as well as possibly its deposits obtained through
customers of regional and local investment banking firms and the deposits
obtained from the Bank's direct solicitation efforts of institutional
investors and high net worth individuals, are potentially subject to the
restrictions described below. Under FDIC regulations, well-capitalized
institutions are subject to no brokered deposit limitations, while
adequately- capitalized institutions are able to accept, renew or roll over
brokered deposits only (i) with a waiver from the FDIC and (ii) subject to
the limitation that they do not pay an effective yield on any such deposit
which exceeds by more than (a) 75 basis points the effective yield paid on
deposits of comparable size and maturity in such institution's normal market
area for deposits accepted in its normal market area or (b) by 120% for
retail deposits and 130% for wholesale deposits, respectively, of the current
yield on comparable maturity U.S. Treasury obligations for deposits accepted
outside the institution's normal market area. Undercapitalized institutions
are not permitted to accept brokered deposits and may not solicit deposits by
offering an effective yield that exceeds by more than 75 basis points the
prevailing effective yields on insured deposits of comparable maturity in the
institution's normal market area or in the market area in which such deposits
are being solicited. At December 31, 1996, the Bank was a well-capitalized
institution which was not subject to restrictions on brokered deposits. See
"Business--Sources of Funds--Deposits."
LIQUIDITY REQUIREMENTS. All savings associations are required to maintain
an average daily balance of liquid assets, which include specified short-term
assets and certain long-term assets, equal to a certain percentage of the sum of
its average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. The liquidity requirement may vary from time to
time (between 4% and 10%) depending upon economic conditions and savings flows
of all savings associations. At the present time, the required liquid asset
ratio is 5%. Historically, the Bank has operated in compliance with these
requirements. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity, Commitments and Off-Balance Sheet Risks."
AFFILIATE TRANSACTIONS. Under federal law and regulation, transactions
between a savings association and its affiliates are subject to quantitative and
qualitative restrictions. Affiliates of a savings association include, among
other
35
entities, companies that control, are controlled by or are under common
control with the savings association. As a result, the Company and its non-bank
subsidiaries are affiliates of the Bank.
Savings associations are restricted in their ability to engage in "covered
transactions" with their affiliates. In addition, covered transactions between a
savings association and an affiliate, as well as certain other transactions with
or benefiting an affiliate, must be on terms and conditions at least as
favorable to the savings association as those prevailing at the time for
comparable transactions with non-affiliated companies. Savings associations are
required to make and retain detailed records of transactions with affiliates.
Notwithstanding the foregoing, a savings association is not permitted to
make a loan or extension of credit to any affiliate unless the affiliate is
engaged only in activities the Federal Reserve Board has determined to be
permissible for bank holding companies. Savings associations also are
prohibited from purchasing or investing in securities issued by an affiliate,
other than shares of a subsidiary.
Savings associations are also subject to various limitations and reporting
requirements on loans to insiders. These limitations require, among other
things, that all loans or extensions of credit to insiders (generally executive
officers, directors or 10% stockholders of the institution) or their "related
interests" be made on substantially the same terms (including interest rates and
collateral) as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with the general
public and not involve more than the normal risk of repayment or present other
unfavorable features.
COMMUNITY INVESTMENT AND CONSUMER PROTECTION LAWS. In connection with its
lending activities, the Bank is subject to a variety of federal laws designed
to protect borrowers and promote lending to various sectors of the economy and
population. Included among these are the federal Home Mortgage Disclosure Act,
Real Estate Settlement Procedures Act, Truth-in-Lending Act, the Equal Credit
Opportunity Act, Fair Credit Reporting Act and the CRA.
SAFETY AND SOUNDNESS. Other regulations which were recently adopted or are
currently proposed to be adopted pursuant to recent legislation include: (i)
real estate lending standards for insured institutions, which provide guidelines
concerning loan-to-value ratios for various types of real estate loans; (ii)
revisions to the risk-based capital rules to account for interest rate risk,
concentration of credit risk and the risks posed by "non-traditional
activities;" (iii) rules requiring depository institutions to develop and
implement internal procedures to evaluate and control credit and settlement
exposure to their correspondent banks; and (iv) rules addressing various
"safety and soundness" issues, including operations and managerial standards,
standards for asset quality, earnings and stock valuations, and compensation
standards for the officers, directors, employees and principal stockholders of
the insured institution.
FEDERAL TAXATION
GENERAL. The Company and all of its subsidiaries currently file, and
expect to continue to file, a consolidated Federal income tax return based on
a calendar year. Prior to October 1, 1996, IMI and its subsidiaries filed a
separate federal consolidated tax return. Consolidated returns have the
effect of eliminating inter-company transactions, including dividends, from
the computation of taxable income.
For taxable years beginning prior to January 1, 1996, a savings
institution such as the Bank that met certain definitional tests relating
to the composition of its assets and the sources of its income (a "qualifying
savings institution") was permitted to establish reserves for bad debts and
to claim annual tax deductions for additions to such reserves. A qualifying
savings institution was permitted to make annual additions to such reserves
based on the institution's loss experience. Alternatively, a qualifying
savings institution could elect, on an annual basis, to use the "percentage
of taxable income" method to compute its addition to its bad debt reserve on
qualifying real property loans (generally, loans secured by an interest in
improved real estate). The percentage of taxable income method permitted the
institution to deduct a specified percentage of its taxable income before
such deduction, regardless of the institution's actual bad debt experience,
subject to certain limitations. From 1988 to 1995, the Bank has claimed bad
debt deductions under the percentage of taxable income method because that
method produced a greater deduction than did the experience method.
36
On August 20, 1996, President Clinton signed the Small Business Job
Protection Act ("the Act") into law. One provision of the Act repealed the
reserve method of accounting for bad debts for savings institutions effective
for taxable years beginning after 1995 and provides for recapture of a portion
of the reserves existing at the close of the last taxable year beginning before
January 1, 1996. See Note 21 to the Consolidated Financial Statements included
in Item 8 hereof for a discussion of the effect of this legislation on the
Bank. For its tax years beginning on or after January 1, 1996, the Bank
will be required to account for its bad debts under the specific charge-off
method. Under this method, deductions may be claimed only as and to the extent
that loans become wholly or partially worthless.
ALTERNATIVE MINIMUM TAX. In addition to the regular corporate income tax,
corporations, including qualifying savings institutions, are subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For Taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carrybacks and carryforwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years.
TAX RESIDUALS. From time to time the Company acquires tax residuals.
Although a tax residual has little or no future economic cash flows from the
REMIC from which it has been issued, the tax residual does bear the income
tax liability or benefit resulting from the difference between the interest
rate paid on the securities by the REMIC and the interest rate received on
the mortgage loans held by the REMIC. This generally results in taxable
income for the Company in the first several years of the REMIC and equal
amounts of tax deductions thereafter. The Company receives cash payments in
connection with the acquisition of tax residuals to compensate the Company
for the time value of money associated with the tax payments related to these
securities and the costs of modeling, recording, monitoring and reporting the
securities. The Company defers all fees received and recognizes such fees in
interest income on a level yield basis over the expected life of the deferred
tax asset related to tax residuals. The Company also adjusts the recognition
in interest income of fees deferred based upon the changes in the actual
prepayment rates of the underlying mortgages held by the REMIC and periodic
reassessments of the expected life of the deferred tax asset related to tax
residuals. At December 31, 1996, the Company's gross deferred tax assets
included $3.7 million which was attributable to the Company's tax residuals
and related deferred income. The Company's current portfolio of tax residuals
are not expected to generate future taxable income. Because of the manner in
which REMIC residuals are treated for tax purposes, at December 31, 1996, the
Company had approximately $10.2 million of net operating loss carryforwards
for federal income tax purposes which were attributable to sales of tax
residuals. See Note 21 to the Consolidated Financial Statements included in
Item 8 hereof.
INVESTMENTS IN LOW-INCOME-HOUSING TAX CREDIT INTERESTS. For a discussion of
the tax effects of investments in low-income-housing tax credit interests, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Results of Operations-Income Tax Expenses" and "Business-Investment
Activities-Investment in Low-Income Housing Tax Credit Interests."
EXAMINATIONS. The most recent examination by the Internal Revenue
Service of the Company's Federal income tax returns was of the tax
returns filed for 1991 and 1992. The statute of limitations has run with
respect to all tax years prior to those years. Thus, the Federal income tax
returns for the years 1991 and 1992 (due to a waiver of the statute of
limitations) and 1993 through 1995 are open for examination. The Internal
Revenue Service currently is completing an examination of the Company's
Federal income tax returns for 1993 and 1994; management of the Company does
not anticipate any material adjustments as a result of these examinations,
although there can be no assurances in this regard. No state return of the
Company has been examined, and no notification has been received by the
Company that any state intends to examine any of its tax returns.
37
STATE TAXATION
The Company's income is subject to tax by the State of Florida, which has
a statutory tax rate of 5.5%, and is determined based on certain apportionment
factors. The Company is taxed in New Jersey on income, net of expenses,
earned in New Jersey at a statutory rate of 3.0%
ITEM 2. PROPERTIES
OFFICES
At December 31, 1996, the Company conducted business from its executive and
administrative offices located in West Palm Beach, Florida and a full-service
Banking office located in northern New Jersey.
The following table sets forth information relating to the Company's
executive and main offices at December 31, 1996.
NET BOOK VALUE OF
PROPERTY OR
LEASEHOLD
LOCATION OWNED/LEASED IMPROVEMENTS
- --------------------------- ------------- -----------------
(DOLLARS IN THOUSANDS)
Executive Offices:
1675 Palm Beach Lakes Blvd.
West Palm Beach, FL Leased $ 5,058
Main Office:
2400 Lemoine Ave.
Lee, NJ Leased $ -
In addition to the above offices, the Company recently established
loan production offices in California, Illinois, Massachusetts and Utah,
all of which are leased. For additional information see "Investment
Activities--Single-Family Residential Loans" of Item 1 hereof.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings occurring in the
ordinary course of business which management of the Company believes will not
have a material adverse effect on the financial condition or operations of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF THE REGISTRANT'S COMMON STOCK
The Company's common stock, which began trading on September 25, 1996, is
quoted on The Nasdaq Stock Market's National Market ("NASDAQ") under the
symbol "OCWN". The following table sets forth, for the periods indicated, the
range of high and low closing sales prices of the Company's common stock:
38
HIGH LOW
--------- ---------
Year Ended December 31, 1996
Third Quarter.............................................................. $ 21.00 $ 19.00
Fourth Quarter............................................................. 30.50 20.25
At the close of business on January 31, 1997, the Company's common stock
price was $28.50.
The Company has not paid any cash dividends on its common stock in the
last three fiscal years. Refer to "Business-Regulations," in Item 1 hereof
and Notes 19 and 24 to the Consolidated Financial Statements included in Item
8 hereof for information with respect to current restrictions on the ability
of the Company and the Bank to pay dividends.
NUMBER OF HOLDERS OF COMMON STOCK
At January 31, 1997, 26,744,170 shares of Company common stock were
outstanding and held by approximately 106 holders of record.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following tables present selected consolidated financial data of the
Company at the dates and for the periods indicated. The historical operations
and balance sheet data at and for the years ended December 31, 1996, 1995,
1994, 1993 and 1992 have been derived from financial statements audited by
Price Waterhouse LLP, independent certified public accountants. The selected
consolidated financial data should be read in conjunction with, and is
qualified in its entirety by reference to, the information in the
Consolidated Financial Statements and related notes set forth elsewhere
herein.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1996 1995(1) 1994(1) 1993(2) 1992
------------ ---------- ---------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Operations Data:
Interest income................. $193,894 $ 137,275 $ 131,458 $ 78,923 $ 71,723
Interest expense................ 116,160 84,060 62,598 35,306 28,148
------------- ---------- ---------- --------- ---------
Net interest income............. 77,734 53,215 68,860 43,617 43,575
Provision for loan losses (3)... 22,450 1,121 -- -- --
------------- ---------- ---------- --------- ---------
Net interest income after
provision for loan losses..... 55,284 52,094 68,860 43,617 43,575
------------- ---------- ---------- --------- ---------
Gains on sales of interest-
earning assets, net............. 21,682 6,955 5,727 8,386 8,842
Gains on sales of branch
offices........................ -- 5,430 62,600 -- --
Income (loss) on real estate
owned, net.................... 3,827 9,540 5,995 (1,158) 1,050
Fees on financing transactions
(4)........................... -- -- -- 15,340 6,760
Other non-interest income....... 11,766 9,255 7,253 13,304 8,130
------------- ---------- ---------- --------- ---------
Total non-interest income....... 37,275 31,180 81,575 35,872 24,782
------------- ---------- ---------- --------- ---------
Non-interest expenses........... 69,578 45,573 68,858 41,859 32,468
Equity in earnings of joint
venture....................... 38,320 -- -- -- --
Income taxes.................... 11,159 4,562 29,724 10,325 11,552
------------- ---------- ---------- --------- ---------
Income from continuing
operations.................... 50,142 33,139 51,853 27,305 24,337
Discontinued operations (5)..... -- (7,672) (4,514) (2,270) (1,946)
Extraordinary gains............. -- -- -- 1,538 2,963
Cumulative effect of a change in
accounting principle.......... -- -- -- (1,341) --
------------- ---------- ---------- --------- ---------
Net income...................... $50,142 $ 25,467 $ 47,339 $ 25,232 $ 23,354
------------- ---------- ---------- --------- ---------
------------- ---------- ---------- --------- ---------
Income per share from continuing
operations.................... $1.88 $ 1.19 $ 1.52 $ 0.80 $ 0.68
------------- ---------- ---------- --------- ---------
------------- ---------- ---------- --------- ---------
Net income per share............ $1.88 $ 0.91 $ 1.39 $ 0.73 $ 0.71
------------- ---------- ---------- --------- ---------
------------- ---------- ---------- --------- ---------
39
DECEMBER 31,
------------------------------------------------------------------
1996 1995(1) 1994(1) 1993(2) 1992
------------ ------------ ------------ ------------ ----------
(DOLLARS IN THOUSANDS)
Balance Sheet Data:
Total assets................................. $ 2,483,685 $ 1,973,590 $ 1,226,403 $ 1,396,677 $ 833,117
Securities available for sale (6)............ 354,005 337,480 187,717 527,183 340,404
Loans available for sale (6)(7).............. 126,366 251,790 102,293 101,066 754
Investment securities, net................... 8,901 18,665 17,011 32,568 30,510
Mortgage-related securities held for
investment, net............................ -- -- 91,917 121,550 114,046
Loan portfolio, net (7)...................... 402,582 295,605 57,045 88,288 41,015
Discounted loan portfolio (7)................ 1,060,953 669,771 529,460 303,634 213,038
Investment in low-income housing tax credit
interests.................................. 93,309 81,362 49,442 16,203 --
Real estate owned, net (8)................... 103,704 166,556 96,667 33,497 4,710
Investment in joint venture (14)............. 67,909 -- -- -- --
Excess of cost over net assets acquired,
net........................................ -- -- -- 10,467 11,825
Deposits..................................... 1,919,742 1,501,646 1,023,268 871,879 339,622
Borrowings and other interest-bearing
obligations................................ 300,518 272,214 25,510 373,792 361,799
Stockholders' equity(9)...................... 203,596 139,547 153,383 111,831 94,396
Other Data (10):
Average assets............................... $ 2,013,283 $ 1,521,368 $ 1,714,953 $ 1,152,655 $ 712,542
Average equity............................... 161,332 121,291 119,500 97,895 82,460
Return on average assets (11):
Income from continuing operations............ 2.35% 2.18% 3.02% 2.37% 3.42%
Net income................................... 2.35 1.67 2.76 2.19 3.56
Return on average equity (11):
Income from continuing operations............ 31.08 27.32 43.39 27.89 29.51
Net income................................... 31.08 21.00 39.61 25.77 30.75
Average equity to average assets............. 8.01 7.97 6.97 8.49 11.57
Net interest spread.......................... 5.46 5.25 4.86 4.05 4.66
Net interest margin.......................... 4.84 4.54 4.75 4.30 6.06
Efficiency ratio (12)........................ 45.38 54.00 45.77 52.66 47.50
Non-performing loans to loans at end of
period (13)................................ 0.56 1.27 4.35 3.71 8.32
Allowance for loan losses to loans at end of
period (13)................................ 0.87 0.65 1.84 0.99 1.80
Bank regulatory capital ratios at end of
period:
Tangible..................................... 9.33 6.52 11.28 5.25 6.94
Core(Leverage)............................... 9.33 6.52 11.28 6.00 6.94
Risk-based................................... 12.85 11.80 14.74 13.31 21.29
Number of full-service offices at end of
period..................................... 1 1 3 28 15
- ------------------------
(1) Financial data at December 31, 1995 and 1994 reflects the Company's sale
of two and twenty-three branch offices which resulted in the transfer of
deposits of $111.7 million and $909.3 million, respectively, and resulted in a
gain on sale of $5.4 million and $62.6 million during 1995 and 1994,
respectively. Operations data for 1995 and 1994 reflects the gains from these
transactions. Exclusive of these gains and related income taxes and profit
sharing expense, the Company's income from continuing operations would have
been $30.3 million and $24.0 million during 1995 and 1994, respectively.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations--Non-Interest Income."
40
(2) Balance sheet data at December 31, 1993 reflects the merger of Berkeley
Federal Savings Company ("Old Berkeley") into the Company on June 3, 1993,
and operations data for the year ended December 31, 1993 reflects the
operations of Old Berkeley from the date of merger. This transaction was
accounted for using the purchase method of accounting.
(3) The provision for loan losses in 1996 consists primarily of $20.6 million
related to the Company's discounted loan portfolio. Beginning in the first
quarter of 1996, the Company, as requested by the OTS, began recording
general valuation allowances on discounted loans. See "Management Discussion
and Analysis of Financial Condition and Results of Operations-Results of
Operations-Provision for Loan Losses" and "Non-Interest Income."
(4) Represents a portion of the amounts paid to the Company in connection
with the Company's acquisition of certain mortgage-related securities which
generate taxable income in the first several years of the instrument's life
and tax losses of an equal amount thereafter, but have minimal or no cash
flows. Commencing in 1994, such amounts are deferred and recognized in
interest income on a level yield basis over the expected life of that portion
of the deferred tax asset which relates to tax residuals. See Note 21 to
the Consolidated Financial Statements.
(5) In September 1995 the Company announced its decision to dispose of its
automated banking division, which was substantially complete at December 31,
1995. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations--Discontinued Operations" and
Note 3 to the Consolidated Financial Statements.
(6) Securities available for sale were carried at market value at December
31, 1996, 1995, 1994 and 1993 and amortized cost at December 31, 1992.
Loans available for sale are carried at the lower of cost or market value.
(7) The discounted loan portfolio consists of mortgage loans purchased at a
discount to the unpaid debt, most of which were non-performing or
under-performing at the date of acquisition. The loan portfolio and loans
available for sale consist of other loans which were originated or purchased
by the Company for investment or for potential sale, respectively. See
"Business -Lending Activities" and "--Discounted Loan Acquisition and
Resolution Activities," respectively. Data related to discounted loans does
not include discounted loans held by the joint venture referenced below.
(8) Real estate owned is primarily attributable to the Company's discounted
loan acquisition and resolution business.
(9) Reflects the Company's repurchase of 8,815,060 shares of its Common Stock
during 1995 for an aggregate of $42.0 million.
(10) Ratios for periods subsequent to 1992 are based on average daily
balances during the respective periods and ratios for 1992 are based on an
average of month-end balances during the period. Ratios are annualized where
appropriate.
(11) Exclusive of the SAIF assessment in 1996 and gains from the sales of
branch offices in 1995 and 1994 and related income taxes and profit sharing
expense, (i) return on average assets on income from continuing operations
amounted to 2.54%, 2.00% and 1.40% during 1996, 1995 and 1994, respectively,
and (ii) return on average equity on income from continuing operations amounted
to 33.35%, 25.02% and 20.06% during 1996, 1995 and 1994, respectively.
(12) The efficiency ratio represents non-interest expense divided by the sum
of net interest income and non-interest income including equity in earnings
of joint venture. Exclusive of the SAIF assessment in 1996 and gains from
the sales of branch offices in 1995 and 1994 and related profit sharing
expense, the efficiency ratio amounted to 41.33%, 56.34% and 64.14%,
respectively.
41
(13) Non-performing loans and total loans do not include loans in the Company's
discounted loan portfolio or loans available for sale.
(14) Relates to the Company's investment in the LLC. At December 31, 1996, the
net discounted loans, which were available for sale, held by such company
amounted to $110.7 million. See "Business-Investment in Joint Venture".
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the Company's consolidated financial
condition and results of operations and capital resources and liquidity
should be read in conjunction with Selected Consolidated Financial Data and
the Consolidated Financial Statements and related notes included elsewhere
herein.
RESULTS OF OPERATIONS
GENERAL. The Company recorded record net income of $50.1 million or $1.88
per share for 1996 compared with $25.5 million or $0.91 per share for 1995
and $47.3 million or $1.39 per share for 1994. Included in net income for
1996 is a net charge of $0.15 per share related to the FDIC's assessment to
recapitalize the SAIF.
The Company's income from continuing operations amounted to $50.1
million, $33.1 million and $51.9 million during 1996, 1995 and 1994,
respectively. Exclusive of charges for the SAIF assessment in 1996 and gains
from the sale of branch offices in 1995 and 1994, net of related profit
sharing expense, the Company's income from continuing operations amounted to
$54.1 million, $30.3 million and $24.0 million during 1996, 1995 and 1994,
respectively. These amounts represented returns on average assets (including
the Company's pro rata share of the LLC's average assets for 1996) of 2.54%,
2.00% and 1.40% during 1996, 1995 and 1994, respectively, and returns on
average equity of 33.55%, 25.02% and 20.06% during the same respective
periods.
In recent years, the Company has emphasized discounted loan acquisition
and resolution activities and a variety of other mortgage lending activities,
which generally reflect the Company's focus on business lines which offer the
potential for above average returns without increased risk of loss. As a
result of the Company's business strategy, the average balance of the
Company's discounted loan portfolio increased 91.5% from $352.6 million
(20.6% of total average assets) during 1994 to $675.3 million (33.5% of total
average assets) during 1996, and the average balance of the Company's other
loans, including loans available for sale, increased 92.9% from $261.0
million (15.2% of total average assets) to $503.5 million (25.0% of total
average assets) during the same respective periods. This growth in the
Company's lending activities, particularly its discounted loan activities,
has substantially contributed to the Company's profitability in recent
periods. As part of its discounted loan activities, the Company recorded
$38.3 million of income related to its investment in the LLC during 1996. The
Company's pro rata share of the income from the LLC consists primarily of
$10.1 million of net interest income and $35.6 million of gains related to
the securitization of residential discounted mortgage loans, offset by $7.6
million of provisions for losses. In addition, the Company, as requested by
the OTS, began recording in 1996 general valuation allowances on discounted
loans to reflect the inherent losses which may have occurred but have yet to
be specifically identified. At December 31, 1996 the Company had a general
allowance for loan losses on its discounted loans of $11.5 million.
The Company's operating results in 1995 and 1994 were significantly
affected by the effects of the sale of branch offices at the end of 1995 and
1994, which resulted in $5.4 million and $62.6 million of gains before profit
sharing expense and income taxes during these respective periods. As a result
of these sales, the Company's average assets decreased during 1995 and the
Company's principal source of deposits shifted to brokered and other
wholesale deposits. The Company's operating results during 1995 and 1994 were
also affected by losses from discontinued operations of its automated banking
division and related activities, which, net of applicable tax effect,
amounted to $7.7 million and $4.5 million during these periods, respectively.
NET INTEREST INCOME. The operations of the Company are substantially
dependent on its net interest income, which is the difference between the
interest income received from its interest-earning assets and the interest
expense paid on its
42
interest-bearing liabilities. Net interest income is determined by an
institution's net interest spread (i.e., the difference between the yield
earned on its interest-earning assets and the rates paid on its
interest-bearing liabilities), the relative amount of interest-earning assets
and interest-bearing liabilities and the degree of mismatch in the maturity
and repricing characteristics of its interest-earning assets and
interest-bearing liabilities.
The following table sets forth, for the periods indicated, information
regarding the total amount of income from interest-earning assets and the
resultant average yields, the interest expense associated with
interest-bearing liabilities, expressed in dollars and rates, and the net
interest spread and net interest margin. Information is based on average
daily balances during the indicated periods.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------------------------
1996 1995 1994
---------------------------------------- ---------------------------------- ----------------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------------ ------------ ------------ ---------- --------- ----------- ---------- --------- -----------
(DOLLARS IN THOUSANDS)
Average Assets:
Federal funds sold and
repurchase
agreements $ 84,997 $ 4,681 5.51% $ 55,256 $ 3,502 6.34% $ 166,592 $ 8,861 5.32%
Securities held
for trading 21,291 1,216 5.71 -- -- -- -- -- --
Securities
available for
sale(1) 284,433 26,932 9.47 211,559 18,391 8.69 449,654 27,988 6.22
Loans available
for sale(2) 175,078 17,092 9.76 167,011 15,608 9.35 179,962 19,353 10.75
Investment
securities and
other(3) 36,264 3,990 11.00 46,440 4,033 8.68 79,895 9,842 12.32
Mortgage-related
securities held
for investment -- -- -- 77,257 4,313 5.58 140,321 6,930 4.94
Loan portfolio
(1) 328,378 36,818 11.21 130,901 15,430 11.79 81,070 5,924 7.31
Discounted loan
portfolio 675,345 103,165 15.28 483,204 75,998 15.73 352,633 52,560 14.91
------------ ------------ ---------- ------- ---------- ---------
Total interest
earning assets,
interest income 1,605,786 193,894 12.07 1,171,628 137,275 11.72 1,450,127 131,458 9.07
Non-interest
earning cash 6,372 17,715 27,717
Investment in
low-income
housing tax
credit
interests 83,110 63,925 39,135
Allowance for
loan losses (11,250) (1,180) (2,689)
Other assets 329,265 269,280 200,663
------------ ------------ ------------
Total assets $ 2,013,283 $ 1,521,368 $ 1,714,953
------------ ------------ ------------
------------ ------------ ------------
Average
Liabilities
and
Stockholders'
Equity:
Interest-bearing
demand deposits $ 33,167 620 1.87 $ 31,373 1,031 3.29 $ 77,433 1,396 1.80
Savings deposits 3,394 78 2.30 20,370 451 2.21 138,434 2,602 1.88
Certificates of
deposit 1,481,197 93,075 6.28 1,119,836 70,371 6.28 928,209 40,963 4.41
------------ ------------ ---------- --------- ---------- ---------
Total interest-
bearing
deposits 1,517,758 93,773 6.18 1,171,579 71,853 6.13 1,144,076 44,961 3.93
Reverse
repurchase
agreements 19,581 1,101 5.62 16,754 951 5.68 254,457 10,416 4.09
Securities sold
but not yet
purchased -- -- -- 17,149 1,142 6.66 39,526 2,780 7.03
Federal Home Loan
Bank advances 71,221 4,053 5.69 14,866 1,126 7.57 26,476 1,232 4.65
Notes, debentures
and other
interest
bearing
obligations 148,282 17,233 11.62 78,718 8,988 11.42 25,041 3,209 12.81
------------ ------------ ---------- --------- ---------- ---------
Total interest-
bearing
liabilities,
interest
expense 1,756,842 116,160 6.61 1,299,066 84,060 6.47 1,489,576 62,598 4.20
Non-interest
bearing
deposits 10,938 19,960 69,276
Advances for
taxes and
insurance 41,306 4,073 2,430
Other
liabilities 42,865 76,978 34,171
------------ --------- ---------
Total liabilities 1,851,951 1,400,077 1,595,453
Stockholders'
equity 161,332 121,291 119,500
------------ --------- ---------
Total liabilities
and
stockholders'
equity $ 2,013,283 $1,521,368 $1,714,953
------------ ---------- ----------
------------ ---------- ----------
Net interest
income $ 77,734 $ 53,215 $ 68,860
------------ --------- ---------
------------ --------- ---------
Net interest
spread 5.46% 5.25% 4.86%
---- ---- ----
---- ---- ----
Net interest
margin 4.84% 4.54% 4.75%
---- ---- ----
---- ---- ----
Ratio of
interest-
earning assets
to interest-
bearing
liabilities 91% 90% 97%
-- -- --
-- -- --
(1) Excludes effect of unrealized gains or losses on securities available for
sale, net of taxes.
(2) The average balances of loans available for sale and the loan portfolio
include non-performing loans, interest on which is recognized on a cash
basis.
(3) Interest income from investment securities and other includes interest
income attributable to that portion of the Company's deferred tax asset
which relates to tax residuals. See "Taxation-Federal Taxation-Tax
Residuals" and Note 21 to the Consolidated Financial Statements. If the
average balance of the deferred tax asset related to tax residuals was
included in the average balance of investment securities and other, the
weighted average yield would have been 7.34%, 5.93% and 11.48% during
1996, 1995 and 1994, respectively.
43
The following table describes the extent to which changes in interest rates
and changes in volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and expense during the
periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior rate), (ii) changes
in rate (change in rate multiplied by prior volume) and (iii) total change in
rate and volume. Changes attributable to both volume and rate have been
allocated proportionately to the change due to volume and the change due to
rate.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1996 VS 1995 1995 VS 1994
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
------------------------------- ---------------------------------
RATE VOLUME TOTAL RATE VOLUME TOTAL
--------- --------- --------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
Interest-Earning Assets:
Federal funds sold and repurchase agreements............. $ (507) $ 1,686 $ 1,179 $ 1,445 $ (6,804) $ (5,359)
Securities available for sale............................ 1,757 6,784 8,541 8,584 (18,181) (9,597)
Securities held for trading.............................. 608 608 1,216 -- -- --
Loans available for sale................................. 713 771 1,484 (2,417) (1,328) (3,745)
Investment securities and other.......................... 947 (990) (43) (2,401) (3,408) (5,809)
Mortgage-related securities held for investment.......... -- (4,313) (4,313) 812 (3,429) (2,617)
Loan portfolio........................................... (788) 22,176 21,388 4,747 4,759 9,506
Discounted loan portfolio................................ (2,235) 29,402 27,167 3,041 20,397 23,438
--------- --------- --------- ---------- --------- ----------
Total interest-earning assets............................ 495 56,124 56,619 13,811 (7,994) 5,817
--------- --------- --------- ---------- --------- ----------
Interest-Bearing Liabilities:
Interest-bearing demand deposits......................... (467) 56 (411) 752 (1,117) (365)
Savings deposits......................................... 17 (390) (373) 395 (2,546) (2,151)
Certificates of deposit.................................. (3) 22,707 22,704 19,777 9,631 29,408
--------- --------- --------- ---------- --------- ----------
Total interest-bearing deposits.......................... (453) 22,373 21,920 20,924 5,968 26,892
Reverse repurchase agreements............................ (9) 159 150 2,926 (12,391) (9,465)
Securities sold but not yet purchased.................... -- (1,142) (1,142) (141) (1,497) (1,638)
Federal Home Loan Bank Advances.......................... (345) 3,272 2,927 574 (680) (106)
Notes, debentures and other.............................. 163 8,082 8,245 (386) 6,165 5,779
--------- --------- --------- ---------- --------- ----------
Total interest-bearing liabilities....................... (644) 32,744 32,100 23,897 (2,435) 21,462
--------- --------- --------- ---------- --------- ----------
Increase (decrease) in net interest income............... $ 1,139 $ 23,380 $ 24,519 $ (10,086) $ (5,559) $ (15,645)
--------- --------- --------- ---------- --------- ----------
--------- --------- --------- ---------- --------- ----------
1996 versus 1995
The Company's net interest income increased by $24.5 million or 46.1% during
1996, as compared to the prior year. This increase resulted from a $56.6 million
or 41.2% increase in interest income due to a $434.2 million or 37.1% increase
in average interest-earning assets during 1996 and, to a lesser extent, a 35
basis point increase in the weighted average yield on such assets. The increase
in interest income was offset in part by a $32.1 million or 38.2% increase in
interest expense due to a $457.8 million or 35.2% increase in average
interest-bearing liabilities, primarily certificates of deposit, FHLB advances,
notes and debentures, and to a lesser extent, a 14 basis point increase in the
weighted average rate paid on interest-bearing liabilities. The Company's net
interest margin increased to 4.84% in 1996 from 4.54% in 1995.
The increase in interest income during 1996, as compared to the prior
year, reflects substantial increases in the average balances on the
discounted loan portfolio and the loan portfolio as a result of the Company's
increased emphasis on multi-family residential and commercial real estate
loans in recent periods, as well as an increase in the average balance of
loans available for sale as a result of the Company's recent emphasis on
single-family residential loans to non-conforming borrowers. Beginning in
1996, adjustments to reduce the carrying value of discounted loans to the
fair value of the property securing the loan are charged against the
allowance for loan losses on the discounted loan portfolio. Prior to 1996,
such adjustments were charged against interest income on discounted loans.
Had charge-offs on discounted loans been included as a reduction of interest
income in 1996, the weighted average yield on the discounted loan portfolio
would have been 13.9%.
The average balance of the Company's interest-bearing liabilities increased
substantially during 1996, as compared to the prior year, as a result of a
$361.4 million or 32.3% increase in the average balance of certificates of
44
deposit, a $56.4 million or 379.1% increase in the average balance of FHLB
advances and a $69.6 million or 88.4% increase in the average balance of
notes and debentures, which reflect the Company's continued reliance on
brokered and other wholesale certificates of deposit and advances from the
FHLB as a source of funds and the Company's issuance of the Notes in
September 1996 and the Bank's issuance of the Debentures in June 1995,
respectively.
1995 versus 1994
The Company's net interest income decreased by $15.6 million or 22.7% during
1995 as a result of a $21.5 million or 34.3% increase in interest expense, which
was primarily attributable to the Company's use of brokered and other wholesale
deposits as a principal source of funds following the branch sale in 1994. The
Company believes that the increase in interest expense in 1995 was substantially
offset by the decrease in non-interest expense during this period as a result of
the branch sales at the end of 1995 and 1994. The Company's interest income
increased by $5.8 million or 4.4% during 1995, but was adversely affected by a
decrease in the average balance of interest-earning assets during the period as
a result of the branch sales. The Company's net interest margin decreased from
4.75% during 1994 to 4.54% during 1995.
The weighted average yield on interest-earning assets increased from
9.07% in 1994 to 11.72% in 1995 primarily as a result of increases in the
weighted average yields on the Company's loan portfolio and discounted loan
portfolio. The weighted average yield on the Company's loan portfolios
increased during 1995 because commercial real estate loans, which have higher
interest rates than single-family residential loans, comprised a
significantly larger proportion of such portfolios during this period.
Average interest-earnings assets decreased by $278.5 million or 19.2% during
1995 as increases in the outstanding balances of the Company's loan
portfolios were more than offset by decreases in the average balances of all
other categories of interest-earning assets as a result of the sales of
branch offices at the end of 1995 and 1994.
The weighted average rate paid on interest-bearing liabilities increased
from 4.20% in 1994 to 6.47% in 1995 as a result of the Company's increased
utilization of brokered and other wholesale deposits, as noted above, and an
increase in market interest rates generally. Average interest bearing
liabilities decreased by $190.5 million or 12.8% in 1995 as increases in the
average balances of certificates of deposits and subordinated debentures and
other interest-bearing obligations, due primarily to the Bank's issuance of
the Debentures in June 1995, were more than offset by decreases in the
average balances of all other categories of interest-bearing liabilities.
PROVISIONS FOR LOAN LOSSES. Provisions for losses on loans are charged to
operations to maintain an allowance for losses on each of the loan portfolio
and the discounted loan portfolio at a level which management considers
adequate based upon an evaluation of known and inherent risks in such loan
portfolios. Management's periodic evaluation is based on an analysis of each of
the discounted loan portfolio and the loan portfolio, historical loss
experience, current economic conditions and other relevant factors.
Prior to 1996, provisions for losses on loans were not established in
connection with the discounted loan portfolio because adjustments to reduce
the carrying value of discounted loans to the lower of amortized cost or the
fair market value of the properties securing the loans discounted at the
effective interest rate, which amounted to $5.0 million in 1995, were
recorded in interest income on discounted loans. This change in methodology
for valuing discounted loans, as requested by the OTS, resulted in the
establishment of a provision for losses on discounted loans of $20.6 million
in 1996. In addition, beginning in 1996 the Company has recorded all
charge-offs net of recoveries on the discounted loan portfolio, which
amounted to $9.0 million, against the allowance for losses on discounted
loans. During 1996, the Company established a $1.9 million provision for
losses related to its loan portfolio, as compared to $1.1 million in 1995 and
$0 in 1994. Charge-offs, net of recoveries, on the loan portfolio amounted to
$296,000 and $245,000 in 1996 and 1995, respectively. The Company had net
recoveries of $187,000 on its loan portfolio in 1994. The increases in the
provisions from 1994 to 1995 and from 1995 to 1996 were primarily the result
of increases in the amount of loans outstanding, particularly multi-family
residential and commercial real estate loans.
Although management utilizes its best judgment in providing for possible
loan losses, there can be no assurance that the Company will not change its
provisions for possible loan losses in subsequent periods to a higher level from
that recorded during 1996. Changing economic and business conditions,
fluctuations in local markets for real estate, future changes in nonperforming
asset trends, large upward movements in market interest rates or other reasons
could affect the Company's future provisions for loan losses. In addition, the
OTS, as an integral part of its examination process, periodically reviews the
adequacy of the Company's allowance for losses on loans and discounted loans.
Such agency may
45
require the Company to recognize changes to such allowances for losses based
on its judgment about information available to it at the time of examination.
NON-INTEREST INCOME. Non-interest income increased by $6.1 million or 19.5%
in 1996 as compared to 1995. The $5.4 million and $62.6 million gains from the
sale of branch offices in 1995 and 1994, respectively, significantly affected
the Company's non-interest income for those years. Exclusive of these gains,
non-interest income increased by $11.5 million or 44.8% in 1996 and by $6.8
million or 35.7% in 1995. The increase in non-interest income was primarily
attributable to gains from the sale of interest-earning assets in 1996, and to
income on real estate owned and gains from the sale of interest-earning assets
in 1995.
The following table sets forth the principal components of the Company's
non-interest income during the periods indicated.
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Servicing fees and other charges................................................. $ 4,682 $ 2,870 $ 4,786
Gains on sales of interest-earning assets, net................................... 21,682 6,955 5,727
Income on real estate owned, net................................................. 3,827 9,540 5,995
Gain on sale of hotel............................................................ -- 4,658 --
Other income..................................................................... 7,084 1,727 2,467
--------- --------- ---------
Subtotal......................................................................... 37,275 25,750 18,975
Gain from sale of branch offices................................................. -- 5,430 62,600
--------- --------- ---------
Total............................................................................ $ 37,275 $ 31,180 $ 81,575
--------- --------- ---------
--------- --------- ---------
Servicing fees and other charges increased in 1996 primarily as a result of
a $3.0 million increase in loan servicing and related fees as a result of the
Company's increase in loans (primarily non-performing) serviced for others. At
December 31, 1996 the Company serviced 30,163 loans for others with an unpaid
principal balance of $1.92 billion, as compared to 1,366 loans with an unpaid
principal balance of $361.6 million at December 31, 1995. Servicing fees and
other charges decreased in 1995, primarily as a result of a $2.3 million
decrease in deposit-related fees, which decreased as a result of the branch
sales at the end of 1995 and 1994, and a $121,000 decrease in loan fees
primarily as a result of a decrease in late charges on loans, offset in part by
a $783,000 servicing fee received by the Company from the purchaser of the
branch offices sold at the end of 1994 for servicing deposits subsequent to the
sale but prior to their effective transfer.
Net gains on sales of interest-earning assets in 1996 were primarily
comprised of a $5.4 million gain from the sale of 256 single-family loans in
the Company's discounted loan portfolio which had been brought current in
accordance with their terms, a $4.5 million gain from the sale of certain
large commercial loans in the Company's discounted loan portfolio, a $7.2
million net gain from the securitization of $219.6 million of single-family
non-conforming loans and subsequent sale of the senior classes of
mortgage-backed securities backed by such loans, and a $7.9 million net gain
from the securitization of $136.5 million of large commercial discounted
loans and subsequent sale of the mortgage-backed securities backed by such
loans. Net gains on sales of interest-earning assets in 1995 were primarily
comprised of a $6.0 million gain from the sale of loans in the Company's
discounted loan portfolio which had been brought current in accordance with
their terms and a $1.6 million gain from the securitization of $83.9 million
of multi-family residential loans and subsequent sale of the FNMA
mortgage-backed securities backed by such loans. Net gains on sales of
interest-earning assets in 1994 were primarily comprised of $7.2 million of
net gains from the sale of multi-family residential loans and mortgage-backed
securities, $1.8 million of gains from trading activities, $890,000 of gains
from the sale of loans in the Company's discounted loan portfolio which had
been brought current in accordance with their terms and $2.1 million of gains
from the sale of timeshare and other consumer loans, which more than offset
$6.3 million of net losses from the sale of mortgage-backed and related
securities backed by single-family residential loans. Gains on sale of
interest-earning assets (as well as other assets, such as real estate owned,
as discussed below) generally are dependent on various factors which are not
necessarily within the control of the Company, including market and economic
conditions. As a result, there can be no assurance that the gains on sale of
interest-earning assets (and other assets) reported
46
by the Company in prior periods will be reported in future periods or that
there will not be substantial inter-period variations in the results from
such activities.
The following table sets forth the information regarding the Company's
income on real estate owned during the periods indicated, which were primarily
related to the discounted loan portfolio.
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Gains on sales................................................................... $ 22,835 $ 19,006 $ 21,308
Provision for losses in fair value............................................... (18,360) (10,510) (9,074)
Rental income (carrying costs), net.............................................. (648) 1,044 (6,239)
--------- --------- ---------
Income on real estate owned, net................................................. $ 3,827 $ 9,540 $ 5,995
--------- --------- ---------
--------- --------- ---------
For additional information relating to the Company's real estate owned,
see "Business--Asset Quality--Real Estate Owned."
In October 1995, the Company sold one of the two hotels owned by the
Company for a gain of $4.7 million.
Other income increased during 1996 primarily as a result of a $4.9
million gain on the sale of certain of the Company's investment in low-income
housing tax credits. See "Business-Investment Activities-Investments in Low
Income Housing Tax Credit Interests." Other income decreased in 1995
primarily because other income in 1994 included $627,000 of servicing fees
received in connection with the servicing of the private mortgage insurance
business of subsidiaries of IMI, which were sold in 1993, and $858,000 of
fees received by Ocwen Asset Management, Inc. ("OAM"), a subsidiary of the
Company which had managed mortgage-backed and related securities as a
discretionary asset manager for an unaffiliated party. These decreases were
partially offset by a $1.0 million litigation settlement received in 1995
from a broker-dealer relating to a tax residual transaction.
The Company realized a $5.4 million gain from the sale of two branch
offices and $111.7 million of related deposits at the end of 1995 and a $62.6
million gain from the sale of 23 branch offices and $909.3 million of related
deposits at the end of 1994. The Company sold these branch offices and the
related deposit liabilities because of the premiums which could be obtained
for such deposits under existing market and economic conditions and because
the Company believed that it could replace these deposits with other sources
of funds, such as brokered and other wholesale deposits, FHLB advances and
reverse repurchase agreements, which management generally believes have an
effective cost to the Company which is more attractive than the deposits
obtained from branch offices after the general and administrative expense
associated with such offices is taken into account. The Company funded the
sale of the deposits transferred in the branch sales with cash and cash
equivalents obtained from brokered and other wholesale deposits, proceeds
obtained from sales of securities classified as available for sale and other
sources of funds. For a breakdown of the components of the gains from the
branch sales, see Note 2 to the Consolidated Financial Statements included in
Item 8 hereof.
NON-INTEREST EXPENSE. Non-interest expense increased by $24.0 million or
52.7% during 1996 and decreased by $23.3 million or 33.8% during 1995. The
increase in non-interest expense in 1996 has primarily related to a $14.6
million or 61.3% increase in employee compensation and benefits and the SAIF
assessment of $7.1 million. The decrease in non-interest expense in 1995
reflects the sale of twenty-three of the Company's branch offices at the end
of 1994 and, to a lesser extent, the sale of two of the Company's other
branch offices at the end of 1995.
47
The following table sets forth the principal components of the Company's
non-interest expense during the periods indicated.
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Compensation and employee benefits............................................... $ 38,357 $ 23,787 $ 42,395
Occupancy and equipment.......................................................... 8,921 8,360 11,537
Amortization of goodwill......................................................... -- -- 1,346
Hotel operations (income) expense, net........................................... (453) 337 (723)
SAIF assessment.................................................................. 7,140 -- --
Other operating expenses......................................................... 15,613 13,089 14,303
--------- --------- ---------
Total............................................................................ $ 69,578 $ 45,573 $ 68,858
--------- --------- ---------
--------- --------- ---------
The increase in compensation and employee benefits in 1996 reflected an
increase in the average number of full-time equivalent employees from 344 in
1995 to 398 in 1996 primarily as a result of the increase in the number of loans
serviced by the Company for its own account and others, as well as an $8.4
million increase in profit sharing expense, whereas the decrease in compensation
and employee benefits in 1995 reflected a decrease in the average number of
full-time equivalent employees from 548 in 1994 to 344 in 1995 as a result of
the sales of branch offices and other reduction in work force measures, as well
as a $10.7 million decrease in profit sharing expense.
The increase in occupancy and equipment expense of $561,000 in 1996 was
related to the increase in leased office space attributable to the increase in
the number of full-time equivalent employees discussed above. The decrease in
occupancy and equipment expense in 1995 reflected the sale of branch offices
at the end of 1994 and lower occupancy costs as a result of the Company's move
to new executive offices in 1995.
Other expenses increased by $2.5 million in 1996, primarily as a result of
an $885,000 increase in FDIC insurance premiums and a $1.7 million increase in
loan related expenses. Other expenses decreased in 1995 primarily as a result
of a $641,000 decrease in travel and lodging expenses, a $337,000 decrease in
marketing expenses and a $683,000 decrease in miscellaneous other expenses,
which were offset in part by a $1.1 million increase in loan related expenses.
See Note 25 to the Consolidated Financial Statements included in Item 8
hereof.
EQUITY IN EARNINGS OF INVESTMENT IN JOINT VENTURE. Equity in earnings of
investment in joint venture relates to the joint venture formed in March
1996 to acquire discounted single-family residential loans from HUD. The
Company's equity in earnings of the LLC of $38.3 million includes 50% of the
net income of the LLC before deduction of the Company's 50% share of loan
servicing fees, which are paid 100% to the Company, 50% of the gain on sale
of loan servicing rights which the Company acquired from the LLC, $7.6
million in provision for losses on the equity investment in the joint venture
and $460,000 in gain on sale of future contracts used to hedge the loans
securitized. The Company's 50% pro rata share of the LLC's income consisted
primarily of $10.1 million of net interest income on discounted loans and
$35.6 million of gains on sales of discounted loans. The gains on the sales
of discounted loans were primarily the result of the securitization of 9,825
loans with an unpaid principal balance of $419.4 million and past due
interest of $86.1 million and a net book value of $394.2 million. The Company
has recognized 50% of the loan servicing fees not eliminated in consolidation
in servicing fees and other charges. See "Business--Investment in Joint
Venture" and Note 2 to the Consolidated Financial Statements included in Item
8 hereof.
INCOME TAX EXPENSE. Income tax expense on the Company's income from
continuing operations amounted to $11.2 million, $4.6 million and $29.7
million during 1996, 1995 and 1994, respectively. The Company's effective tax
rate amounted to 18.2%, 12.1% and 36.4% during 1996, 1995 and 1994,
respectively. The Company's low effective tax rates in 1996 and 1995 were
primarily attributable to the tax credits resulting from the Company's
investment in low-income housing tax credit interests, which amounted to $9.3
million, $7.7 million and $5.4 million during 1996, 1995 and 1994,
respectively. The Company's effective tax rate in 1994 includes the effects
of the Company's write-off of the remaining goodwill of $9.1 million in
connection with the sale of branch offices which was not deductible for tax
purposes, and an increase in state taxes, which more than offset the benefits
of tax credits resulting from the Company's investment in low-income housing
tax credit interests. Exclusive of the above amounts, the Company's effective
tax rate amounted to 33.4%, 32.6% and 43.1% during 1996, 1995 and 1994,
respectively.
48
DISCONTINUED OPERATIONS. In September 1995, the Company announced its
decision to dispose of its automated banking division and related activities. As
a result of this decision, an after-tax loss on disposal of $3.2 million was
recorded, which consisted of a net loss of $2.0 million on the sale of assets
and a loss of $1.2 million incurred from related
operations until the sale and disposition, which was substantially completed at
December 31, 1995. Losses from the operations of the discontinued division prior
to discontinuance, net of tax, amounted to $4.5 million during 1995 and 1994.
See Note 3 to the Consolidated Financial Statements included in Item 8 hereof.
CHANGES IN FINANCIAL CONDITION
The following table sets forth information relating to certain of the
Company's assets and liabilities at the dates indicated.
DECEMBER 31, INCREASE (DECREASE) IN
---------------------- -----------------------
1996 1995 DOLLARS PERCENT
---------- ---------- ---------- -----------
(DOLLARS IN THOUSANDS)
Assets:
Securities held for trading........................................ $ 75,606 $ -- $ 75,606 -- %
Securities available for sale...................................... 354,005 337,480 16,525 4.9
Loans available for sale........................................... 126,366 251,790 (125,424) (49.8)
Loan portfolio, net................................................ 402,582 295,605 106,977 36.2
Discounted loan portfolio, net..................................... 1,060,953 669,771 391,182 58.4
Investment in low-income housing tax credit interests.............. 93,309 81,362 11,947 14.7
Investment in joint venture........................................ 67,909 -- 67,909 --
Real estate owned, net............................................. 103,704 166,556 (62,852) (37.7)
Investment in real estate.......................................... 41,033 11,957 29,076 243.2
Deferred tax asset................................................. 5,860 22,263 (16,403) (73.7)
Total assets....................................................... 2,483,685 1,973,590 510,095 25.8
Liabilities:
Deposits........................................................... 1,919,742 1,501,646 418,096 27.8
FHLB advances...................................................... 399 70,399 (70,000) (99.4)
Reverse repurchase agreements...................................... 74,546 84,761 (10,215) (12.1)
Subordinated debentures............................................ 225,573 117,054 108,519 92.7
Total liabilities.................................................. 2,280,089 1,834,043 446,046 24.3
Stockholders' equity............................................... 203,596 139,547 64,049 45.9
SECURITIES HELD FOR TRADING.. The Company held $75.6 million in
single-family CMOs for trading at December 31, 1996. This security, which was
sold in January 1997, was acquired from the LLC in connection with the LLC's
securitization of a portion of the HUD Loans. See "Business-Investment in Joint
Venture-Securitization of the HUD Loans".
SECURITIES AVAILABLE FOR SALE. Securities available for sale increased
by $16.5 million or 4.9% during 1996 primarily as a result of the purchase of
$88.6 million of I/Os, the acquisition of two REMIC residual securities with
a carrying value of $20.6 million in connection with the Company's
securitization of $219.6 million of single-family residential loans to
non-conforming borrowers, the acquisition of a subordinate security with a
carrying value of $18.9 million from the LLC in connection with the LLC's
securitization of the HUD Loans and the acquisition of an additional $32.1
million of subordinate securities, of which $9.2 million were acquired in
connection with the Company's securitization of $136.5 million of commercial
discounted loans offset by the sale and repayment of $76.3 million of CMOs,
the sale of $46.4 million of subordinate securities and the sale of $16.1
million of IOs. For additional
49
information relating to these investments, see "Business -Investment
Activities--Mortgage-Backed and Related Securities" and Note 6 to the
Consolidated Financial Statements included in Item 8 hereof.
LOANS AVAILABLE FOR SALE. Loans available for sale decreased by $125.4
million or 49.8% during 1996 and consists primarily of single-family residential
loans to non-conforming borrowers. The decrease in 1996 occurred primarily as a
result of sales of $381.1 million of single-family residential loans, $14.9
million of multi-family residential loans and principal payments of $26.7
million, which substantially offset the purchase and origination of $304.5
million of such loans. Of the single-family loans sold during 1996, $219.6
million were due to the Company's securitization of such loans. See "Business
- -Lending Activities-- Single-Family Residential Loans."
LOAN PORTFOLIO, NET. The Company's net loan portfolio increased by $107.0
million or 36.2% during 1996 primarily as a result of increased investment in
multi-family residential loans, particularly construction loans, and commercial
real estate loans secured by hotel and office buildings. From December 31, 1995
to December 31, 1996, multi-family residential loans, including construction
loans, increased by $18.8 million, and commercial real estate and land loans
increased by $142.6 million, including a $74.5 million and a $67.5 million
increase in loans secured by hotels and office
buildings, respectively. See "Business--Lending Activities."
Non-performing loans amounted to $2.3 million or 0.6% of total loans at
December 31, 1996, as compared to $3.9 million or 1.3% of total loans at
December 31, 1995. At December 31, 1996, non-performing loans consisted
primarily of $2.1 million of single-family residential loans. The Company's
allowance for loan losses amounted to 154.2% and 50.5% of non-performing loans
at December 31, 1996 and 1995, respectively. See "Business - Asset Quality" and
Note 9 to the Consolidated Financial Statements included in Item 8
hereof.
DISCOUNTED LOAN PORTFOLIO, NET. The $391.2 million or 58.4% increase in
the Company's net discounted loan portfolio during 1996 occurred primarily
because discounted loan acquisitions having an unpaid principal balance of
$1.11 billion more than offset $371.2 million of resolutions and repayments,
$138.5 million of transfers to real estate owned and $230.2 million of sales.
Of the discounted loans sold during 1996, $136.5 million were due to the
Company's securitization of performing commercial discounted loans. See
"Business--Discounted Loan Acquisition and Resolution Activities" and Note 10
to the Consolidated Financial Statements included in Item 8 hereof.
At December 31, 1996, discounted loans which were performing in accordance
with original or modified terms amounted to $579.6 million or 44.1% of the gross
discounted loan portfolio, as compared to $351.6 million or 37.3% of the gross
discounted loan portfolio at December 31, 1995. The Company's
allowance for losses on its discounted loan portfolio of $11.5 million amounted
to 1.1% of the net discounted loan portfolio at December 31, 1996 as compared to
0% at December 31, 1995. See "Business-Asset Quality."
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. In 1993, the Company
commenced a multi-family residential lending program which includes direct and
indirect investments in multi-family residential projects which have been
allocated low-income housing tax credits under Section 42 of the Code by a state
tax credit allocating agency. At December 31, 1996, the Company had $93.3
million of investments in low-income housing tax credit interests, as compared
to $81.4 million at December 31, 1995.
Investments by the Company in low-income housing tax interests made on or
after May 18, 1995 in which the Company invests solely as a limited partner,
which amounted to $12.9 million at December 31, 1996, are accounted for using
the equity method in accordance with the consensus of the Emerging Issues Task
Force through Issue Number 94-1. Limited partnership investments made prior to
May 18, 1995, which amounted to $55.6 million at December 31, 1996, are
accounted for under the effective yield method as a reduction of income tax
expense. Low-income housing tax credit partnerships in which the Company invests
as both a limited and, through a subsidiary, a general partner amounted to $24.8
million at December 31, 1996 and are presented on a consolidated basis. See
"Business-Investment Activities-Investment in Low-Income Housing Tax Credit
Interests" and Note 14 to the Consolidated Financial Statements included in
Item 8 hereof.
50
INVESTMENT IN JOINT VENTURE. The $67.9 million investment in the joint
venture at December 31, 1996 represented the Company's investment in a
newly-formed company in which the Company and a co-investor each have a 50%
interest and is net of valuation allowances of $5.1 million. The LLC was formed
to acquire 16,196 single-family residential loans , most of which were not
performing in accordance with their original terms, from HUD. The LLC's assets
at December 31, 1996 of $146.8 million consist primarily
of $110.7 million of discounted loans and $25.6 million of real estate acquired
through foreclosure or deed-in-lieu thereof. See "Business-Investment in Joint
Venture" and Note 2 to the Consolidated Financial Statement included in Item 8
hereof.
REAL ESTATE OWNED, NET. Real estate owned, net consists almost entirely
of properties acquired by foreclosure or deed-in-lieu thereof on loans in the
Company's discounted loan portfolio. Such properties amounted to $100.0
million or 96.5% of total real estate owned at December 31, 1996 and
consisted of $49.7 million, $14.0 million and $36.3 million of properties
attributable to single-family residential loans, multi-family residential
loans and commercial real estate loans, respectively. Real estate owned
decreased by $62.9 million or 37.7% during 1996 as a result of decreases in
single-family and multi-family real estate owned attributable to the
discounted loan portfolio.
The Company actively manages its real estate owned. During 1996, the
Company sold 1,175 properties with a carrying value of $160.6 million as
compared to the sale of 1,229 properties with a carrying value of $139.2
million during 1995. These sales resulted in gains, net of the provision for
loss, of $4.5 million, $8.5 million and $12.2 million during 1996, 1995 and
1994, respectively, which are included in determining the Company's net
income on real estate owned. See "Business-Asset Quality-Real Estate Owned"
and Note 11 to the Consolidated Financial Statements.
INVESTMENT IN REAL ESTATE. In conjunction with its multi-family and
commercial real estate lending business activities, the Company has made
certain acquisition, development and construction loans in which the Company
participates in the expected residual profits of the underlying real estate
and the borrower has not made an equity contribution substantial to the
overall project. As such, the Company accounts for these loans under the
equity method of accounting as though it has made an investment in a real
estate limited partnership. The Company's investment in such loans amounted
to $24.9 million at December 31, 1996 as compared to $0 at December 31, 1995.
Currently, the Company does not intend, except for commitments outstanding,
to originate loans on which it participates in the residual profits in the
underlying real estate. See "Recent Regulatory Developments" below.
The Company also has invested indirectly in The Westin Hotel located in
Columbus, Ohio. The Company's investment in such property increased to $16.1
million at December 31, 1996 from $12.0 million at December 31, 1995 as a
result of capital improvements made to the hotel.
DEFERRED TAX ASSET. At December 31, 1996, the deferred tax asset, net of
deferred tax liabilities, amounted to $5.9 million, a decrease of $16.4
million from the $22.3 million deferred tax asset at December 31, 1995. At
December 31, 1996, the gross deferred tax asset amounted to $15.1 million and
consisted primarily of $3.7 million related to tax residuals, $3.5 million
mark-to-market and reserves on real estate owned properties and $3.9 million
of deferred interest expense on the discounted loan portfolio. The gross
deferred tax liability amounted to $9.2 million and consisted primarily of
$4.6 million of deferred interest income on the discounted loan portfolio and
$2.1 million mark-to-market on securities available for sale. At December 31,
1995, the gross tax asset amounted to $39.4 million, of which $27.6 million
related to the Company's tax residuals, and the gross deferred tax liability
amounted to $17.2 million and consisted primarily of $12.4 million of bad
debt reserves established for tax purposes in excess of book reserves and
$4.3 million of deferred interest income on the discounted loan portfolio.
As a result of the Company's earnings history, current tax position and
taxable income projections, management believes that the Company will generate
sufficient taxable income in future years to realize the deferred tax asset
which existed at December 31, 1996. In evaluating the expectation of sufficient
future taxable income, management considered future reversals of temporary
differences and available tax planning strategies that could be implemented, if
required. A valuation allowance was not required at December 31, 1996 because it
was management's assessment that, based on available information, it is
more likely than not that all of the deferred tax asset will be realized. A
valuation allowance will be established in the future to the extent of a change
in management's assessment of the amount of the net deferred tax asset that is
expected to be realized. See Note 21 to the Consolidated Financial Statements
included in Item 8 hereof.
51
DEPOSITS. Deposits increased $418.1 million during 1996 primarily as a
result of brokered deposits obtained through national investment banking
firms which solicit deposits from their customers, which amounted to $1.22
billion at December 31, 1996, as compared to $1.12 billion at December 31,
1995. The Company's deposits also increased during 1996 as a result of the
Company's direct solicitation and marketing efforts to regional and local
investment banking firms and institutional investors and high net worth
individuals. Deposits obtained in this manner amounted to $540.6 million at
December 31, 1996 as compared to $273.4 million at December 31, 1995. See
"Business -Sources of Funds--Deposits" and Note 16 to the Consolidated
Financial Statements.
FHLB ADVANCES AND REVERSE REPURCHASE AGREEMENTS. FHLB advances and reverse
repurchase agreements decreased $80.2 million during 1996 primarily as a result
of the repayment of a $70.0 million outstanding FHLB advance which matured
in 1996. At December 31, 1996, and from time to time, the Company utilizes such
collateralized borrowings as additional sources of liquidity. See Business
- -Sources of Funds--Borrowings" and Notes 17 and 18 to the Consolidated
Financial Statements included in Item 8 hereof.
NOTES, DEBENTURES AND OTHER INTEREST-BEARING OBLIGATIONS. Notes,
debentures and other interest-bearing obligations increased by $108.5 million
during 1996 primarily as a result of the $125.0 million of 11.875% Notes
issued by the Company in September 1996. This increase more than offset the
repayment of $8.6 million of short-term notes which were privately issued to
stockholders of the Company and a $7.8 million decrease in hotel mortgages
payable due to the Company's decision in November 1996 to acquire the
mortgage payable on the Company's hotel in Columbus, Ohio. See Note 19 to the
Consolidated Financial Statements included in Item 8 hereof.
STOCKHOLDERS' EQUITY. The $64.0 million increase in stockholders' equity
during 1996 was primarily due to $50.1 million of net income earned during
1996, a $4.9 million increase in unrealized gain on securities available for
sale and a $13.0 million increase in common stock and additional paid-in
capital in connection with the issuance of 2,928,830 shares of common stock
as a result of the exercise of vested stock options by certain of the
Company's and the Bank's current and former officers and directors. These
increases more than offset the loans made to certain of such officers and
directors to fund their exercise of the stock options, which had an unpaid
principal balance of $3.8 million at December 31, 1996.
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude
of the repricing of assets and liabilities. It is the objective of the
Company to attempt to control risks associated with interest rate movements.
In general, management's strategy is to match asset and liability balances
within maturity categories to limit the Company's exposure to earnings
variations and variations in the value of assets and liabilities as interest
rates change over time. The Company's asset and liability management strategy
is formulated and monitored by the Asset/Liability Committee, which is
composed of directors and officers of the Company and the Bank, in accordance
with policies approved by the Board of Directors of the Bank. The
Asset/Liability Committee meets regularly to review, among other things, the
sensitivity of the Company's assets and liabilities to interest rate changes,
the book and market values of assets and liabilities, unrealized gains and
losses, including those attributable to hedging transactions, purchase and
sale activity, and maturities of investments and borrowings. The
Asset/Liability Committee also approves and establishes pricing and funding
decisions with respect to the Company's overall asset and liability
composition.
The Asset/Liability Committee is authorized to utilize a wide variety of
off-balance sheet financial techniques to assist it in the management of
interest rate risk. These techniques include interest rate
exchange agreements, pursuant to which the parties exchange the difference
between fixed-rate and floating-rate interest payments on a specified principal
amount (referred to as the "notional amount") for a specified period without the
exchange of the underlying principal amount. Interest rate exchange agreements
are utilized by the Company to protect against the decrease in value of a
fixed-rate asset or the increase in borrowing cost from a short-term, fixed-rate
liability, such as reverse repurchase agreements, in an increasing interest rate
environment. Interest rate exchange agreements had the effect of (decreasing)
increasing the Company's net interest income by $(58,000), $358,000 and
$(754,000) during 1996, 1995 and 1994, respectively. For additional information
see Note 20 to the Consolidated Financial Statements included in Item 8 hereof.
52
The Company also enters into interest rate futures contracts, which are
commitments to either purchase or sell designated financial instruments at a
future date for a specified price and may be settled in cash or through
delivery. Eurodollar futures contracts have been sold by the Company to hedge
the repricing or maturity risk of certain short duration mortgage-related
securities, and U.S. Treasury futures contracts have been sold by the Company
to offset declines in the market value of its fixed-rate loans and certain
fixed-rate mortgage-backed and related securities available for sale in the
event of an increasing interest rate environment. At December 31, 1996 and
1995, the Company had entered into Eurodollar futures (short) contracts with
an aggregate notional amount of $405.0 million and $412.0 million,
respectively, and U.S. Treasury futures (short) contracts with an aggregate
notional amount of $165.1 million and $11.1 million, respectively. Futures
contracts had the effect of (decreasing) increasing the Company's net
interest income by $(729,000), $(619,000) and $650,000 during 1996, 1995 and
1994, respectively. For additional information, see Note 20 to the
Consolidated Financial Statements included in Item 8 hereof.
The Asset/Liability Committee's methods for evaluating interest rate risk
include an analysis of the Company's interest rate sensitivity "gap," which is
defined as the difference between interest-earning assets and interest-bearing
liabilities maturing or repricing within a given time period. A gap is
considered positive when the amount of interest-rate sensitive assets exceeds
the amount of interest-rate sensitive liabilities. A gap is considered negative
when the amount of interest-rate sensitive liabilities exceeds interest-rate
sensitive assets. During a period of rising interest rates, a negative gap would
tend to adversely affect net interest income, while a positive gap would tend to
result in an increase in net interest income. During a period of falling
interest rates, a negative gap would tend to result in an increase in net
interest income, while a positive gap would tend to affect net interest income
adversely. Because different types of assets and liabilities with the same or
similar maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
The following table sets forth the estimated maturity or repricing of the
Company's interest-earning assets and interest-bearing liabilities at
December 31, 1996. The amounts of assets and liabilities shown within a
particular period were determined in accordance with the contractual terms of
the assets and liabilities, except (i) adjustable-rate loans, securities and
FHLB advances are included in the period in which they are first scheduled to
adjust and not in the period in which they mature, (ii) fixed-rate,
mortgage-related securities reflect estimated prepayments, which were
estimated based on analyses of broker estimates, the results of a prepayment
model utilized by the Company and empirical data, (iii) nonperforming
discounted loans reflect the estimated timing of resolutions which result in
repayment to the Company, (iv) fixed-rate loans reflect scheduled contractual
amortization, with no estimated prepayments, (v) NOW and money market
checking deposits and savings deposits, which do not have contractual
maturities, reflect estimated levels of attrition, which are based on
detailed studies of each such category of deposit by the Company, and (vi)
escrow deposits and other non-interest bearing checking accounts, which
amounted to $96.6 million at December 31, 1996, are excluded. Management
believes that these assumptions approximate actual experience and considers
them reasonable; however, the interest rate sensitivity of the Company's
assets and liabilities in the table could vary substantially if different
assumptions were used or actual experience differs from the historical
experience on which the assumptions are based.
53
DECEMBER 31, 1996
------------------------------------------------------------------------------------------
FOUR TO
WITHIN THREE TWELVE MORE THAN ONE YEAR TO THREE
MONTHS MONTHS YEARS THREE YEARS AND OVER TOTAL
------------ ------------- --------------------------- -------------------- ----------
(DOLLARS IN THOUSANDS)
Rate-Sensitive
Assets:
Interest-earning
cash............. $ 45,341 $ -- $ -- $ -- $ 45,341
Securities held for
trading.......... 5,031 14,160 17,335 39,080 75,606
Securities
available for
sale............. 27,341 65,571 76,434 184,659 354,005
Loans available for
sale(1).......... 11,699 47,281 16,637 50,749 126,366
Investment
securities, net.. 103 -- -- 8,798 8,901
Loan portfolio,
net(1)........... 121,664 98,160 59,744 123,014 402,582
Discounted loan
portfolio, net... 205,290 279,894 259,604 316,165 1,060,953
------------ ------------- -------- ---------- ----------
Total rate-
sensitive
assets........... 416,469 505,066 429,754 722,465 2,073,754
Rate-Sensitive
Liabilities:
NOW and money
market checking
deposits......... 8,097 10,993 624 2,494 22,208
Savings deposits... 613 331 363 1,454 2,761
Certificates of
deposit.......... 361,337 565,954 370,937 499,982 1,798,210
------------ ------------- -------- ---------- ----------
Total interest-
bearing
deposits......... 370,047 577,278 371,924 503,930 1,823,179
FHLB advances...... -- 399 -- -- 399
Securities sold
under agreement
to repurchase.... 74,546 -- -- -- 74,546
Notes, debentures
and other
interest-bearing
obligations...... -- -- -- 225,573 225,573
------------ ------------- -------- ---------- ----------
Total rate-
sensitive
liabilities...... 444,593 577,677 371,924 729,503 2,123,697
Interest rate
sensitivity gap
before off-
balance sheet
financial
instruments...... (28,124) (72,611) 57,830 (7,038) (49,943)
Futures
contracts and
interest rate
swap............. 559,480 (186,781) (154,632) (218,067) --
------------ ------------- -------- ---------- ----------
Interest rate
sensitivity gap.. $ 531,356 $ (259,392) $ (96,802) $ (225,105) $ (49,943)
------------ ------------- -------- ---------- ----------
------------ ------------- -------- ---------- ----------
Cumulative interest
rate sensitivity
gap.............. $ 531,356 $ 271,964 $ 175,162 $ (49,943)
------------ ------------- -------- ----------
------------ ------------- -------- ----------
Cumulative interest
rate sensitivity
gap as a
percentage of
total rate-
sensitive
assets........... 25.62% 13.11% 8.45% (2.41)%
(1) Balances have not been reduced for non-performing loans.
Although interest rate sensitivity gap is a useful measurement and
contributes toward effective asset and liability management, it is difficult to
predict the effect of changing interest rates based solely on that measure. As a
result, and as required by OTS regulations, the Asset/Liability Committee also
regularly reviews interest rate risk by forecasting the impact of alternative
interest rate environments on net interest income and market value of portfolio
equity ("MVPE"), which is defined as the net present value of an institution's
existing assets, liabilities and off-balance sheet instruments, and evaluating
such impacts against the maximum potential changes in net interest income and
MVPE that is authorized by the Board of Directors of the Company.
The following table sets forth at December 31, 1996 the estimated
percentage change in the Company's net interest income over a four-quarter
period and MVPE based upon the indicated changes in interest rates, assuming an
instantaneous and sustained uniform change in interest rates at all maturities.
54
DECEMBER 31, 1996
--------------------------------
CHANGE (IN BASIS ESTIMATED CHANGE IN
POINTS) IN INTEREST --------------------------------
RATES NET INTEREST INCOME MVPE
- --------------------- ------------------- ------
+400 12.58% (29.62)%
+300 9.43 (29.80)
+200 6.29 (24.68)
+100 3.14 (9.76)
0 -- --
-100 (3.14) 0.49
-200 (6.29) (2.24)
-300 (9.43) (6.63)
-400 (12.58) (9.53)
The negative estimated changes in MVPE for -100 to -400 changes in interest
rates for 1996 is attributable to the Company's sensitivity to decreases in
interest rates. Such sensitivity stems from the Company's investments in IO
mortgage-backed securities. IO strips exhibit considerably more price volatility
than mortgage or ordinary mortgage pass-through securities, due in part to the
uncertain cash flows that result from changes in the prepayment rates of the
underlying mortgages. In the case of IO strips, increased prepayments of the
underlying mortgages as a result of a decrease in market interest rates or other
factors can result in a loss of all or part of the purchase price of such
security. The Company generally attempts to offset the interest rate risk
associated with a particular IO strip by purchasing other securities which
reduce such risk.
Management of the Company believes that the assumptions used by it to
evaluate the vulnerability of the Company's operations to changes in interest
rates approximate actual experience and considers them reasonable; however, the
interest rate sensitivity of the Company's assets and liabilities and the
estimated effects of changes in interest rates on the Company's net interest
income and MVPE could vary substantially if different assumptions were used or
actual experience differs from the historical experience on which they are
based.
LIQUIDITY
Liquidity is a measurement of the Company's ability to meet potential cash
requirements, including ongoing commitments to fund deposit withdrawals, repay
borrowings, fund investment, discounted loan and lending activities and for
other general business purposes. The primary sources of funds for liquidity
currently consist of deposits, FHLB advances, reverse repurchase agreements and
maturities and principal payments on loans and securities and proceeds from
sales thereof.
The Company's liquidity is actively managed on a daily basis, monitored
regularly by the Asset/ Liability Committee and reviewed periodically with the
Board of Directors. This process is intended to ensure the maintenance of
sufficient funds to meet the needs of the Company, including adequate cash flows
for off-balance sheet instruments.
Sources of liquidity include certificates of deposit which are obtained
primarily from wholesale sources. At December 31, 1996, the Company had $1.79
billion of certificates of deposit, including $1.22 billion of brokered
certificates of deposit obtained through national investment banking firms,
all of which are non-cancelable. At the same date, scheduled maturities of
certificates of deposit during the 12 months ending December 31, 1997 and
1998 and thereafter amounted to $916.1 million, $375.3 million and $506.9
million, respectively. Brokered and other wholesale deposits generally are
more responsive to changes in interest rates than core deposits and, thus,
are more likely to be withdrawn from the Company upon maturity as changes in
interest rates and other factors are perceived by investors to make other
investments more attractive. Management of the Company believes that it can
adjust the rates paid on certificates of deposit to retain deposits in
changing interest rate environments, and that brokered and other
55
wholesale deposits can be both a relatively cost-effective and stable
source of funds. There can be no assurance that this will continue to be the
case in the future, however.
Sources of borrowings include FHLB advances, which are required to be
secured by single-family and/ or multi-family residential loans or other
acceptable collateral, and reverse repurchase agreements. At December 31, 1996,
the Company had $399,000 of FHLB advances outstanding, was eligible to borrow up
to an aggregate of $140.0 million from the FHLB of New York (subject to
availability of acceptable collateral) and had $96.1 million of
single-family residential loans, approximately $10.4 million of multi-family
residential loans and $33.5 million of hotel loans which could be pledged as
security for such advances. At the same date, the Company had contractual
relationships with 12 brokerage firms and the FHLB of New York pursuant to which
it could obtain funds from reverse repurchase agreements and had $292.9
million of unencumbered investment securities and mortgage-backed and related
securities which could be used to secure such borrowings.
The Company's operating activities provided cash flows of $101.4 million
and used cash flows of $189.4 million and $108.8 million during 1996, 1995
and 1994, respectively. During the foregoing years cash resources were
provided primarily by net income and proceeds from sales of loans available
for sale, and cash resources were used primarily to purchase and originate
loans available for sale.
The Company's investing activities used cash flows totaling $558.3 million
and $474.5 million during 1996 and 1995, respectively, and provided cash flows
of $234.5 million during 1994. During the foregoing years, cash flows from
investing activities were provided primarily by principal payments on discounted
loans and loans held for investment, maturities of and principal payments
received on securities available for sale and proceeds from sales of discounted
loans, securities available for sale and real estate owned, and cash flows from
investing activities were primarily utilized to purchase and originate
discounted loans and loans held for investment and purchase securities available
for sale.
The Company's financing activities provided cash flows of $454.5 million and
$681.8 during 1996 and 1995, respectively, and used cash flows of $127.9 million
during 1994. Cash flows from financing activities were primarily related to
changes in the Company's deposits, issuance of the Notes in 1996, issuance of
the Debentures in 1995 and advances from FHLB. Cash flows used by financing
activities were primarily utilized to repay advances from the FHLB and reverse
repurchase agreements and include the transfer of deposits in connection with
the sale of branch offices in 1995 and 1994.
The Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of U.S. Government,
federal agency and other investments having maturities of five years or less.
Current OTS regulations require that a savings association maintain liquid
assets of not less than 5% of its average daily balance of net withdrawable
deposit accounts and borrowings payable in one year or less, of which short-term
liquid assets must consist of not less than 1%. Monetary penalties may be
imposed for failure to meet applicable liquidity requirements. The Bank's
liquidity, as measured for regulatory purposes, averaged, 8.8%, 12.9% and 14.2%
during the years ended December 31, 1996, 1995 and 1994, respectively. The high
level of liquidity during 1994 was attributable to the Bank's efforts to
increase cash, interest-bearing deposits and other liquid sources of funds to
fund the transfer of deposits in connection with the sale of 23 offices
consummated at year end.
COMMITMENTS AND OFF-BALANCE SHEET RISKS
At December 31, 1996, the Company had commitments to fund (i) $105.5
million of multi-family residential loans, (ii) $55.9 million of hotel loans,
(iii) $19.8 million of office building loans and (iv) $12.8 million of land
loans. The Company also was committed to lend up to $5.7 million under
outstanding unused lines of credit. Management of the Company believes that
the Company has adequate resources to fund all of its commitments to the
extent required and that substantially all of such commitments will be funded
during 1997. For additional information relating to commitments and
contingencies, see Note 27 to the Consolidated Financial Statements included
in Item 8 hereof.
In addition to commitments to extend credit, the Company is party to
various off-balance sheet financial instruments in the normal course of
business to manage its interest rate risk. See "--Asset and Liability
Management" above and Note 20 to the Consolidated Financial Statements
included in Item 8 hereof.
56
The Company conducts business with a variety of financial institutions and
other companies in the normal course of business, including counterparties to
its off-balance sheet financial instruments. The Company is subject to potential
financial loss if the counterparty is unable to complete an agreed upon
transaction. The Company seeks to limit counterparty risk through financial
analysis, dollar limits and other monitoring procedures.
REGULATORY CAPITAL REQUIREMENTS
Federally-insured savings associations such as the Bank are required to
maintain minimum levels of regulatory capital. These standards generally must be
as stringent as the comparable capital requirements imposed on national Banks.
The OTS also is authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis.
The following table sets forth the Bank's actual and required regulatory
capital ratios at December 31, 1996:
TIER 1 TOTAL
TANGIBLE CORE RISK-BASED RISK-BASED
DECEMBER 31, 1996 CAPITAL CAPITAL CAPITAL CAPITAL
- ------------------------------------------------- ---------- ---------- ----------- -------------
(Dollars in thousands)
Actual capital:
Amount $ 224,385 $ 224,385 $ 224,385 $ 340,442 (1)
Ratio 9.33% 9.33% 8.47% 12.85%
FIRREA minimum required capital:
Amount $ 36,057 $ 72,114 $ n/a $ 212,014
Ratio 1.50% 3.00% n/a 8.00%
FDICIA well capitalized required capital:
Amount n/a $ 120,190 $ 159,011 $ 265,018
Ratio n/a 5.00% 6.00% 10.00%
(1) At December 31, 1996, the Bank's supplementary capital included $100.0
million attributable to the Debentures and $16.1 million of general
valuation allowances.
(2) In order to be "well capitalized", an institution must also not be
subject to any written agreement, order or directive issued by the
appropriate federal banking agency to meet and maintain a specific capital
level for any capital measure.
In August 1993, the OTS promulgated regulations which incorporate an
interest rate risk component into the OTS risk-based capital requirements,
and in August 1995 the OTS postponed the effectiveness of this regulation
after having previously deferred the effective date several times. Because
only institutions whose measured interest rate risk exceeds certain
parameters will be subject to the interest rate risk capital requirement,
management of the Company does not believe that this regulation will increase
the Bank's risk-based regulatory capital requirement if it becomes effective
in its current form. For additional information relating to regulatory
capital requirements, see "Business--Regulation--Regulatory Capital
Requirements" and see Note 24 to the Consolidated Financial Statements
included in Item 8 hereof.
RECENT REGULATORY DEVELOPMENTS
Subsequent to December 31, 1996, in connection with a recent examination
of the Bank, the staff of the OTS expressed concern about many of the Bank's
non-traditional operations, which generally are deemed by the OTS to involve
higher risk, and the adequacy of the Bank's capital in light of the Bank's
lending and investment strategies, notwithstanding that it is a
"well-capitalized institution" under OTS regulations. The activities which
are of concern to the OTS include the Bank's single-family residential
lending activities to non-conforming borrowers, the Bank's origination of
acquisition, development and construction loans with terms which provide for
shared participation in the results of the underlying real estate, the Bank's
discounted loan activities, which involve significantly higher investment in
non-performing and classified assets than the majority of the savings
industry and the Bank's investment in subordinated classes of
mortgage-related securities issued in connection with the Bank's asset
securitization activities and otherwise.
57
In connection with the examination, the OTS instructed the Bank,
commencing on June 30, 1997, to maintain a ratio of Tier 1 capital to assets
of at least 12% and a total risk-based capital ratio of no less than 18%,
which amounts may be decreased in the event that the Bank reduces its risk
profile in a manner which is satisfactory to the OTS. Although the Bank
strongly disagrees with the level of risk perceived by the OTS in its
businesses, the Bank has taken the following actions in response to the OTS
concerns: (i) sold to the Company subordinated, participating interests in a
total of eleven acquisition, development and construction loans which
interests had an aggregate principal balance of $16.9 million, (ii) modified
certain of its accounting practices, including, among other things, ceasing
to accrue unaccreted discount on non-performing single-family residential
loans commencing as of January 1, 1997, (iii) ceased originating acquisition,
development and construction loans with profit participation features in the
underlying real estate, with the exception of existing commitments, and (iv)
established as of December 31, 1996 requested reserves, which amounted to
$7.2 million, against loans and securities resulting from its investment in
loans acquired from HUD.
The Company intends to meet with the OTS staff to present recommendations
by the Bank to transfer some of its nontraditional assets to the Company, one
or more affiliates of the Company and/or one or more affiliates of the Bank
in order to decrease the specified capital ratios the Bank has been
instructed to maintain. Based on discussions with the OTS, the Bank does not
believe at this time that any requirement to maintain higher levels of
capital will be pursuant to a written agreement, order or directive which
would cause it to cease to be a "well-capitalized institution" under OTS
regulations, assuming compliance with any new capital requirements.
FORWARD-LOOKING STATEMENTS
Certain statements contained herein are not, and certain statements
contained in future filings by the Company with the OTS, in the Company's
press releases or in the Company's other public or shareholder communications
may not be, based on historical facts and are "Forward-looking statements"
within the meaning of the Private securities Litigation Reform Act of 1995.
Forward-looking statements which are based in various assumption (some of
which are beyond the Company's control), may be identified by reference to
future period or periods, or by the use of forward-looking terminology, such
as "may," "will," "believe," "expect," "anticipate," "continue," or similar
terms or variation on those terms, or the negative of those terms. Actual
results could differ materially from those set forth in forward-looking
statements due to a variety of factors, including, but not limited to, those
related to the economic environment, particularly in the market areas in
which the Company operates, competitive products and pricing, fiscal and
monetary policies of the U.S. Government, changes in government regulations
affecting financial institutions, including regulatory fees and capital
requirements, changes in prevailing interest rates, acquisitions and the
integration of acquired business, credit risk management, asset/liability
management, the financial and securities markets and the availability of and
costs associated with sources of liquidity.
For information relating to the effect of recent accounting standards on the
Company, see Note 1 to the Consolidated Financial Statements included in
Item 8 hereof.
ITEM 8. FINANCIAL STATEMENTS
See index to financial statements on page F-1 and financial statements
beginning on page F-3.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
58
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Information regarding directors, executive officers and principal
shareholders appears in the Proxy Statement for the Annual Meeting of
Stockholders to be held on May 27, 1997 and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation appears in the Proxy Statement
for the Annual Meeting of Stockholders to be held on May 27, 1997 and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management appears in the Proxy Statement for the
Annual Meeting of Stockholders to be held on May 27, 1997 and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions appears
in the Proxy Statement for the Annual Meeting of Stockholders to be held on
May 27, 1997 and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Exhibits:
3.1 Amended and Restated Articles of Incorporation (1)
3.2 Bylaws (1)
4.0 Form of certificate of Common Stock (1)
4.1 Form of indenture between the Company and Bank One, Columbus, NA as Trustee (1)
4.2 Form of Notes due 2003 (included in Exhibit 4.1) (1)
10.1 Ocwen Financial Corporation 1991 Non-Qualified Stock Option Plan, as amended (1)
10.2 Annual Incentive Plan (1)
10.3 Ocwen Financial Corporation 1996 Stock Plan for Directors, as amended (2)
21.0 Subsidiaries (see "Business-General")
27.0 Financial Data Schedule
99.0 BCBF, L.L.C. December 31, 1996 audited financial statements
(1) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-1, File
No.333-5153, effective on September 25, 1996.
(2) Incorporated by reference to the similarly described exhibit included with
the Registrants Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996.
The Company's management contracts or compensation plans or arrangements
consist of Exhibits No. 10.1, 10.2, and 10.3.
59
FINANCIAL STATEMENTS AND SCHEDULES. See index to Consolidated Financial
Statements on page F-1 and Consolidated Financial Statements commencing on page
F-3. Financial statement schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated Financial
Statements or notes thereto.
REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED DECEMBER 31, 1996. None.
60
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Ocwen Financial Corporation
By: /s/ William C. Erbey
______________________________________________
William C. Erbey
Chairman of the Board, President and
Chief Executive Officer
(duly authorized representative)
Date: March 28, 1997
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and
on the date indicated:
/s/ William C. Erbey Date: March 28, 1997
- ----------------------------------------
William C. Erbey, Chairman of the Board,
Chief Executive Officer and President
(principal executive officer)
/s/ Barry N. Wish Date: March 28, 1997
- ----------------------------------------
Barry N. Wish, Director
/s/ W.C. Martin Date: March 28, 1997
- ----------------------------------------
W.C. Martin, Director
/s/ Howard E. Simon Date: March 28, 1997
- ----------------------------------------
Howard E. Simon, Director
/s/ Christine A. Reich Date: March 28, 1997
- ----------------------------------------
Christine A. Reich, Managing
Director and Chief Financial Officer
(principal financial officer)
/s/ Ronald M. Faris Date: March 28, 1997
- ----------------------------------------
Ronald M. Faris, Chief Accounting Officer
(principal accounting officer)
61
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Audited consolidated Financial Statements:
Report on Independent Certified Public Accountant.............. F-2
Consolidated Statements of Financial Condition at December 31,
1996 and 1995................................................ F-3
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 1996, 1995 and 1994... F-4
Consolidated Statements of changes in Stockholders' Equity for
each of the three years in the period ended December 31,
1996, 1995 and 1994.......................................... F-6
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1996, 1995 and 1994... F-7
Notes to Consolidated Financial Statements..................... F-9
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Ocwen Financial Corporation
In our opinion, the accompanying consolidated statements of financial
condition and the related consolidated statements of operations, of changes
in stockholders' equity and of cash flows present fairly, in all material
respects, the financial position of Ocwen Financial Corporation and its
subsidiaries (the "Company") at December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of
these statements in accordance with generally accepted auditing standards
which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
- ----------------------------------------
PRICE WATERHOUSE LLP
Fort Lauderdale, Florida
January 21, 1997
F-2
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
DECEMBER 31, 1996 1995
- ------------------------------------------------------------------ ----------- ------------
Assets
Cash and amounts due from depository institutions................. $ 6,878 $ 4,200
Interest bearing deposits......................................... 13,341 50,432
Federal funds sold and repurchase agreeements..................... 32,000 --
Securities held for trading....................................... 75,606 --
Securities available for sale, at market value.................... 354,005 337,480
Loans available for sale, at lower of cost or market.............. 126,366 251,790
Investment securities, net........................................ 8,901 18,665
Loan portfolio, net............................................... 402,582 295,605
Discounted loan portfolio, net.................................... 1,060,953 669,771
Principal, interest and dividends receivable...................... 16,821 12,636
Investments in low income housing tax credit interests............ 93,309 81,362
Investment in joint venture....................................... 67,909 --
Real estate owned, net............................................ 103,704 166,556
Investment in real estate......................................... 41,033 11,957
Premises and equipment, net....................................... 14,619 13,402
Income taxes receivable........................................... 15,115 1,005
Deferred tax asset................................................ 5,860 22,263
Other assets...................................................... 44,683 36,466
------------ ------------
$ 2,483,685 $ 1,973,590
------------ ------------
------------ ------------
Liabilities and Stockholders' Equity
Liabilities:
Deposits........................................................ $ 1,919,742 $ 1,501,646
Advances from the Federal Home Loan Bank........................ 399 70,399
Securities sold under agreements to repurchase.................. 74,546 84,761
Notes, debentures and other interest bearing obligations........ 225,573 117,054
Accrued expenses, payables and other liabilities................ 59,829 60,183
------------ ------------
Total liabilities............................................. 2,280,089 1,834,043
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 20,000,000 shares authorized;0
shares issued and outstanding................................. - -
Common stock, $.01 par value; 200,000,000 shares
authorized; 26,744,170 and 23,812,270 shares issued and
outstanding at December 31, 1996 and 1995, respectively....... 267 238
Additional paid-in capital...................................... 23,258 10,449
Retained earnings............................................... 180,417 130,275
Unrealized gain (loss) on securities available for sale, net of
taxes......................................................... 3,486 (1,415)
Notes receivable on exercise of common stock options............ (3,832) -
------------ ------------
Total stockholders' equity.................................... 203,596 139,547
------------ ------------
$ 2,483,685 $ 1,973,590
------------ ------------
------------ ------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
F-3
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------------------------- --------- --------- ---------
Interest income:
Federal funds sold and repurchase agreements................................... $ 4,681 $ 3,502 $ 8,861
Securities available for sale.................................................. 26,932 18,391 27,988
Securities held for trading.................................................... 1,216 -- --
Loans available for sale....................................................... 17,092 15,608 19,353
Mortgage-related securities held for investment................................ -- 4,313 6,930
Loans.......................................................................... 36,818 15,430 5,924
Discounted loans............................................................... 103,165 75,998 52,560
Investment securities and other................................................ 3,990 4,033 9,842
--------- --------- ---------
193,894 137,275 131,458
--------- --------- ---------
Interest expense:
Deposits....................................................................... 93,773 71,853 44,961
Securities sold under agreements to repurchase................................. 1,101 951 10,416
Securities sold but not yet purchased.......................................... -- 1,142 2,780
Advances from the Federal Home Loan Bank....................................... 4,053 1,126 1,232
Notes, debentures and other interest bearing obligations....................... 17,233 8,988 3,209
--------- --------- ---------
116,160 84,060 62,598
--------- --------- ---------
Net interest income before provision for loan losses......................... 77,734 53,215 68,860
Provision for loan losses........................................................ 22,450 1,121 --
--------- --------- ---------
Net interest income after provision for loan losses.......................... 55,284 52,094 68,860
--------- --------- ---------
Non-interest income:
Servicing fees and other charges............................................... 4,682 2,870 4,786
Gains on sales of interest earning assets, net................................. 21,682 6,955 5,727
Gains from sale of branch offices.............................................. -- 5,430 62,600
Income on real estate owned, net............................................... 3,827 9,540 5,995
Gain on sale of real estate held for investment................................ -- 4,658 --
Other income................................................................... 7,084 1,727 2,467
--------- --------- ---------
37,275 31,180 81,575
--------- --------- ---------
Non-interest expense:
Compensation and employee benefits............................................. 38,357 23,787 42,395
Occupancy and equipment........................................................ 8,921 8,360 11,537
Amortization of excess cost over net assets acquired........................... -- -- 1,346
Hotel operations (income) expense, net......................................... (453) 337 (723)
Savings Association Insurance Fund recapitalization assessment................. 7,140 -- --
Other operating expenses....................................................... 15,613 13,089 14,303
--------- --------- ---------
69,578 45,573 68,858
--------- --------- ---------
Equity in earnings of investment in joint venture................................ 38,320 -- --
--------- --------- ---------
Income from continuing operations before income taxes.......................... 61,301 37,701 81,577
Income tax expense............................................................... 11,159 4,562 29,724
--------- --------- ---------
Income from continuing operations.............................................. 50,142 33,139 51,853
Discontinued operations:
Loss from operations of discontinued divisions to September 30, 1995 net of
tax benefits of $2,321 and $2,227 for 1995 and 1994, respectively............ -- (4,468) (4,514)
Loss on disposal of divisions, net of tax benefit of $1,776.................... -- (3,204) --
--------- --------- ---------
Net income................................................................... $50,142 $ 25,467 $ 47,339
--------- --------- ---------
--------- --------- ---------
(CONTINUED ON NEXT PAGE)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
F-4
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(Dollars in thousands, except share data)
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994
- --------------------------------------------------------------------------------- --------- --------- ---------
Earnings per share:
Income from continuing operations.............................................. $ 1.88 $ 1.19 $ 1.52
Discontinued operations, net of tax benefit.................................... -- (0.28) (0.13)
----------- ----------- -----------
Net income................................................................... $ 1.88 $ 0.91 $ 1.39
----------- ----------- -----------
----------- ----------- -----------
Weighted average common shares outstanding....................................... 26,689,441 27,769,080 34,084,160
----------- ----------- -----------
----------- ----------- -----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
F-5
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except share data)
For the years ended December 31, 1994, 1995 and 1996
UNREALIZED NOTES
GAIN (LOSS) RECEIVABLE
ON SECURITIES ON EXERCISE
COMMON STOCK ADDITIONAL AVAILABLE OF COMMON
----------------- PAID-IN RETAINED FOR SALE, STOCK
SHARES AMOUNT CAPITAL EARNINGS NET OF TAXES OPTIONS TOTAL
------ ------ ---------- -------- ------------ ---------- -----
Balances at December 31, 1993........... 32,195,040 $322 $13,726 $ 94,891 $ 2,892 $ - $111,831
Net income.............................. - - - 47,339 - - 47,339
Repurchase of common stock options...... - - (73) - - - (73)
Repurchase of common stock.............. (330) - (1) - - - (1)
Change in unrealized gain (loss) on
securities available for sale, net of
tax benefit......................... - - - - (5,713) - (5,713)
---------- ---- ------- --------- ------- ------ --------
Balances at December 31, 1994........... 32,194,710 322 13,652 142,230 (2,821) - 153,383
Net income.............................. - - - 25,467 - - 25,467
Repurchase of common stock options...... - - (132) - - - (132)
Exercise of common stock options........ 432,620 4 1,416 - - - 1,420
Repurchase of common stock.............. (8,815,060) (88) (4,487) (37,422) - - (41,997)
Change in unrealized gain (loss) on
securities available for sale, net
of taxes.............................. - - - - 1,406 - 1,406
---------- ---- ------- --------- ------- ------ --------
Balances at December 31, 1995........... 23,812,270 238 10,449 130,275 (1,415) - 139,547
Net income.............................. - - - 50,142 - - 50,142
Repurchase of common stock options...... - - (177) - - - (177)
Exercise of common stock options........ 2,928,830 29 12,963 - - - 12,992
Directors compensation payable in
common stock.......................... 3,070 - 23 - - - 23
Notes receivable on exercise of common
stock options......................... - - - - - (3,832) (3,832)
Change in unrealized gain (loss) on
securities available for sale, net
of taxes.............................. - - - - 4,901 - 4,901
---------- ---- ------- --------- ------- ------ --------
Balances at December 31, 1996........... 26,744,170 $267 $23,258 $ 180,417 $ 3,486 $(3,832) $203,596
---------- ---- ------- --------- ------- ------ --------
---------- ---- ------- --------- ------- ------ --------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
F-6
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994
- -------------------------------------------------- ---------- ---------- ----------
Cash flows from operating activities:
Net income...................................... $ 50,142 $ 25,467 $ 47,339
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Net cash (used) provided from trading
activities.................................. (60,881) 2,949 4,118
Proceeds from sales of loans available for
sale........................................ 397,606 100,104 383,673
Purchases of loans available for sale......... (295,054) (271,210) (510,362)
Origination of loans available for sale....... (9,447) (2,829) (39,546)
Principal payments received on loans available
for sale.................................... 26,689 10,103 36,966
Amortization of excess of costs over net
assets acquired............................. - - 1,346
Premium amortization (discount accretion),
net........................................... 11,640 (2,401) (8,268)
Depreciation and amortization................. 7,646 3,755 4,877
Provision for loan losses..................... 22,450 1,121 -
Loss on sales of premises and equipment....... 97 3,002 -
Gains on sales of interest earning assets,
net......................................... (21,682) (6,955) (5,727)
Gain on sale of low income housing tax credit
interests................................... (4,861) - -
Gain on sale of real estate owned, net........ (2,464) (8,496) (12,234)
Gain on sales of branch offices............... - (5,430) (62,600)
Gain on sale of hotel......................... - (4,658) -
(Increase) decrease in principal, interest and
dividends receivable........................ (2,277) (6,484) 5,710
(Increase) decrease in income taxes
receivable.................................. (14,110) (11,030) 16,473
(Increase) decrease in deferred tax asset..... 16,403 (1,568) (799)
(Increase) decrease in other assets........... (20,303) (13,189) 8,841
(Decrease) increase in accrued expenses,
payables and other liabilities.............. (226) (1,677) 21,386
--------- --------- ---------
Net cash provided (used) in operating activities.. 101,368 (189,426) (108,807)
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of securities available for
sale.......................................... 175,857 836,247 877,911
Purchases of securities available for sale...... (233,858) (934,179) (511,694)
Maturities of and principal payments received on
securities available for sale................. 28,756 21,639 115,357
Purchase of securities held for investment...... (276) - (4,804)
Maturities of and principal payments received on
securities held for investments............... 10,006 17,545 44,133
Proceeds from sale of low income housing tax
credit interests.............................. 24,667 - -
Proceeds from sale of hotel..................... - 25,193 -
Purchases of low income housing tax credit
interests..................................... (34,240) (29,280) (31,821)
Proceeds from sales of discounted loans and
loans held for investment..................... 205,499 38,942 35,161
Purchase of discounted loans.................... (925,850) (547,987) (543,982)
Purchase of loans held for investment........... (305) (35,073) -
Originations of loans held for investment....... (237,220) (235,527) (29,013)
Investment in joint venture..................... (67,909) - -
Principal payments received on discounted loans
and loans held for investment................. 364,128 251,485 188,850
Purchase of and capital improvements to
real estate held for investment............... (29,946) - -
Proceeds from sales of real estate owned........ 169,084 148,225 129,671
Purchases of real estate owned in connection
with discounted loan purchases................ (1,628) (24,617) (38,071)
Additions to premises and equipment............. (5,243) (12,207) (7,438)
Other, net...................................... 227 5,067 10,262
--------- --------- ---------
Net cash (used) provided by investing activities.. (558,251) (474,527) 234,522
--------- --------- ---------
(CONTINUED ON NEXT PAGE)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
F-7
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994
- -------------------------------------------------- ---------- ---------- ----------
Cash flows from financing activities:
Increase in deposits............................ 414,728 585,335 1,065,300
Proceeds from issuance of notes and
debentures.................................... 125,000 107,615 -
Payment of debt issuance costs.................. (5,252) (3,301) -
Sales of deposits............................... - (111,686) (909,315)
Premium received on sales of deposits........... - 5,492 66,595
Advances from the Federal Home Loan Bank........ 76,000 170,000 17,000
Payments on advances from the Federal Home Loan
Bank.......................................... (146,000) (105,000) (69,000)
Increase (decrease) in securities sold under
agreements to repurchase...................... (10,215) 84,761 (276,095)
Payments and repurchase of notes and mortgages
payable....................................... (8,798) (10,672) (22,270)
Loans to executive officers, net................ (3,832) - -
Exercise of common stock options................ 12,993 1,420 -
Repurchase of common stock options and common
stock......................................... (177) (42,129) (74)
Other........................................... 23 - -
--------- --------- ---------
Net cash provided (used) by financing activities.. 454,470 681,835 (127,859)
--------- --------- ---------
Net (decrease) increase in cash and cash
equivalents..................................... (2,413) 17,882 (2,144)
Cash and cash equivalents at beginning of year.... 54,632 36,750 38,894
--------- --------- ---------
Cash and cash equivalents at end of year.......... $ 52,219 $ 54,632 $ 36,750
--------- --------- ---------
--------- --------- ---------
Reconciliation of cash and cash equivalents at
end of year:
Cash and amounts due from depository
institutions.................................. $ 6,878 $ 4,200 $ 32,954
Interest bearing deposits....................... 13,341 50,432 3,796
Federal funds sold and repurchase agreements.... 32,000 - -
--------- --------- ---------
$ 52,219 $ 54,632 $ 36,750
--------- --------- ---------
--------- --------- ---------
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest...................................... $ 115,015 $ 72,626 $ 58,174
--------- --------- ---------
--------- --------- ---------
Income taxes.................................. $ 4,725 $ 12,858 $ 11,170
--------- --------- ---------
--------- --------- ---------
Supplemental schedule of non-cash investing and
financing activities:
Exchange of discount loans and loans available
for sale for securities....................... $ 357,628 $ 83,875 $ 346,588
--------- --------- ---------
--------- --------- ---------
Real estate owned acquired through foreclosure.. $ 102,140 $ 185,001 $ 136,764
--------- --------- ---------
--------- --------- ---------
Transfer of mortgage-related securities from
held for investment to available for sale..... $ - $ 73,706 $ -
--------- --------- ---------
--------- --------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
THESE CONSOLIDATED FINANCIAL STATEMENTS
F-8
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
Ocwen Financial Corporation (the "Company") is a financial services holding
company engaged primarily in the acquisition, servicing and resolution of
non-performing and underperforming mortgage loans ("Discounted Loans"),
multi-family residential and commercial real estate lending activities, single-
family residential lending activities involving non-conforming borrowers and
various investment activities including mortgage related securities, low income
housing tax credit interests and hotels. The Company owns directly and
indirectly all of the outstanding common and preferred stock of its primary
subsidiaries, Ocwen Federal Bank FSB, formerly Berkeley Federal Bank & Trust FSB
(the "Bank") and Investors Mortgage Insurance Holding Company ("IMI"), which are
included in the Company's consolidated financial statements. All significant
intercompany transactions and balances have been eliminated in consolidation.
The Bank is a federally chartered savings bank regulated by the Office of
Thrift Supervision ("OTS"). IMI's primary subsidiaries are engaged in hotel
operations and other real estate related ventures.
RECLASSIFICATION
Certain amounts included in the 1995 and 1994 consolidated financial
statements have been reclassified in order to conform to the 1996 presentation.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash
on hand, interest bearing and non-interest bearing deposits, and all highly
liquid debt instruments purchased with an original maturity of three months or
less. Cash flows associated with items intended as hedges of identifiable
transactions or events are classified in the same category as the cash flows
from the items being hedged.
TRADING ACTIVITIES
From time to time the Company purchases investment and mortgage-backed and
related securities into its trading account. In addition, securities acquired
and sold shortly thereafter resulting from the securitization of loans available
for sale are accounted for as the sale of loans and the purchase and sale of
trading securities. Securities held for trading purposes are carried at
F-9
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
market value with the unrealized gains or losses included in gains on sales
of interest earning assets, net.
SECURITIES AVAILABLE FOR SALE
Certain U.S. Treasury securities, mortgage-backed securities and
mortgage-related securities are designated as assets available for sale because
the Company does not intend to hold them to maturity. Securities available for
sale are carried at market value with the net unrealized gains or losses
reported as a separate component of stockholders' equity. Unrealized losses on
securities that reflect a decline in value which is other than temporary, if
any, are charged to earnings. At disposition the realized net gain or loss is
included in earnings on a specific identification basis. The amortization of
premiums and accretion of discounts are computed using the interest method after
considering actual and estimated prepayment rates, if applicable. Actual
prepayment experience is periodically reviewed and effective yields are
recalculated when differences arise between prepayments originally anticipated
and amounts actually received plus anticipated future prepayments.
During December 1995, in conjunction with a transition provision provided by
the Financial Accounting Standards Board pertaining to the classification of
securities in accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", the Company transferred all of its mortgage-related securities held
for investment, with a book value of $75,194 and a market value of $73,706 to
securities available for sale.
INVESTMENTS AND MORTGAGE-RELATED SECURITIES HELD FOR INVESTMENT
Investments and mortgage-related securities held for investment are stated
at cost, adjusted for amortization of premiums and accretion of discounts,
because the Company has the ability and the intent to hold them to maturity.
Unrealized losses on securities that reflect a decline in value which is other
than temporary, if any, are charged to earnings. The amortization of premiums
and accretion of discounts are computed using the interest method after
considering actual and estimated prepayment rates, if applicable. Actual
prepayment experience is periodically reviewed and effective yields are
recalculated when differences arise between prepayments originally anticipated
and amounts actually received plus anticipated future prepayments.
F-10
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
LOAN AVAILABLE FOR SALE AND HELD FOR INVESTMENT
Loans originated or purchased by the Company which the Company presently
does not intend to hold to maturity are designated as loans available for sale
upon origination or purchase and are stated at the lower of cost, after
considering deferred loan fees and costs, or aggregate market value. Upon the
sale of a loan, any unamortized deferred loan fees, net of costs, are included
in the gain or loss on sale of interest earning assets. Gains and losses on
disposal of such assets are computed on a specific identification basis.
Loans held for investment are stated at amortized cost, less an allowance
for loan losses, because the Company has the ability and the intent to hold them
to maturity.
Interest income is accrued as it is earned. Loans are placed on non-accrual
status after being delinquent greater than 89 days, or earlier if the borrower
is deemed by management to be unable to continue performance. When a loan is
placed on non-accrual status, interest accrued but not received is reversed.
While a loan is on non-accrual status, interest is recognized only as cash is
received. Loans are returned to accrual status only when the loan is reinstated
and ultimate collectibility of future interest is no longer in doubt.
Loan origination fees and certain direct loan origination costs are deferred
and recognized over the lives of the related loans as a yield adjustment and
included in interest income using the interest method applied on a loan-by-loan
basis.
ALLOWANCE FOR ESTIMATED LOAN LOSSES ON LOAN PORTFOLIO
The allowance for estimated loan losses is maintained at a level that
management, based upon an evaluation of known and inherent risks in the
portfolio, considers adequate to provide for potential losses. Specific
valuation allowances are established for impaired loans in the amount by
which the carrying value, before allowance for estimated losses, exceeds the
fair value of collateral less costs to dispose on an individual loan basis,
except for single family residential mortgage loans and consumer loans which
are generally evaluated for impairment as homogeneous pools of loans. The
Company considers a loan to be impaired when, based upon current information
and events, it believes that it is probable that the Company will be unable
to collect all amounts due according to the contractual terms of the loan
agreement on a timely basis. The Company measures these impaired loans at the
fair value of the loans' underlying collateral less estimated disposal costs.
Impaired loans may be left on accrual status during the period the Company is
pursuing repayment of the loan. These loans are placed on non-accrual status
at such time that the loans either: (i) become 90 days delinquent; or (ii)
the Company determines the borrower is incapable of, or has ceased efforts
toward, curing the cause of the
F-11
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
impairment. Impairment losses are recognized through an increase in the
allowance for loan losses and a corresponding charge to the provision for
loan losses. When an impaired loan is either sold, transferred to REO or
charged off, any related valuation allowance is credited to the allowance for
loan losses. Charge-offs occur when loans, or a portion thereof, are
considered uncollectible and of such little value that their continuance as
bankable assets is not warranted. General valuation allowances are also
established for the inherent risks in the loan portfolio which have occurred
but have yet to be specifically identified. Management's periodic evaluation
of the allowance for estimated loan losses is based upon an analysis of the
portfolio, historical loss experience, economic conditions and trends,
collateral values and other relevant factors. Future adjustments to the
allowance may be necessary if economic conditions and trends, collateral
values and other relevant factors differ substantially from the assumptions
used in making the evaluation.
DISCOUNTED LOAN PORTFOLIO
Certain mortgage loans, for which the borrower is not current as to
principal and interest payments or which there is a reason to believe the
borrower will be unable to continue to make its scheduled principal and interest
payments are acquired at a discount. The acquisition cost for a pool of loans is
allocated to each individual loan within the pool based upon the Company's
pricing methodology. The discount associated with single family residential
mortgage loans is recognized as a yield adjustment and included in interest
income using the interest method applied on a loan-by-loan basis to the extent
the timing and amount of cash flows can be reasonably determined. For those
single family residential mortgage loans which are brought current by the
borrower and certain multi-family and commercial real estate loans which are
current and the Company believes will remain current, the remaining unamortized
discount is accreted to income as a yield adjustment using the interest method
over the contractual maturity of the loan. For all other loans, interest is
reported as cash is received. Gains on the repayment and discharging of loans
are reported as interest income. In situations where the collateral is
foreclosed upon, the loans are transferred to real estate owned upon receipt of
title to the property and accretion of the related discount is discontinued.
REAL ESTATE OWNED
Properties acquired through foreclosure are valued at the lower of the
adjusted cost basis of the loan or fair value less estimated costs of disposal
of the property at the date of foreclosure. Properties held are periodically
re-evaluated to determine that they are being carried at the lower of cost or
fair value less estimated costs to dispose. Sales proceeds and related costs are
recognized with passage of title to the buyer and, in cases where the Company
finances the sale, receipt of sufficient down payment. Rental income related to
properties is reported as income as
F-12
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
earned. Holding and maintenance costs related to properties are reported as
period costs as incurred. No depreciation expense related to properties has
been recorded. Decreases in market value of foreclosed real estate subsequent
to foreclosure are recognized as a valuation allowance on a property specific
basis. Subsequent increases in market value of the foreclosed real estate are
reflected as reductions in the valuation allowance, but not below zero. Such
changes in the valuation allowance are charged or credited to income.
VALUATION ALLOWANCES ON DISCOUNTED LOANS AND REAL ESTATE OWNED
Beginning in the first quarter of 1996 the Company, as requested by the
OTS, began recording general valuation allowances on discounted loans and
real estate owned to reflect the inherent losses which may have occurred but
have yet to be specifically identified. Management has established the
valuation allowances based upon historical loss experience, economic
conditions and trends, collateral values and other relevant factors. Also
beginning in 1996, the Company began recording losses and charge-offs on
discounted loans against the allowance for loan losses. Previously these
amounts were deducted from interest income.
INVESTMENT IN REAL ESTATE
In conjunction with its multi-family and commercial lending business
activity, the Company has made certain acquisition, development and construction
loans in which the Company participates in the residual profits of the
underlying real estate and the borrower has not made an equity contribution
substantial to the overall project. As such, the Company accounts for these
loans under the equity method of accounting as though it has made an investment
in a real estate limited partnership.
The Company also has invested indirectly, through its IMI subsidiaries, in
certain hotel properties. Net operating income from the hotel properties
including depreciation expense is recorded as part of non-interest income.
INVESTMENTS IN LOW INCOME HOUSING TAX CREDIT INTERESTS
Low income housing tax credit partnerships own multi-family residential
properties which have been allocated tax credits under the Internal Revenue
Code. The obligations of the partnership to sustain qualifying status of the
properties covers a 15-year period; however, tax credits accrue over a 10-year
period on a straight-line basis. Investments by the Company in low income
housing tax credit partnerships made on or after May 18, 1995 in which the
Company invests
F-13
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
solely as a limited partner are accounted for using the equity method in
accordance with the consensus of the Emerging Issues Task Force through issue
number 94-1. For the Company's limited partnership investments made prior to
this date, the Company records its receipt of income tax credits and other
tax benefits on a level yield basis over the 15-year obligation period and
reports the tax credits and tax benefits net of amortization of its
investment in the limited partnership as a reduction of income tax expense.
Low income housing tax credit partnerships in which the Company has invested
as a limited partner, and through a subsidiary, acts as the general partner
are presented on a consolidated basis. For all investments in low income
housing tax credit partnerships made after May 18 1995, the Company
capitalizes interest expense and certain direct costs incurred during the
pre-operating period.
EXCESS OF COST OVER NET ASSETS ACQUIRED
On February 17, 1988, the Company acquired 100% of the common stock of First
Federal Savings Bank (of Delaware). Through 1994 the excess of cost over net
assets acquired was being amortized over the estimated periods benefited. As of
December 31, 1994, the remaining depository branches acquired in 1988, along
with certain other branches subsequently acquired, were sold, and the
unamortized excess of cost over net assets acquired of $9,135 was retired and
charged against the gain recorded on the sale of branch offices.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost and, except for land, are
depreciated over their estimated useful lives on the straight-line method. The
estimated useful lives of the related assets range from 3 to 10 years.
INTEREST RATE RISK MANAGEMENT ACTIVITIES
The Company manages its exposure to interest rate movements by seeking to
match asset and liability balances within maturity categories, both directly and
through the use of derivative financial instruments. These derivative
instruments include interest rate swaps ("swaps") and interest rate futures
contracts that are designated and effective as hedges, as well as swaps that are
designated and effective in modifying the interest rate and/or maturity
characteristics of specified assets or liabilities.
The net interest received or paid on swaps is reflected as interest income
or expense of the related hedged position. Gains and losses resulting from the
termination of swaps are recognized over the shorter of the remaining contract
lives of the swaps or the lives of the related hedged positions or, if the
hedged positions are sold, are recognized in the current period as gains on
F-14
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
sales of interest earning assets, net. Gains and losses on futures contracts are
deferred and amortized over the terms of the related assets or liabilities and
reflected as interest income or expense of the related hedged positions. If the
hedged positions are sold, any unamortized deferred gains or losses on futures
contracts are recognized in the current period as gains on sales of interest
earning assets, net.
Interest rate contracts used in connection with the securities portfolio
designated as available for sale are carried at fair value with gains and
losses, net of applicable taxes, reported in a separate component of
stockholders' equity, consistent with the reporting of unrealized gains and
losses on such securities.
INCOME TAXES
The Company files consolidated Federal income tax returns with its
subsidiaries. Consolidated income tax is allocated among the subsidiaries
participating in the consolidated returns as if each subsidiary of the Company
which has one or more subsidiaries filed its own consolidated return.
The Company accounts for income taxes using the asset and liability
method which requires the recognition of deferred tax liabilities and assets
for the expected future tax consequences of temporary differences between the
carrying amounts and the tax basis of assets and liabilities. Additionally,
deferred taxes are adjusted for subsequent tax rate changes.
INVESTMENT IN JOINT VENTURE
In March 1996, the Company and BlackRock Capital Finance L.P.
("BlackRock") formed BCBF, L.L.C. (the "LLC"), a limited liability
corporation, to acquire loans from the U.S. Department of Housing and Urban
Development ("HUD"). The Company and BlackRock each own 50% of the LLC.
The Company's investment in the LLC is accounted for under the equity method
of accounting. Under the equity method of accounting, an investment in the
shares or other interests of an investee is initially recorded at the cost of
the shares or interests acquired and thereafter is periodically increased
(decreased) by the investor's proportionate share of the earnings (losses) of
the investee and decreased by all dividends received by the investor from the
investee.
F-15
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The Company services all loans on behalf of the LLC for a fee, and all
intercompany transactions between the Company and the LLC are eliminated for
financial reporting purposes to the extent of the Company's ownership in the
LLC.
INVESTMENT MANAGEMENT AND TRUST ACTIVITIES
At December 31, 1996 and 1995 Ocwen Asset Management Inc. ("OAM"), a
subsidiary of the Bank, had under management $1,629 and $48,229, respectively,
of mortgage-backed and related securities and mortgage loans for an unaffiliated
account. Such amounts are not included in the Company's consolidated statements
of financial condition.
At December 31, 1996 and 1995 the Bank held $0 and $2,002, respectively, in
investments in trust accounts for customers. Such amounts are not included in
the Company's consolidated statements of financial condition.
RISKS AND UNCERTAINTIES
In the normal course of business, the Company encounters two significant
types of risk: economic and regulatory. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest earning assets. Credit risk is the risk of default on the Company's
loan portfolio that results from a borrowers' inability or unwillingness to make
contractually required payments. Market risk reflects changes in the value of
loans held for sale, securities available for sale and purchased mortgage
servicing rights due to changes in interest rates or other market factors
including the rate of prepayments of principal and the value of the collateral
underlying loans and the valuation of real estate held by the Company.
The Bank is subject to the regulations of various government
agencies. These regulations can and do change significantly from period to
period. The Bank also undergoes periodic examinations by the regulatory
agencies, which may subject it to further changes with respect to asset
valuations, amounts of required loss allowances and operating restrictions
resulting from the regulators' judgments based on information available to them
at the time of their examination.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Material
estimates that are particularly
F-16
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
susceptible to significant change in the near or medium term relate to the
determination of the allowance for losses on loans and discounted loans.
RECENT ACCOUNTING STANDARDS
On January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,"
which requires that long-lived assets to be held and used by an entity and
certain identifiable intangibles be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Additionally, SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles to be disposed of be reported at the lower of
carrying amount or fair value less cost to sell, except for certain assets. The
adoption of SFAS No. 121 did not have a material effect on the Company's
financial condition or results of operations in 1996.
On January 1, 1996 the Company adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights", which requires that an institution engaged in
mortgage banking activities recognize as a separate asset rights to service
mortgage loans for others, regardless of the manner in which those servicing
rights are acquired. Upon sale or securitization of loans with servicing rights
retained, the Company is required to capitalize the cost associated with the
mortgage servicing rights based on their relative fair values. SFAS
No. 122 also requires that an institution assess its capitalized mortgage
servicing rights for impairment based on the fair value of those rights.
Impairment is recognized through a valuation allowance. See Note 13 for
disclosures regarding capitalized mortgage servicing rights as required by SFAS
No. 122.
On January 1, 1996, the Company also adopted SFAS No. 123, "Accounting for
Stock-Based Compensation", which requires that the fair value of employee
stock-based compensation plans be recorded as a component of compensation
expense in the statement of operations as of the date of grant of awards related
to such plans or that the impact of such fair value on net income and earnings
per share be disclosed on a pro forma basis in a footnote to financial
statements for awards granted after December 15, 1994, if the accounting for
such awards continues to be in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). The Company
will continue such accounting under the provisions of APB 25 and has disclosed
the pro forma information as required in Note 23.
In June 1996, SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", was issued. SFAS No. 125
(i) sets forth the criteria for (a) determining when to recognize financial and
servicing assets and liabilities; and (b) accounting for transfers of financial
assets as sales or borrowings; and (ii) requires (a) liabilities and derivatives
related to a transfer of financial assets to be recorded at fair value; (b)
servicing assets
F-17
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
and retained interests in transferred assets carrying amounts be determined
by allocating carrying amounts based on fair value; (c) amortization of
servicing assets and liabilities be in proportion to net servicing income;
(d) impairment measurement based on fair value; and (e) pledged financial
assets to be classified as collateral.
SFAS No. 125 provides implementation guidance for assessing isolation of
transferred assets and for accounting for transfers of partial interests,
servicing of financial assets, securitizations, transfers of sales-type and
direct financing lease receivables, securities lending transactions, repurchase
agreements including "dollar rolls", "wash sales", loan syndications and
participations, risk participations in banker's acceptances, factoring
arrangements, transfers of receivables with recourse and extinguishments of
liabilities. In December 1996, the FASB issued SFAS No 127, "Deferral of the
Effective Date of FASB Statement No. 125", which delayed implementation of
certain provisions of SFAS 125. SFAS Nos. 125 and 127 are effective for fiscal
years ending after December 15, 1996. The Company does not anticipate these
Statements to have any material impact on the results of operations,
financial position or cash flows as a result of implementing these
Statements.
EARNINGS PER SHARE
Earnings per share is calculated based upon the weighted average number of
shares of common stock outstanding during the year. The computation of the
weighted average number of shares includes the impact of the exercise of the
outstanding options to purchase common stock and assumes that the proceeds from
such issuance are used to repurchase common shares at fair value.
NOTE 2 ACQUISITION AND DISPOSITION TRANSACTIONS
The LLC is a limited liability company formed in March 1996 between the
Company and BlackRock Capital Finance L.P. On March 22, 1996, the LLC was
notified by HUD that it was the successful bidder to purchase 16,196
single-family residential loans offered by HUD ("HUD Loans"). On April 10, 1996
the LLC consummated the acquisition of the HUD Loans.
At December 31, 1996, the Company's investment in the LLC amounted to
$67,909 and is net of valuations allowances of $5,114. Because the LLC is a
pass-through entity for federal income tax purposes, provisions for income taxes
are established by each of the Company and its co-investor and not the LLC.
F-18
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
Set forth below is the statement of financial condition of the LLC at
December 31, 1996 and a statement of operations for the period from the date of
formation of the LLC through December 31, 1996.
BCBF, L.L.C.
STATEMENT OF FINANCIAL CONDITION
December 31, 1996
Assets:
Cash............................................................ $ 10
Loans held for sale, at lower of cost or market value........... 110,702
Real estate owned, net of a valuation allowance of $511......... 25,595
Other assets.................................................... 10,526
---------
$ 146,833
---------
---------
Liabilities and Owners' Equity
Liabilities:
Accrued expenses, payables and other liabilities................ $ 787
---------
Total liabilities............................................. 787
---------
Owners' Equity:
Ocwen Federal Bank FSB.......................................... 73,023
BlackRock Capital Finance L.P................................... 73,023
---------
Total owners' equity.......................................... 146,046
---------
$ 146,833
---------
---------
F-19
BCBF, L.L.C.
STATEMENT OF OPERATIONS
For Period March 13, 1996 Through December 31, 1996
Interest income.................................................... $ 38,647
Interest expense................................................... 18,503
---------
Net interest income.............................................. 20,144
---------
Non-interest income:
Gain on sale of discounted loans................................. 71,156
Gain on sale of loan servicing rights............................ 1,048
Loss on real estate owned........................................ (130)
Loan fees........................................................ 50
---------
72,124
---------
Operating expenses:
Loan servicing fees.............................................. 5,743
Other loan expenses.............................................. 273
---------
$ 6,016
---------
Net income.........................................................$ 86,252
---------
---------
In October, 1996, the LLC securitized 9,825 loans with an unpaid
principal balance of $419,382 and past due interest of $86,131 and a net
book value of $394,234. Proceeds from sales of loans by the LLC amounted to
$466,806 for the period ending December 31, 1996. The Company continues to
service such loans and is paid a servicing fee.
The Company's equity in earnings of the LLC of $38,320 includes 50% of the
net income of the LLC before deduction of the Company's 50% share of loan
servicing fees which are paid 100% to the Company, 50% of the gain on sale of
loan servicing rights which the Company acquired from the LLC, $7,614 in
provision for losses on the equity investment in the joint venture and $460 from
gain on sale of future contracts used to hedge the loans securitized. The
Company has recognized 50% of the loan servicing fees not eliminated in
consolidation in servicing fees and other charges.
F-20
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
DISPOSITIONS
The Company sold two branches with deposit liabilities totaling $111,686 as
of November 17, 1995, and twenty-three branches with deposit liabilities
totaling $909,315 as of December 31, 1994. The components of the gain recorded
on these transactions is summarized below:
1995 1994
--------- ---------
Premium received on deposit liabilities sold............................. $ 5,492 $ 66,595
Difference between carrying value and face value of deposits sold........ -- 4,596
Retirement of excess of cost over net assets acquired, net............... -- (9,135)
Net gain on sale of land, buildings, furniture, fixtures and equipment... 158 2,908
Broker's fee and other costs associated with the sale of the deposits.... (220) (2,364)
--------- ---------
Gains on sales of branch offices..................................... $ 5,430 $ 62,600
--------- ---------
--------- ---------
Additionally, on October 4, 1995 the Company sold a hotel which it owned and
operated for a gain of $4,658.
NOTE 3 DISCONTINUED OPERATIONS
In September 1995, the Company announced its decisions to dispose of its
automated banking division and related activities. As a result of these
decisions, a loss of $3,204, net of a tax benefit of $1,776 was recorded
consisting of a net loss of $1,954 on the sale of assets and a loss of $1,250,
incurred from related operations until the sales and dispositions, both of which
were substantially complete at December 31, 1995. The Company's consolidated
statements of operations have been restated for all periods presented to reflect
the discontinuance of these operations. Losses from operations of the
discontinued division, net of tax, amounted to $4,468 and $4,514 for the nine
months ended September 30, 1995 and the year ended December 31, 1994,
respectively. Gross revenues from the automated banking division and related
activities for the years ended December 31, 1995 and 1994 amounted to $1,822 and
$1,768, respectively.
NOTE 4 FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's assets, liabilities and off-balance
sheet instruments and commitments are considered financial instruments. For
the majority of the Company's financial instruments, principally loans and
deposits, fair values are not readily available since there are no available
trading markets as characterized by current exchanges between willing
parties. Accordingly, fair values can only be derived or estimated using
various valuation techniques, such as computing the present value of
estimated future cash flows using discount rates commensurate with the risks
involved. However, the determination of estimated future cash flows is
inherently subjective and imprecise. In addition, for those financial
instruments with
F-21
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
option-related features, prepayment assumptions are incorporated into the
valuation techniques. It should be noted that minor changes in assumptions or
estimation methodologies can have a material effect on these derived or
estimated fair values.
The fair values reflected below are indicative of the interest rate
environments as of December 31, 1996 and 1995 and do not take into
consideration the effects of interest rate fluctuations. In different
interest rate environments, fair value results can differ significantly,
especially for certain fixed-rate financial instruments and non-accrual
assets. In addition, the fair values presented do not attempt to estimate the
value of the Company's fee generating businesses and anticipated future
business activities. In other words, they do not represent the Company's
value as a going concern. Furthermore, the differences between the carrying
amounts and the fair values presented may not be realized because, except as
indicated, the Company generally intends to hold these financial instruments
to maturity and realize their recorded values.
Reasonable comparability of fair values among financial institutions is
difficult due to the wide range of permitted valuation techniques and numerous
estimates that must be made in the absence of secondary market prices. This lack
of objective pricing standards introduces a degree of subjectivity to these
derived or estimated fair values. Therefore, while disclosure of estimated fair
values of financial instruments is required, readers are cautioned in using this
data for purposes of evaluating the financial condition of the Company.
The methodologies used and key assumptions made to estimate fair value, the
estimated fair values determined and recorded carrying values follow:
CASH AND CASH EQUIVALENTS
Cash and cash equivalents have been valued at their carrying amounts as
these are reasonable estimates of fair value given the relatively short
period of time between origination of the instruments and their expected
realization.
INVESTMENTS AND MORTGAGE-BACKED AND RELATED SECURITIES
For investments and mortgage-backed and related securities, fair value
equals quoted price, if available. For securities for which a quoted market
price is not available, fair value is estimated using quoted market prices
for similar instruments.
LOANS AND DISCOUNTED LOANS
The fair value of performing whole loans is estimated based upon quoted
market prices for similar whole loan pools. The fair value of the discounted
loan portfolio is estimated based upon current market yields at which recent
pools of similar mortgages have traded taking into consideration the timing and
amount of expected cash flows.
F-22
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
LOW INCOME HOUSING TAX CREDIT INTERESTS
The fair value of the investments in low income housing tax credit interests
is estimated by discounting the future tax benefits expected to be realized from
these investments using discount rates at which similar investments were being
made on or about the respective financial statement dates.
DEPOSITS
The fair value of demand deposits, savings accounts and money market
deposits is the amount payable on demand at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated by discounting the
required cash payments at the market rates offered for deposits with similar
maturities on or about the respective financial statement dates.
BORROWINGS
The fair value of the Company's notes and debentures is based upon quoted
market prices. The fair value of the Company's other borrowings is estimated
based upon the discounted value of the future cash flows expected to be paid on
such borrowings using estimated market discount rates that reflect the
borrowings of others with similar terms and maturities.
RISK MANAGEMENT INSTRUMENTS
The fair value of interest rate swap agreements is the estimated amount
that the Company would receive or pay to terminate the swap agreements at the
reporting date taking into account interest rates and the credit worthiness
of the swap counterparties on or about the respective financial statement
dates. Market quotes are used to estimate the fair value of interest rate
futures contracts.
LOAN COMMITMENTS
The fair value of loan commitments is estimated considering the difference
between interest rates on or about the respective financial statement dates and
the committed rates.
REAL ESTATE OWNED
Real estate, although not a financial instrument, is an integral part of the
Company's business. The fair value of real estate is estimated based upon
appraisals, broker price opinions and other standard industry valuation methods,
less anticipated selling costs.
F-23
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The carrying amounts and the estimated fair values of the Company's
financial instruments and real estate owned are as follows:
DECEMBER 31, 1996 DECEMBER 31, 1995
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- ---------- ---------- ----------
Financial assets:
Cash and cash equivalents..................................... $ 52,219 $ 52,219 $ 54,632 $ 54,632
Securities held for trading................................... 75,606 75,606 - -
Securities available for sale................................. 354,005 354,005 337,480 337,480
Loans available for sale...................................... 126,366 128,784 251,790 253,854
Investment securities......................................... 8,901 8,901 18,665 18,657
Loan portfolio, net........................................... 402,582 410,934 295,605 300,075
Discounted loan portfolio, net................................ 1,060,953 1,140,686 669,771 682,241
Investments in low income housing tax credit interest......... 93,309 113,850 81,362 94,238
Real estate owned, net........................................ 103,704 130,221 166,556 187,877
Financial liabilities:
Deposits...................................................... 1,919,742 1,934,717 1,501,646 1,488,668
Advances from the Federal Home Loan Bank...................... 399 399 70,399 70,530
Securities sold under agreements to repurchase................ 74,546 74,546 84,761 84,761
Notes, debentures and other interest bearing obligations...... 225,573 246,511 117,054 120,398
Other:
Loan commitments.............................................. 194,128 194,128 54,405 54,405
F-24
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 5 SECURITIES HELD FOR TRADING
The book and market values and gross unrealized gains and losses for the
Company's securities held for trading at December 31, 1996 were as follows:
GROSS GROSS
BOOK UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
--------- ------------- ----------- ---------
Collateralized mortgage obligations................................ $ 75,526 $ -- $ (140) $ 75,386
Futures contracts.................................................. -- 220 -- 220
--------- ----- ----------- ---------
$ 75,526 $ 220 $ (140) $ 75,606
--------- ----- ----------- ---------
--------- ----- ----------- ---------
The Company traded assets totaling $373,723, $93,942 and $621,991 in
aggregate sales proceeds during the years ended December 31, 1996, 1995 and
1994, respectively, resulting in realized net gains of $14,645, $2,949 and
$4,118 for the years ended December 31, 1996, 1995 and 1994, respectively.
Unrealized gains on securities held for trading and included in gains on sales
of interest earning assets amounted to $80, $0 and $0, respectively, in 1996,
1995 and 1994.
F-25
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 6 SECURITIES AND LOANS AVAILABLE FOR SALE
The amortized cost, fair value and gross unrealized gains and losses on the
Company's securities and loans available for sale are as follows at the periods
ended:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1996: COST GAINS LOSSES VALUE
- ----------------------------------------------------------------- ---------- ----------- ----------- ----------
Mortgage-related securities:
Single family residential:
AAA-rated collateralized mortgage obligations.................... $ 74,224 $ 227 $ (516) $ 73,935
FHLMC interest only.............................................. 46,735 963 (127) 47,571
FNMA interest only............................................... 48,573 1,315 (508) 49,380
AAA-rated interest only.......................................... 1,166 27 (20) 1,173
Subordinates..................................................... 15,550 3,614 -- 19,164
REMIC residuals.................................................. 19,211 1,349 -- 20,560
Futures contracts................................................ -- 19 (1,940) (1,921)
---------- ----------- ----------- ----------
205,459 7,514 (3,111) 209,862
---------- ----------- ----------- ----------
Multi-family and commercial:
AAA-rated interest only.......................................... 82,996 1,353 (759) 83,590
Non-investment grade interest only............................... 3,620 205 (26) 3,799
Subordinates..................................................... 56,500 1,856 (822) 57,534
Futures contracts................................................ -- -- (780) (780)
---------- ----------- ----------- ----------
143,116 3,414 (2,387) 144,143
---------- ----------- ----------- ----------
$ 348,575 $ 10,928 $ (5,498) $ 354,005
---------- ----------- ----------- ----------
---------- ----------- ----------- ----------
Loans:
Single family residential........................................ $ 111,980 2,949 (970) $ 113,959
Multi-family..................................................... 13,657 305 -- 13,962
Consumer......................................................... 729 142 (8) 863
---------- ----------- ----------- ----------
$ 126,366 $ 3,396 $ (978) $ 128,784
---------- ----------- ----------- ----------
---------- ----------- ----------- ----------
F-26
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
DECEMBER 31, 1995: COST GAINS LOSSES VALUE
- ----------------------------------------------------------------- ---------- ----------- ----------- ----------
Mortgage-related securities:
Single family residential:
AAA-rated collateralized mortgage obligations.................... $ 140,304 $ 9 $ (1,482) $ 138,831
FHLMC interest only.............................................. 2,217 -- (35) 2,182
FNMA interest only............................................... 10,080 -- (488) 9,592
FNMA principal only.............................................. 8,104 114 -- 8,218
Subordinates..................................................... 27,410 -- (100) 27,310
Planned amortization class (PAC) residuals....................... 759 -- (185) 574
REMIC residuals.................................................. 616 -- (144) 472
Futures contracts................................................ -- 168 (1,766) (1,598)
---------- ----------- ----------- ----------
189,490 291 (4,200) 185,581
---------- ----------- ----------- ----------
Multi-family and commercial:
AAA-rated interest only.......................................... 101,110 2,840 (18) 103,932
FNMA interest only............................................... 5,520 16 (275) 5,261
Subordinates..................................................... 43,605 845 (1,496) 42,954
Futures contracts................................................ -- -- (248) (248)
---------- ----------- ----------- ----------
150,235 3,701 (2,037) 151,899
---------- ----------- ----------- ----------
$ 339,725 $ 3,992 $ (6,237) $ 337,480
---------- ----------- ----------- ----------
---------- ----------- ----------- ----------
Loans:
Single family residential........................................ $ 221,927 $ 1,736 $ -- $ 223,663
Multi-family..................................................... 28,694 314 -- 29,008
Consumer......................................................... 1,169 14 -- 1,183
---------- ----------- ----------- ----------
$ 251,790 $ 2,064 $ -- $ 253,854
---------- ----------- ----------- ----------
---------- ----------- ----------- ----------
F-27
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 6 SECURITIES AND LOANS AVAILABLE FOR SALE (CONTINUED)
A profile of the maturities of securities available for sale at December 31,
1996 follows. Mortgage-backed securities are included based on their
weighted-average maturities, reflecting anticipated future prepayments based on
a consensus of dealers in the market.
AMORTIZED COST FAIR VALUE
-------------- ----------
Due within one year............................................... $ 17,601 $ 17,735
Due after 1 through 5 years....................................... 211,955 209,887
Due after 5 through 10 years...................................... 92,023 95,103
Due after 10 years................................................ 26,996 31,280
-------------- ----------
$ 348,575 $ 354,005
-------------- ----------
-------------- ----------
Gross realized gains and losses, proceeds on sales, premiums amortized
against and discounts accreted to income were as follows during the periods
ended December 31:
1996 1995 1994
---------- ---------- ----------
Securities:
Gross realized gains......................................................... $ 4,323 $ 1,266 $ 10,654
Gross realized losses........................................................ (3,757) (2,079) (7,999)
---------- ---------- ----------
Net realized gains (losses).................................................. $ 566 $ (813) $ 2,655
---------- ---------- ----------
---------- ---------- ----------
Proceeds on sales............................................................ $ 175,857 $ 836,247 $ 877,911
---------- ---------- ----------
---------- ---------- ----------
Premiums amortized against interest income................................... $ 23,508 $ 5,188 $ 2,782
Discounts accreted to interest income........................................ (3,261) (3,135) (553)
---------- ---------- ----------
Net premium amortization..................................................... $ 20,247 $ 2,053 $ 2,229
---------- ---------- ----------
---------- ---------- ----------
Loans:
Gross realized gains......................................................... $ 2,150 $ 1,817 $ 3,399
Gross realized losses........................................................ (3,152) -- (806)
---------- ---------- ----------
---------- ---------- ----------
Net realized gains (losses).................................................. $ (1,002) $ 1,817 $ 2,593
---------- ---------- ----------
---------- ---------- ----------
Proceeds on sales............................................................ $ 397,606 $ 100,104 $ 383,673
---------- ---------- ----------
---------- ---------- ----------
One security in the available for sale portfolio, with a market value of
$6,570, is pledged as collateral to the State of New Jersey in connection with
the Bank's sales of certificates of deposit over $100 to New Jersey
municipalities. Additionally, certain mortgage-related securities are pledged as
collateral for securities sold under agreements to repurchase (see Note 18).
F-28
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 7 INVESTMENT SECURITIES
The book and fair values and gross unrealized gains and losses on the
Company's investment securities are as follows at December 31:
GROSS GROSS
BOOK UNREALIZED UNREALIZED FAIR
VALUE GAINS LOSSES VALUE
--------- ------------- ------------- ---------
1996:
Federal Home Loan Bank stock....................................... $ 8,798 -- -- $ 8,798
Limited partnership interests...................................... 103 -- -- 103
--------- ------------ ------------- ---------
8,901 -- -- 8,901
--------- ------------ ------------- ---------
--------- ------------ ------------- ---------
1995:
U.S. Treasury securities........................................... $ 10,036 $ -- $ (8) $ 10,028
Federal Home Loan Bank stock....................................... 8,520 -- -- 8,520
Limited partnership interests...................................... 109 -- -- 109
--------- ------------ ------------- ---------
$ 18,665 $ -- $ (8) $ 18,657
--------- ------------ ------------- ---------
--------- ------------ ------------- ---------
Premiums amortized against and discounts accreted to income on U.S. Treasury
securities held for investment were as follows for the periods ended December
31:
1996 1995 1994
----- --------- ---------
Premiums amortized against interest income............................... $ 36 $ 289 $ 324
Discounts accreted to interest income.................................... -- -- (12)
--- --------- ---------
Net premium amortization................................................. $ 36 $ 289 $ 312
--- --------- ---------
--- --------- ---------
Included in interest income on investment securities and other for the
periods ended December 31, 1996, 1995 and 1994 are $1,767, $1,388 and $5,654,
respectively, of deferred fees accreted on tax residuals (see Note 21).
As a member of the FHLB system, the Bank is required to maintain an
investment in the capital stock of the FHLB in an amount at least equal to the
greater of 1% of residential mortgage assets, 5% of outstanding borrowings
(advances) from the FHLB, or 0.3% of total assets. FHLB capital stock is
generally pledged to secure FHLB advances.
F-29
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 8 MORTGAGE-RELATED SECURITIES
In December 1995 the Company transferred all of its mortgage-related
securities held for investment to its available for sale portfolio (see Note 1).
Premiums amortized against and discounts accreted to interest income on
mortgage-related securities were as follows for the periods ended December 31:
1996 1995 1994
----- --------- ---------
Premiums amortized against interest income.............................. $ -- $ 652 $ 1,043
Discounts accreted to interest income................................... -- (36) (277)
-- --------- ---------
Net premium amortization................................................ $ -- $ 616 $ 766
-- --------- ---------
-- --------- ---------
NOTE 9 LOAN PORTFOLIO
The Company's loan portfolio consisted of the following at December 31:
1996 1995
---------- ----------
Carrying value:
Single family residential............................................. $ 73,186 $ 75,928
Multi-family residential:
Permanent............................................................. 31,252 41,306
Construction.......................................................... 36,590 7,741
---------- ----------
Total multi-family residential........................................ 67,842 49,047
---------- ----------
Commercial real estate:
Hotel:
Permanent............................................................. 173,947 125,791
Construction.......................................................... 26,364 --
Office................................................................ 128,782 61,262
Land.................................................................. 2,332 24,904
Other................................................................. 25,623 2,494
---------- ----------
Total commercial real estate.......................................... 357,048 214,451
---------- ----------
Commercial non-mortgage............................................... 2,614 --
---------- ----------
Consumer.............................................................. 424 3,223
---------- ----------
Total loans........................................................... 501,114 342,649
Undisbursed loan funds................................................ (89,840) (39,721)
Unaccreted discount................................................... (5,169) (5,376)
Allowance for loan losses............................................. (3,523) (1,947)
---------- ----------
Loans, net............................................................ $ 402,582 $ 295,605
---------- ----------
---------- ----------
F-30
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
At December 31, 1996 the Company had $6,407 of single family residential
loans, $2,310 of land loans and $3,733 of multi-family residential loans
outstanding, at market interest rates and terms, which were issued to
facilitate the sale of the Company's real estate owned and real estate held
for development.
Included in the loan portfolio at December 31, 1996 and 1995 are $315,871 and
$180,223 of loans in which the Company participates in the residual profits
of the underlying real estate of which $233,749 and $142,139, respectively,
have been funded. The Company records any residual profits as part of
interest income when received.
The following table presents a summary of the Company's non-performing loans,
allowance for loan losses and significant ratios as of and for the years
ended December 31:
1996 1995 1994
--------- --------- ---------
Non-performing loans:
Single family residential.................... $ 2,123 $ 2,923 $ 2,478
Multi-family................................. 106 731 152
Consumer..................................... 55 202 29
--------- --------- ---------
$ 2,284 $ 3,856 $ 2,659
--------- --------- ---------
--------- --------- ---------
Allowance for loan losses:
Balance, beginning of year................... $ 1,947 $ 1,071 $ 884
Provision for loan losses.................... 1,872 1,121 --
Charge-offs.................................. (296) (263) (472)
Recoveries................................... -- 18 659
--------- --------- ---------
Balance, end of year......................... $ 3,523 $ 1,947 $ 1,071
--------- --------- ---------
--------- --------- ---------
F-31
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
Significant ratios:
Non-performing loans as a percentage of:
Loans.................................... 0.56% 1.27% 4.35%
Total assets............................. 0.09% 0.20% 0.21%
Allowance for loan losses as a percentage of:
Loans...................................... 0.87% 0.65% 1.84%
Non-performing loans....................... 154.24% 50.49% 40.28%
Net charge-offs (recoveries) as a percentage
of average loans.......................... 0.09% 0.19% (0.28%
If non-accrual loans had been current in accordance with their original
terms, interest income for the years ended December 31, 1996, 1995 and 1994
would have been approximately $214, $322 and $207 higher, respectively. No
interest has been accrued on loans greater than 89 days past due.
At December 31, 1996, the Company had no investment in impaired loans as
defined in accordance with SFAS No. 114, and as amended by SFAS No. 118.
The loan portfolio is geographically located throughout the United States.
The following table sets forth the five states in which the largest amount of
properties securing the Company's loans were located at December 31, 1996.
SINGLE
FAMILY MULTI-FAMILY COMMERCIAL COMMERCIAL
RESIDENTIAL RESIDENTIAL REAL ESTATE NON-MORTGAGE CONSUMER TOTAL
------------ ----------- ----------- ------------- ----------- ----------
New York.................................. $ 7,644 $ 34,115 $ 76,326 $ -- $ -- $ 118,085
Illinois.................................. 56 -- 81,280 -- -- 81,336
California................................ 18,551 15,733 39,710 2,614 -- 76,608
New Jersey................................ 32,996 -- 14,267 -- 22 47,285
Georgia................................... -- -- 30,114 -- -- 30,114
Other..................................... 13,939 17,994 115,351 -- 402 147,686
------------ ----------- ----------- ------------- ------------ ---------
Total..................................... $ 73,186 $ 67,842 $ 357,048 $ 2,614 $ 424 $ 501,114
------------ ----------- ----------- -------------- ------------ ---------
------------ ----------- ----------- -------------- ------------ ---------
NOTE 10 DISCOUNTED LOAN PORTFOLIO
The Company has acquired through private sales and auctions mortgage loans at
a discount because the borrowers are either not current as to principal and
interest payments or there is doubt as to the borrowers' ability to pay in
full the contractual principal and interest. The Company estimates the
amounts it will realize through foreclosure, collection efforts or other
F-32
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
resolution of each loan and the length of time required to complete the
collection process in determining the amounts it will bid to acquire such
loans.
The resolution alternatives applied to the discounted loan portfolio are (i)
the borrower brings the loan current in accordance with original or modified
terms; (ii) the borrower repays the loan or a negotiated amount; (iii) the
borrower agrees to a deed-in-lieu of foreclosure, in which case it is
classified as real estate owned and held for sale by the Company and (iv)
the Company forecloses on the loan and the property is either acquired at
the foreclosure sale by a third party or by the Company, in which case it is
classified as real estate owned and held for sale. The Company periodically
reviews the discounted loan portfolio performance to ensure that
nonperforming loans are carried at the lower of amortized cost or net
realizable value of the underlying collateral and the remaining unaccreted
discount is adjusted accordingly. Upon receipt of title to the property,
the loans are transferred to real estate owned.
The Company's discounted loan portfolio consists of the following at
December 31:
CARRYING VALUE
------------------------
1996 1995
------------ ----------
Loan type:
Single family residential........................................... $ 504,049 $ 376,501
Multi-family residential............................................ 341,796 176,259
Commercial real estate.............................................. 465,801 388,566
Other............................................................... 2,753 2,203
------------ ----------
Total discounted loans.............................................. 1,314,399 943,529
Unaccreted discount................................................. (241,908) (273,758)
Allowance for loan losses........................................... (11,538) --
------------ ----------
Discounted loans, net............................................... $ 1,060,953 $ 669,771
------------ ----------
------------ ----------
DECEMBER 31,
------------------------
1996 1995
------------ ----------
Loan status:
Past due less than 31 days.......................................... $ 579,597 $ 351,630
Past due 31 to 89 days.............................................. 22,161 86,838
Past due 90 days or more............................................ 563,077 385,112
Acquired and servicing not yet transferred.......................... 149,564 119,949
------------ ----------
$ 1,314,399 $ 943,529
------------ ----------
------------ ----------
F-33
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
A summary of income on discounted loans is as follows for the years ended
December 31:
1996 1995 1994
---------- --------- ---------
Interest income:
Realized........................................................................ $ 97,174 $ 70,807 $ 48,734
Accreted and unrealized......................................................... 5,991 5,191 3,826
---------- --------- ---------
$ 103,165 $ 75,998 $ 52,560
---------- --------- ---------
---------- --------- ---------
Gains on sales:
Realized gains on sales......................................................... $ 7,393 $ 6,008 $ 890
---------- --------- ---------
---------- --------- ---------
Proceeds on sales............................................................... $ 190,616 $ 38,942 $ 32,684
---------- --------- ---------
---------- --------- ---------
The following table sets forth the activity in the Company's gross discounted
loan portfolio during the years ended December 31:
1996 1995 1994
------------ ---------- ----------
Principal balance, beginning of year....................................... $ 943,529 $ 785,434 $ 433,516
Acquisitions............................................................... 1,110,887 791,195 826,391
Resolutions and repayments................................................. (371,228) (300,161) (265,292)
Loans transferred to real estate owned..................................... (138,543) (281,344) (171,300)
Sales...................................................................... (230,246) (51,595) (37,881)
--------- -------- --------
Principal balance, end of year............................................. $ 1,314,399 $ 943,529 $ 785,434
--------- -------- --------
--------- -------- --------
The discounted loan portfolio is geographically located throughout the United
States. The following table sets forth the five states in which the largest
amount of properties securing the Company's discounted loans were located at
December 31, 1996:
SINGLE COMMERCIAL
FAMILY MULTI-FAMILY REAL ESTATE
RESIDENTIAL RESIDENTIAL AND OTHER TOTAL
------------ ----------- ----------- ------------
California................................................ $ 175,916 $ 80,326 $ 114,279 $ 370,521
New Jersey................................................ 50,551 4,794 78,698 134,043
New York.................................................. 76,290 12,688 40,176 129,154
Pennsylvania.............................................. 8,856 97,062 4,430 110,348
Connecticut............................................... 39,591 62,953 2,284 104,828
Other..................................................... 152,845 83,973 228,687 465,505
------- ------- ------- ---------
Total..................................................... $ 504,049 $ 341,796 $ 468,554 $ 1,314,399
------- ------- ------- ---------
------- ------- ------- ---------
F-34
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The following schedule presents a summary of the Company's allowance for loan
losses and significant ratios for its discounted loans as of and for the
years ended December 31:
1996 1995 1994
--------- ----- -----
Allowance for loan losses:
Balance, beginning of year............................................................... $ -- $ -- $ --
Provision for loan losses................................................................ 20,578 -- --
Charge-offs.............................................................................. (9,216) -- --
Recoveries............................................................................... 176 -- --
------ --- ---
Balance, end of year..................................................................... $ 11,538 $ -- $ --
------ --- ---
------ --- ---
Significant ratios:
Allowances for loan losses as a percentage of discounted loan portfolio, net............. 1.09% -% -%
Net charge-offs (recoveries) as a percentage of average discounted loans................. 1.34% -% -%
NOTE 11 REAL ESTATE OWNED
Real estate owned, net of allowance for losses, is held for sale and consists
of the following at December 31:
1996 1995
---------- ----------
Discounted loan portfolio:
Single family residential............................................. $ 49,728 $ 75,144
Multi-family residential.............................................. 14,046 59,932
Commercial real estate................................................ 36,264 31,218
---------- ----------
Total discounted loan portfolio....................................... 100,038 166,294
Loan portfolio........................................................ 592 262
Loans available for sale.............................................. 3,074 --
---------- ----------
$ 103,704 $ 166,556
---------- ----------
---------- ----------
F-35
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The following schedule presents the activity, in aggregate, in the valuation
allowances on real estate owned for the years ended December 31:
1996 1995 1994
------ ------ ------
Balance, beginning of year.................. $ 4,606 $ 3,937 $ 2,455
Provision for losses........................ 18,360 10,510 9,074
Charge-offs and sales....................... (11,473) (9,841) (7,592)
-------- -------- -------
Balance, end of year........................ $ 11,493 $ 4,606 $ 3,937
-------- -------- -------
-------- -------- -------
The following table sets forth the results of the Company's investment in
real estate owned, which were primarily related to the discounted loan
portfolio, during the years ended December 31:
1996 1995 1994
------ ------ ------
Gains on sales.............................. $ 22,835 $ 19,006 $ 21,308
Provision for losses........................ (18,360) (10,510) (9,074)
Rental income (carrying costs), net......... (648) 1,044 (6,239)
-------- -------- --------
$ 3,827 $ 9,540 $ 5,995
-------- -------- --------
-------- -------- --------
NOTE 12 INVESTMENT IN REAL ESTATE
December 31,
------------------
1996 1995
------- ------
Loans accounted for as investments in real estate:
Multi-family residential............................. $ 24,946 $ -
Hotels:
Land................................................. 613 613
Building and leasehold improvements.................. 14,874 11,402
Office and computer equipment........................ 2,248 720
Less accumulated depreciation and amortization....... (1,648) (778)
-------- --------
16,087 11,957
-------- --------
$ 41,033 $ 11,957
-------- --------
-------- --------
F-36
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 13 MORTGAGE SERVICING RIGHTS
The Company services for other investors mortgage loans which it does not
own. The total amount of such loans serviced for others was $1,918,098 and
$361,608 at December 31, 1996 and 1995, respectively. Servicing fee income
on such loans amounted to $2,414, $493 and $231 for the years ended December
31, 1996, 1995 and 1994, respectively.
The unamortized balance of mortgage servicing rights, which are included in
other assets, is as follows at December 31:
1996 1995
------ ------
Unamortized balance.................................... $ 4,048 $ 3,433
Valuation allowance.................................... (1,630) -
-------- --------
$ 2,418 $ 3,433
-------- --------
-------- --------
Periodically, the Company evaluates the recoverability of mortgage servicing
rights based on the projected value of future net servicing income. Future
prepayment rates are estimated based on current interest rates and various
portfolio characteristics, including loan type, interest rate, and market
prepayment estimates. If the estimated recovery is lower than the current
amount of mortgage servicing rights, a reduction to mortgage servicing rights
is recorded through an increase in the valuation allowance. Valuation
allowances were established through charges to servicing fees and other
charges during 1996 primarily as a result of higher than projected prepayment
rates.
NOTE 14 INVESTMENTS IN LOW INCOME HOUSING TAX CREDIT INTERESTS
The carrying value of the Company's investments in low income housing tax
credit interests are as follows at December 31:
1996 1995
------ ------
Investments solely as a limited partner made prior to
May 18, 1995......................................... $ 55,595 $ 58,911
Investments solely as a limited partner made on or
after May 18, 1995................................... 12,887 4,223
Investments as both a limited and, through
subsidiaries, general partner........................ 24,827 18,228
-------- --------
$ 93,309 $ 81,362
-------- --------
-------- --------
F-37
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The qualified affordable housing projects underlying the Company's
investments in low income housing tax credit interests are geographically
located throughout the United States. At December 31, 1996, the Company's
largest single investment was $15,402 which is in a project located in Fort
Lauderdale, Florida.
Income on the Company's limited partnership investments made prior to May 18,
1995 is recorded under the level yield method as a reduction of income tax
expense, and amounted to $9,330, $7,709 and $5,410 for the years ended
December 31, 1996, 1995 and 1994, respectively. Had these investments been
accounted for under the equity method, net income would have been reduced by
$2,223, $2,798 and $2,742 for the years ended December 31, 1996, 1995 and
1994, respectively. For limited partnership investments made after May 18,
1995, and for investments as a limited and, through subsidiaries, general
partner, the Company recorded a loss of $636 from operations of the underlying
real estate after depreciation, for the year ended December 31, 1996, and no
income or expense for the years ended December 31, 1995 and 1994.
Other liabilities include $9,105 and $9,794 at December 31, 1996 and 1995,
respectively, representing contractual obligations to fund certain limited
partnerships which invest in low income housing tax credit interests.
Included in other income for the year ended December 31 1996 is a gain of
$4,861 on the sale of certain investments in low income housing tax credit
interests which had a carrying value of $19,806 at time of sale.
NOTE 15 PREMISES AND EQUIPMENT
December 31,
------------------
1996 1995
------ ------
Land................................................... $ 485 $ 485
Leasehold improvements................................. 5,999 5,672
Office and computer equipment.......................... 15,950 12,726
Other.................................................. - 347
Less accumulated depreciation and amortization......... (7,815) (5,828)
-------- -------
$ 14,619 $ 13,402
-------- --------
-------- --------
F-38
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 16 DEPOSITS
The Company's deposits consist of the following at December 31:
1996 1995
---------------- ----------------
Weighted Weighted
Average Book Average Book
Rate Value Rate Value
-------- --------- -------- ----------
Non-interest bearing deposits...... - % $ 96,563 - % $ 48,482
NOW and money market
checking accounts................ 2.99 22,208 3.37 17,147
Savings accounts................... 2.30 2,761 2.30 3,471
---------- ----------
121,532 69,100
---------- ----------
Certificates of deposit............ 1,809,098 1,440,240
Unamortized deferred fees.......... (10,888) (7,694)
---------- ----------
5.80 1,798,210 5.68 1,432,546
---------- ----------
5.47 $1,919,742 5.46 $1,501,646
---------- ----------
---------- ----------
At December 31, 1996 and 1995 certificates of deposit include $1,572,081 and
$1,123,196 respectively, of deposits originated through national, regional
and local investment banking firms which solicit deposits from their
customers, all of which are non-cancelable. Additionally, at December 31,
1996 and 1995, $147,488 and $80,045, respectively, of certificates of deposit
were issued on an uninsured basis. Non-interest bearing deposits include
$82,885 and $37,686 of advance payments by borrowers for taxes and insurance
and principal and interest collected but not yet remitted in accordance with
loan servicing agreements at December 31, 1996 and 1995, respectively.
The contractual maturity of the Company's certificates of deposit at December
31, 1996 follows:
Contractual Remaining Maturity:
Within one year........................................... $ 916,056
Within two years.......................................... 375,286
Within three years........................................ 222,477
Within four years......................................... 144,978
Within five years......................................... 138,744
Thereafter................................................ 669
-----------
$ 1,798,210
-----------
-----------
F-39
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The amortization of the deferred fees of $5,384, $4,729 and $1,606 for the
years ended December 31, 1996, 1995 and 1994, respectively, and the accretion
of the purchase accounting discount of $0, $0 and $(2,991) for the years
ended December 31, 1996, 1995 and 1994, respectively, are computed using the
interest method and are included in interest expense on certificates of
deposit. The interest expense by type of deposit account is as follows for
the years ended December 31:
1996 1995 1994
-------- -------- --------
NOW accounts and money market checking..... $ 620 $ 1,031 $ 1,395
Savings.................................... 78 451 2,602
Certificates of deposit.................... 93,075 70,371 40,964
-------- -------- --------
$ 93,773 $ 71,853 $ 44,961
-------- -------- --------
-------- -------- --------
Accrued interest payable on deposits in the amount of $18,249 and $18,994 as
of December 31, 1996 and 1995, respectively, is included in accrued expenses,
payables and other liabilities.
NOTE 17 ADVANCES FROM THE FEDERAL HOME LOAN BANK ("FHLB")
Advances from the FHLB mature as follows:
December 31, 1996 December 31, 1995
---------------------- ---------------------
Interest Book Interest Book
Due Date Rate Value Rate Value
- -------- -------- ----- -------- -----
1996........................... - % $ - 5.83% $70,000
1997........................... 7.02% $ 399 7.02% $ 399
----- -------
$ 399 $70,399
----- -------
----- -------
Accrued interest payable on FHLB advances amounted to $2 and $297 as of
December 31, 1996 and 1995, respectively, and is included in accrued
expenses, payables and other liabilities. All interest rates are fixed by
contract. Under the terms of its collateral agreement, the Company is
required to maintain otherwise unencumbered qualifying assets with a fair
market value ranging from 105% to 125% of FHLB advances depending on the type
of collateral. At December 31, 1995 the Company's FHLB stock was pledged as
additional collateral for these advances.
F-40
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 18 SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company periodically enters into sales of securities under agreements to
repurchase the same securities (reverse repurchase agreements). Fixed coupon
reverse repurchase agreements with maturities of three months or less are
treated as financings, and the obligations to repurchase securities sold are
reflected as a liability in the accompanying consolidated statements of
financial condition. All securities underlying reverse repurchase agreements
are reflected as assets in the accompanying consolidated statements of
financial condition and are held in safekeeping by broker/dealers. For the
years ended December 31, 1996, 1995 and 1994, interest rate swap agreements
and Eurodollar futures contracts used for risk management purposes had the
effect of increasing interest expense on securities sold under agreements to
repurchase and certificates of deposit by $0, $261 and $296, respectively.
December 31,
---------------------------
1996 1995 1994
------ ------ ------
Other information concerning securities
sold under agreements to repurchase:
Balance, end of year................... $ 74,546 $ 84,761 $ -
Accrued interest payable, end of year.. $ 12 $ 153 $ -
Weighted average interest rate,
end of year.......................... 5.46% 5.70% - %
Average balance during the year........ $ 19,581 $ 16,754 $ 254,457
Weighted average interest rate
during the year...................... 5.62% 5.68% 4.09%
Maximum month-end balance.............. $ 84,321 $ 84,761 $ 537,629
Mortgage-related securities at amortized cost of $75,526 and a market value
of $75,386 were posted as collateral for securities sold under agreements to
repurchase at December 31, 1996.
F-41
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 19 NOTES, DEBENTURES AND OTHER INTEREST BEARING OBLIGATIONS
Notes, debentures and other interest bearing obligations mature as
follows:
December 31,
----------------------
1996 1995
1996:
12% subordinated notes due January 2................ $ - $ 1,012
10.5% subordinated notes due May 1.................. - 7,615
--------- ---------
- 8,627
2003:
12% mortgage loan due September 1................... - 7,817
11.875% notes due October 1......................... 125,000 -
2005:
12% subordinated debentures due June 15............. 100,000 100,000
2014:
0 - 8.5% mortgage loan due December 1............... 573 610
--------- ---------
$ 225,573 $ 117,054
--------- ---------
--------- ---------
The notes which matured in 1996 were payable to current or former
shareholders and executive officers.
On June 12, 1995 the Bank issued $100,000 of 12% Subordinated Debentures due
2005 (the "Debentures") with interest payable semiannually on June 15 and
December 15. The Debentures are unsecured general obligations of the Bank
and are subordinated in right of payment to all existing and future senior
debt.
The Debentures may not be redeemed prior to June 15, 2000, except as
described below. On or after such date, the Debentures may be redeemed at
any time at the option of the Bank, in whole or in part, together with
accrued and unpaid interest, if any, on not less than 30 nor more than 60
days' notice at the following redemption prices (expressed as a percentage of
the principal amount), if redeemed during the twelve month period beginning
June 15 of the years indicated below:
F-42
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
Year Redemption Price
----------- ----------------------
2000 105.333%
2001 104.000%
2002 102.667%
2003 101.333%
2004 and thereafter 100.000%
In addition, the Bank may redeem, at its option, up to $35,000 principal
amount of the Debentures at any time prior to June 15, 1998 with the net
cash proceeds received by the Bank from one or more public equity offerings
at a purchase price of 112.000% of the principal amount thereof, plus accrued
and unpaid interest.
In connection with the issuance of the Debentures, the Bank incurred certain
costs which have been capitalized and are being amortized on a straight-line
basis over the expected life of the Debentures. The unamortized balance of
these issuance costs amounted to $2,745 and $3,170, at December 31, 1996 and
1995, respectively, and is included in other assets. Accrued interest
payable on the Debentures amounted to $500 at December 31, 1996 and 1995 and
is included in accrued expenses, payables and other liabilities.
On September 25, 1996 the Company completed the public offering of $125,000
aggregate principal of 11.875% Notes due October 1, 2003 ("the Notes") with
interest payable semi-annually on April 1 and October 1. The Notes are
unsecured general obligations of the Company and are subordinated in right of
payment to the claims of creditors of the Company and the Company's
subsidiaries.
The Notes may not be redeemed prior to October 1, 2001 except as described
below. On or after such date, the Notes may be redeemed at any time at the
option of the Company, in whole or in part, at the following redemption
prices (expressed as a percentage of the principal amount) plus accrued and
unpaid interest, if redeemed during the twelve-month period beginning October
1 of the years indicated below:
Year Redemption Price
----------- ----------------------
2001 105.938%
2002 102.969%
In addition, the Company may redeem, at its option, up to 35% of the original
aggregate principal amount of the Notes at any time and from time to time
until October 1, 1999 with the net cash proceeds received by the Company from
F-43
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
one or more public or private equity offerings at a redemption price of
111.875% of the principal amount thereof, plus accrued and unpaid interest.
The indenture governing the Notes requires the Company to maintain, at all
times when the Notes are not rated in an investment grade category by one or
more nationally recognized statistical rating organization unencumbered
liquid assets with a value equal to 100% of the required interest payments
due on the Notes on the next two succeeding semi-annual interest payment
dates. The Company maintains a $15,000 investment in repurchase agreements at
December 31, 1996 that is restricted for purposes of meeting this liquidity
requirement. The indenture further provides that the Company shall not sell,
transfer or otherwise dispose of shares of common stock of the Bank or permit
the Bank to issue, sell or otherwise dispose of shares of its common stock
unless in either case the Bank remains a wholly-owned subsidiary of the
Company.
Proceeds from the offering of the Notes amounted to approximately $120,156
(net of underwriting discount). On September 30, 1996, the Company
contributed $50,000 of such proceeds to the Bank to support future growth.
The remainder of the proceeds retained by the Company are available for
general corporate purposes, with the exception of the liquidity maintenance
requirement described above.
In connection with the issuance of the Notes, the Company incurred certain
costs which have been capitalized and are being amortized on a straight-line
basis over the life of the Notes. The unamortized balance of these issuance
costs amounted to $5,252 at December 31, 1996 and is included in other
assets. Accrued interest payable on the Notes amounted to $3,752 at December
31, 1996 and is included in accrued expenses, payables and other liabilities.
In November 1996, the Company acquired the 12% first mortgage note due
September 1, 2003 from an unaffiliated third party. The principal balance and
related interest have been eliminated in consolidation at December 31, 1996.
NOTE 20 INTEREST RATE RISK MANAGEMENT INSTRUMENTS
In managing its interest rate risk, the Company on occasion enters into
swaps. Under swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between fixed-rate and floating-rate
interest amounts calculated by reference to an agreed notional amount. The
terms of the swaps provide for the Company to receive a floating rate of
interest based on the London Interbank Offered Rate ("LIBOR") and to pay
fixed interest rates. The notional amount of the swap outstanding at December
31, 1996 is amortized (i.e., reduced) monthly based on estimated prepayment
rates. The Company had no outstanding swaps at December 31, 1995. The terms
of the outstanding swap at December 31, 1996 follows:
F-44
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
Notional LIBOR Floating Rate
Maturity Amount Index Fixed Rate at End of Year Fair Value
- -------- -------- ----- ---------- -------------- ----------
1998 $ 45,720 1-Month 6.18% 5.67% $ (103)
The 1-month LIBOR was 5.50% on December 31, 1996. The interest expense or
benefit of the swaps had the effect of increasing (decreasing) net interest
income by ($58), $358 and ($754) for the years ended December 31, 1996, 1995
and 1994, respectively.
The Company also enters into short sales of Eurodollar and U.S. Treasury
interest rate futures contracts as part of its overall interest rate risk
management activity. Interest rate futures contracts are commitments to
either purchase or sell designated financial instruments at a future date for
a specified price and may be settled in cash or through delivery. The
Eurodollar futures contracts have been sold by the Company to hedge the
maturity risk of certain short duration mortgage-related securities. U.S.
Treasury futures have been sold by the Company to hedge the risk of a
reduction in the market value of fixed rate mortgage loans and certain fixed
rate mortgage-backed and related securities available for sale in a rising
interest rate environment.
F-45
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
Terms and other information on interest rate futures contracts sold short are
as follows:
Maturity Notional Principal Fair Value
-------- ------------------ ----------
December 31, 1996:
Eurodollar futures............. 1997 $ 365,000 $ (558)
1998 40,000 (87)
U.S. Treasury futures.......... 1997 165,100 498
December 31, 1995:
Eurodollar futures............. 1996 $ 386,000 $ (1,598)
1997 26,000 (168)
U.S. Treasury futures.......... 1996 11,100 (80)
The following table summarizes the Company's use of interest rate risk
management instruments.
Notional Amount
------------------------------------------
Short Short
Eurodollar U.S. Treasury
Swaps Futures Futures
----------- -------------- --------------
Balance, December 31, 1994..... $ 40,000 $ 493,000 $ 222,500
Purchases.................... - 336,000 708,600
Maturities................... (40,000) - -
Terminations................. - (417,000) (920,000)
--------- ---------- ------------
Balance, December 31, 1995..... - 412,000 11,100
Purchases.................... 47,350 564,000 3,362,400
Maturities................... (1,630) - -
Terminations................. - (571,000) (3,208,400)
--------- ---------- ------------
Balance, December 31, 1996..... $ 45,720 $ 405,000 $ 165,100
--------- ---------- ------------
--------- ---------- ------------
Because interest rate futures contracts are exchange traded, holders of these
instruments look to the exchange for performance under these contracts and
not the entity holding the offsetting futures contract, thereby minimizing
the risk of nonperformance under these contracts. The Company is exposed to
credit loss in the event of nonperformance by the counterparty to the swap
F-46
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
and controls this risk through credit monitoring procedures. The notional
principal amount does not represent the Company's exposure to credit loss.
U.S. Treasury Bills with a carrying value of $3,138 and $1,134 and a
fair value of $3,138 and $1,134 were pledged by the Company as security for
the obligations under these swaps and interest rate futures contracts at
December 31, 1996 and 1995, respectively.
NOTE 21 INCOME TAXES
Total income tax expense (benefit) was allocated as follows:
Years Ended December 31,
----------------------------------
1996 1995 1994
------ ------ ------
Income from continuing operations.......... $ 11,159 $ 4,562 $ 29,724
Discontinued operations.................... - (4,097) (2,227)
Benefit of tax deduction in excess of
amounts recognized for financial
reporting purposes related to employee
stock options reflected in stockholders'
equity................................... - (375) (39)
-------- -------- --------
$ 11,159 $ 90 $ 27,458
-------- -------- --------
-------- -------- --------
The components of income tax expense (benefit) attributable to income from
continuing operations were as follows:
Years Ended December 31,
---------------------------------
1996 1995 1994
------ ------ ------
Current: Federal $ (6,844) $ 1,673 $ 26,267
State (576) 5,011 2,261
-------- -------- --------
(7,420) 6,684 28,528
-------- -------- --------
Deferred: Federal 16,616 1,762 1,022
State 1,962 (3,884) 174
-------- -------- --------
18,578 (2,122) 1,196
-------- -------- --------
Total $ 11,158 $ 4,562 $ 29,724
-------- -------- --------
-------- -------- --------
F-47
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
Income tax expense differs from the amounts computed by applying the U.S.
Federal corporate income tax rate of 35% as follows:
Years Ended December 31,
--------------------------------
1996 1995 1994
------ ------ ------
Expected income tax expense at
statutory rate........................... $ 21,455 $ 13,196 $ 28,552
Differences between expected and actual tax:
Excess of cost over net assets acquired
adjustments.............................. (76) (76) 3,592
Tax effect of (utilization) non-utilization
of net operating loss.................... (1,782) (1,380) 23
State tax (after Federal tax benefit)...... 901 733 2,054
Low income housing tax credits............. (9,330) (7,709) (5,410)
Other...................................... (10) (202) 913
-------- --------- --------
Actual income tax expense................ $ 11,158 $ 4,562 $ 29,724
-------- --------- --------
-------- --------- --------
For taxable years beginning prior to January 1, 1996, a savings institution
that met certain definitional tests relating to the composition of its
assets and the sources of its income (a "qualifying savings institution") was
permitted to establish reserves for bad debts and make annual additions
thereto under the experience method. Alternatively, a qualifying savings
institution could elect, on an annual basis, to use the percentage of taxable
income method to compute its allowable addition to its bad debt reserve on
qualifying real property loans (generally loans secured by an interest in
improved real estate). The applicable percentage was 8% for tax periods
after 1987. The Bank utilized the percentage of taxable income method for
these years.
On August 20, 1996, President Clinton signed the Small Business Job
Protection Act (the "Act") into law. One provision of the Act repeals the
reserve method of accounting for bad debts for savings institutions effective
for taxable years beginning after 1995. The Bank, therefore, will be
required to use the specific charge-off method on its 1996 and subsequent
federal income tax returns. The Bank will be required to recapture its
"applicable excess reserves", which are its federal tax bad debt reserves in
excess of the base year reserve amount described in the following paragraph.
The Bank will include one-sixth of its applicable excess reserves in taxable
income in each year from 1996 through 2001. As of December 31, 1995, the
Bank had approximately $42.4 million of applicable excess reserves. As of
December 31, 1996, the Bank had fully provided for the tax related to this
recapture. The base year reserves will continue to be subject to recapture
and the Bank could be required to recognize a tax liability if: (1) the Bank
fails to qualify as a "bank" for federal income tax purposes, (2) certain
distributions are made with respect to the stock of the Bank, (3) the bad
debt reserves are used for any purpose other than to absorb bad debt losses,
or (4) there is a change in federal tax law. The enactment of this
F-48
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
legislation is expected to have no material impact on the Bank's or the
Company's operations or financial position.
In accordance with SFAS No. 109 "Accounting for Income Taxes," a deferred tax
liability has not been recognized for the tax bad debt base year reserves of
the Bank. The base year reserves are generally the balance of reserves as of
December 31, 1987 reduced proportionately for reductions in the Bank's loan
portfolio between that date and December 31, 1995. At December 31, 1996 and
1995, the amount of those reserves was approximately $5.7 million. This
reserve could be recognized in the future under the conditions described in
the preceding paragraph.
The net deferred tax liability was comprised of the following:
December 31,
------------------------
1996 1995
------ ------
Deferred Tax Assets:
Tax residuals and deferred income on
tax residuals.................................. $ 3,712 $ 27,648
State taxes...................................... 552 2,563
Application of purchase accounting............... 1,503 1,031
Accrued profit sharing........................... 1,422 2,940
Accrued other liabilities........................ 420 739
Deferred interest expense on discounted loan
portfolio...................................... 3,989 2,130
Mark to market and reserves on REO properties.... 3,513 1,059
Other............................................ - 105
-------- --------
15,111 38,215
-------- --------
Deferred Tax Liabilities:
Bad debt reserves................................ 810 12,356
Deferred interest income on discounted loan
portfolio...................................... 4,632 4,276
Partnership losses............................... 1,205 -
Other............................................ 500 553
-------- --------
7,147 17,185
-------- --------
7,964 21,030
Mark to market on certain mortgage-backed and
related securities available for sale.......... (2,104) 1,233
-------- --------
5,860 22,263
-------- --------
Deferred tax asset valuation allowance........... - -
Net deferred tax assets.......................... $ 5,860 $ 22,263
-------- --------
-------- --------
Deferred tax assets, net of deferred fees, include tax residuals which result
from the ownership of Real Estate Mortgage Investment Conduits ("REMIC").
While a tax residual is anticipated to have little or no future cash flows
from the REMIC from which it has been issued, the tax residual does bear the
income tax liability and benefit resulting from the annual differences
between the interest paid on the debt instruments issued by the REMIC and the
F-49
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
interest received on the mortgage loans held by the REMIC. Typically this
difference generates taxable income to the Company in the first several years
of the REMIC and equal amounts of tax losses thereafter, thus resulting in
the deferred tax asset. As a result of the manner in which REMIC residual
interests are treated for tax purposes, at December 31, 1996, 1995 and 1994,
the Company had approximately $10,228, $55,000 and $12,400, respectively, of
net operating loss carryforwards for tax purposes. The net operating loss
carryforward of $10,228 will expire, if unused, in the year 2010.
As a result of the Company's earnings history, current tax position and
taxable income projections, the Company believes that it will generate
sufficient taxable income in future years to realize the net deferred tax
asset position as of December 31, 1996. In evaluating the expectation of
sufficient future taxable income, the Company considered future reversals of
temporary differences and available tax planning strategies that could be
implemented, if required.
A valuation allowance was not required as of December 31, 1996 and 1995 as it
was the Company's assessment that, based on available information, it is more
likely than not that all of the deferred tax asset will be realized. A
valuation allowance will be established in the future to the extent of a
change in the Company's assessment of the amount of the net deferred tax
asset that is expected to be realized.
NOTE 22 RETIREMENT PLAN
The Company maintains a defined contribution 401(k) plan. The Company
matches 50% of each employee's contributions, limited to 2% of the employee's
compensation.
In connection with its acquisition of Berkeley Federal Savings Bank in June
1993, the Bank assumed the obligations under a noncontributory defined
benefit pension plan (the "Plan") covering substantially all employees upon
their eligibility under the terms of the Plan. The Plan was frozen for the
plan year ended December 31, 1993 and has been fully funded.
The Company's combined contributions to 401(k) plan in the years ended
December 31, 1996, 1995, and 1994 were $258, $248 and $163, respectively.
NOTE 23 STOCKHOLDERS' EQUITY
On July 12, 1996 stockholders of the Company approved an amendment to the
Company's articles of incorporation to increase the authorized number of
common shares from 20,000,000 to 200,000,000 shares, to increase the
authorized number of preferred shares from 250,000 to 20,000,000 shares and
F-50
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
to decrease the par value of the authorized preferred shares from $1.00 to
$0.01 per share. On July 30, 1996, the Company's Board of Directors declared
a 10 for 1 stock split for each share of common stock then outstanding in the
form of a stock dividend which was paid to holders of record on July 31,
1996. All references in the interim consolidated financial statements to
the number of shares and per share amounts have been adjusted retroactively
for the recapitalization and stock split.
During September 1996, 2,928,830 shares of common stock were issued in
connection with the exercise of vested stock options by certain of the
Company's and the Bank's current and former officers and directors. The
Company loaned $6,654 to certain of such officers to fund their exercise of
the stock options. Such notes, which are presented as a reduction of
shareholders' equity, have an unpaid principal balance of $3,832 at December
31, 1996, bear interest at 10.5% per annum, are payable in two equal
installments on March 1, 1998 and March 1, 1999 and are secured by the
related shares of common stock.
On September 25, 1996, certain stockholders of Ocwen completed an initial
public offering of 2,300,000 shares of Ocwen common stock. Prior to this
offering, there had been no public trading market for the common stock. The
common stock is quoted on The NASDAQ Stock Market under the symbol "OCWN".
The Company did not receive any of the proceeds from the common stock
offering.
During 1995, the Company repurchased from stockholders and retired 8,815,060
shares of common stock for the aggregate price of $41,997.
In December 1991, as part of its annual incentive compensation plan, the
Company adopted a Non-Qualified Stock Option Plan (the "Stock Plan"). The
Stock Plan provides for the issuance of stock options to key employees to
purchase shares of common stock at prices less than the fair market value of
the stock at the date of grant.
Options
Options Exercise Options Forfeited or Options
Granted Price Exercised Repurchased Vested
------- -------- --------- ------------ --------
1994: 1,149,320 .79 1,059,440 89,880 -
1995: 297,380 5.76 - 44,400 252,980
1995: 7,110 .94 - - 7,110
1996: 573,686 22.00 - - -
F-51
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The difference between the fair market value of the stock at the date of
grant and the exercise price is treated as compensation expense; included in
compensation expense is $2,725, $65, and $4,571 for the years ended December
31, 1996, 1995 and 1994, respectively.
The Company has adopted SFAS No. 123 during 1996. In accordance with the
provisions of SFAS No. 123, the Company has retained its current accounting
method for its stock-based employee compensation plans under the provisions
of APB 25, "Accounting for Stock Issued to employees" ("APB 25"). However,
entities continuing to apply APB 25 are required to disclose pro forma net
income and earnings per share as if the fair value method of accounting for
stock-based employee compensation plans as prescribed by SFAS No.123 had been
utilized. The following is a summary of the Company's for forma information:
Net income (as reported) $ 50,142
Pro forma net income $ 47,777
Earnings per share(as reported) $ 1.88
Pro forma earnings per share $ 1.79
The fair value of the option grants were estimated using the Black-Scholes
option-pricing model with the following assumptions:
Expected dividend yield 0.00%
Expected stock price volatility 21.00%
Risk-free interest rate 6.20%
Expected life of options 5 year
NOTE 24 REGULATORY REQUIREMENTS
The Financial Institutions Reform, Recovery and Enforcement Act of 1989,
("FIRREA") and the regulations promulgated thereunder established certain
minimum levels of regulatory capital for savings institution subject to OTS
supervision. The Bank must follow specific capital guidelines stipulated by
the OTS which involve quantitative measures of the Bank's assets, liabilities
and certain off-balance sheet items. An institution that fails to comply
with its regulatory capital requirements must obtain OTS approval of a
capital plan and can be subject to a capital directive and certain
restrictions on its operations. At December 31, 1996, the minimum regulatory
capital requirements were:
F-52
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
- Tangible and core capital of 1.5 percent and 3 percent of total
adjusted assets, respectively, consisting principally of stockholders'
equity, but excluding most intangible assets, such as goodwill and
any net unrealized holding gains or losses on debt securities
available for sale.
- Risk-based capital consisting of core capital plus certain
subordinated debt and other capital instruments and, subject to
certain limitations, general valuation allowances on loans receivable,
equal to 8 percent of the value of risk-weighted assets.
- At December 31, 1996, the Bank was "well capitalized" under the
prompt corrective action ("PCA") regulations adopted by the OTS
pursuant to the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA"). To be categorized as "well capitalized", the Bank
must maintain minimum core capital, Tier 1 risk-based capital and
risk-based capital ratio as set forth in the table below. The
Bank's capital amounts and classification are subject to review by
federal regulators about components, risk-weightings and other
factors. There are no conditions or events since December 31, 1996
that management believes have changed the institution's category.
The following tables summarizes the Bank's actual and required regulatory
capital at December 31, 1996 and 1995.
F-53
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
December 31, 1996
To Be Well
Capitalized
For Prompt
Minimum For Capital Corrective
Actual Adequacy Purposes Action Provisions
------------------------ ---------------------- -------------------------
Ratio Amount Ratio Amount Ratio Amount
------- ---------- ------- ---------- ------- ----------
Stockholders' equity, and ratio to total assets 9.49% $ 228,153
Net unrealized (gain) on certain available
for sale securities.......................... (3,526)
Excess mortgage servicing rights............... (242)
-----------
Tangible capital, and ratio to adjusted
total assets................................. 9.33% $ 224,385 1.50% $ 36,057
----------- ---------
----------- ---------
Tier 1 (core) capital, and ratio to adjusted
total assets................................. 9.33% $ 224,385 3.00% $ 72,114 5.00% $ 120,190
----------- --------- ---------
----------- --------- ---------
Tier 1 capital, and ratio to risk-weighted
assets....................................... 8.47% $ 224,385 6.00% $ 159,011
----------- ---------
----------- ---------
Allowance for loan and lease losses............ 16,057
Subordinated debentures........................ 100,000
-----------
Tier 2 Capital................................. 116,057
-----------
Total risk-based capital, and ratio to
risk-weighted assets......................... 12.85% $ 340,442 8.00% $ 212,014 10.00% $ 265,018
----------- ---------- ---------
----------- ---------- ---------
Total regulatory assets........................ $ 2,405,188
-----------
-----------
Adjusted total assets.......................... $ 2,403,790
-----------
-----------
Risk-weighted assets........................... $ 2,650,175
-----------
-----------
F-54
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
December 31, 1995
To Be Well
Capitalized
For Prompt
Minimum For Capital Corrective
Actual Adequacy Purposes Action Provisions
------------------------ ---------------------- -------------------------
Ratio Amount Ratio Amount Ratio Amount
------- ---------- ------- ---------- ------- ----------
Stockholders' equity, and ratio to total assets 6.47% $ 124,725
Net unrealized loss on certain available for
sale securities.............................. 1,416
Excess mortgage servicing rights............... (344)
-----------
Tangible capital, and ratio to adjusted total
assets....................................... 6.52% $ 125,797 1.50% $ 28,952
----------- ---------
----------- ---------
Tier 1 (core) capital, and ratio to adjusted
total assets................................. 6.52% $ 125,797 3.00% $ 57,904 5.00% $ 96,506
----------- --------- ---------
----------- --------- ---------
Tier 1 capital, and ratio to risk-weighted
assets....................................... 6.52% $ 125,797 6.00% $ 115,743
----------- ---------
----------- ---------
Allowance for loan and lease losses............ 1,757
Subordinated debentures........................ 100,000
-----------
Tier 2 Capital................................. 101,757
-----------
Total risk-based capital, and ratio to
risk-weighted assets......................... 11.80% $ 227,554 8.00% $ 154,324 10.00% $ 192,906
----------- --------- ---------
----------- --------- ---------
Total regulatory assets........................ $ 1,929,054
-----------
-----------
Adjusted total assets.......................... $ 1,930,126
-----------
-----------
Risk-weighted assets........................... $ 1,929,056
-----------
-----------
The OTS has promulgated a regulation governing capital distributions. The
Bank is considered to be a Tier 1 association under this regulation because
it met or exceeded its fully phased-in capital requirements at December 31,
1996. A Tier 1 association that before and after a proposed capital
distribution meets or exceeds its fully phased-in capital requirements may
make capital distributions during any calendar year equal to the greater of
(i) 100% of net income for the calendar year to date plus 50% of its "surplus
F-55
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
capital ratio" at the beginning of the year or (ii) 75% of its net income
over the most recent four-quarter period. In order to make these capital
distributions, the Bank must submit written notice to the OTS 30 days in
advance of making the distribution.
In addition to these OTS regulations governing capital distributions (see
Note 19) the indenture governing the Bank's debentures limits the
declaration or payment of dividends and the purchase or redemption of common
or preferred stock in the aggregate to the sum of 50% of consolidated net
income and 100% of all capital contributions and proceeds from the issuance
or sale (other than to a subsidiary) of common stock, since the date the
Debentures were issued.
Subsequent to December 31, 1996, in connection with a recent examination of
the Bank, the staff of the OTS expressed concern about many of the Bank's
non-traditional operations, which generally are deemed by the OTS to involve
higher risk, and the adequacy of the Bank's capital in light of the Bank's
lending and investment strategies, notwithstanding that it is a
"well-capitalized institution" under OTS regulations. The activities which
are of concern to the OTS include the Bank's single-family residential
lending activities to non-conforming borrowers, the Bank's origination of
acquisition, development and construction loans with terms which provide for
shared participation in the results of the underlying real estate, the Bank's
discounted loan activities, which involve significantly higher investment in
non-performing and classified assets than the majority of the savings
industry, and the Bank's investment in subordinated classes of
mortgage-related securities issued in connection with the Bank's asset
securitization activities and otherwise.
In connection with the examination, the OTS instructed the Bank, commencing
on June 30, 1997, to maintain a ratio of Tier 1 capital to assets of at least
12% and a total risk-based capital ratio of no less than 18%, which amounts
may be decreased in the event that the Bank reduces its risk profile in a
manner which is satisfactory to the OTS. Although the Bank strongly disagrees
with the level of risk perceived by the OTS in its businesses, the Bank has
taken the following actions in response to the OTS concerns: (i) sold to
Ocwen subordinated, participating interests in a total of eleven acquisition,
development and construction loans, which interests had an aggregate principal
balance of $16,949, (ii) modified certain of its accounting practices,
including, among other things, ceasing to accrue unaccreted discount on
non-performing single-family residential loans commencing as of January 1,
1997, (iii) ceased originating acquisition, development and construction
loans with profit participation features in the underlying real estate, with
the exception of existing commitments, and (iv) established as of December
31, 1996 requested reserves, which amounted to $7.2 million, against loans
and securities resulting from its investment in loans acquired from HUD.
The Bank intends to meet with the OTS staff to present recommendations by the
Bank to transfer some of its non-traditional assets to Ocwen, one or more
affiliates of Ocwen and/or one or more affiliates of the Bank in order to
decrease the specified capital ratios the Bank has been instructed to
maintain. Based on discussions with the OTS, the Bank does not believe at
this time that any requirement to maintain higher levels of capital will be
pursuant to a written agreement, order or directive which would cause it to
cease to be a "well-capitalized institution" under OTS regulations, assuming
compliance with any new capital requirements.
NOTE 25 OTHER EXPENSES
Years Ended December 31,
----------------------------------
1996 1995 1994
------ ------ ------
Other operating expenses:
Professional fees........................ $ 2,979 $ 2,786 $ 2,928
Loan related expenses.................... 4,111 2,433 1,332
FDIC insurance........................... 3,098 2,212 2,220
Marketing................................ 701 968 1,305
Travel and lodging....................... 1,291 925 1,566
Corporate insurance...................... 1,209 637 501
Investment and treasury services......... 438 387 681
Deposit related expenses................. 91 303 513
OTS assessment........................... 293 257 393
Other.................................... 1,402 2,181 2,864
-------- -------- --------
$ 15,613 $ 13,089 $ 14,303
-------- -------- --------
-------- -------- --------
Included in the 1996 results of operations is a non-recurring expense of
$7,140 related to the Federal Deposit Corporation's ("FDIC") assessment to
recapitalized the Savings Association Insurance Fund ("SAIF") as a result of
federal legislation passed into law on September 30, 1996.
F-56
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 26 BUSINESS LINE REPORTING
The Company considers itself to be involved in the single business segment of
providing financial services and conducts a variety of business activities
within this segment. Such activities are as follows:
Income From
Continuing
Interest Operations
Income Before Taxes Assets
-------- ------------ ------
December 31, 1996:
Asset acquisition, servicing and
resolution....................... $ 111,209 $ 51,711 $ 1,454,320
Residential finance................ 22,609 8,600 204,880
Commercial finance................. 26,433 1,038 373,316
Investment management.............. 27,590 3,344 342,801
Retail banking..................... 6,006 (5,983) 34,873
Hotel operations................... - 453 16,087
Other.............................. 47 2,138 57,408
--------- -------- -----------
$ 193,894 $ 61,301 $ 2,483,685
--------- -------- -----------
--------- -------- -----------
December 31, 1995:
Asset acquisition and resolution... $ 77,143 $ 28,184 $ 910,680
Residential finance................ 13,323 1,338 321,350
Commercial finance................. 23,708 (1,686) 356,690
Investment management.............. 21,855 3,641 328,263
Retail banking..................... 44 4,053 3,449
Hotel operations................... - 2,593 19,451
Other.............................. 1,202 (422) 33,707
--------- -------- -----------
$ 137,275 $ 37,701 $ 1,973,590
--------- -------- -----------
--------- -------- -----------
December 31, 1994:
Asset acquisition and resolution... $ 53,357 $ 18,008 $ 656,125
Residential finance................ 4,573 (303) 59,513
Commercial finance................. 21,566 4,550 175,958
Investment management.............. 47,906 7,504 308,530
Retail banking..................... 121 53,214 27,282
Hotel operations................... - (1,808) 26,149
Other.............................. 3,935 412 12,846
--------- -------- -----------
$ 131,458 $ 81,577 $ 1,266,403
--------- -------- -----------
--------- -------- -----------
F-57
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
The asset acquisition, servicing and resolution activity includes the
Company's discounted loan activities, including residential and commercial
loans and the related real estate owned. Residential finance includes the
Company's acquisition of single family residential loans to non-conforming
borrowers, which began in late 1994 and which are recorded as available for
sale, and the Company's historical loan portfolio of single family
residential loans held for investment. The commercial finance activities
include the Company's origination of multi-family and commercial real estate
loans held for investment, the origination and purchase of multi-family
residential loans available for sale, and investments in low income housing
tax credit partnerships. Low income housing tax credits and benefits of
$9,330, $7,709 and $5,410 were earned as part of the commercial finance
activity for the years ended December 31, 1996, 1995 and 1994, respectively,
and are not reflected in the above table as they are included as credits
against income tax expense. Investment management includes the results of
the securities portfolio, whether available for sale, trading or investment,
other than REMIC residuals and subordinate interests related to the
Company's securitization activities which have been included in the related
business activity. Retail banking activities include the results of the
Company's retail branch network which consists of one branch at December 31,
1996 and 1995. Included in retail banking income from continuing operations
before taxes for 1996 is the SAIF recapitalization assessment of $7,140. In
addition, retail banking income from continuing operations before taxes for
the years ended December 31, 1995 and 1994 include gains on sales of
branches, net of profit sharing expense, of $4,344 and $50,080, respectively.
Interest income and expense has been allocated to each business segment for
the investment of funds raised or funding of investments made at an interest
rate based upon the treasury yield curve taking into consideration the actual
duration of such liabilities or assets. Allocations of non-interest expense
generated by corporate support services were made to each business segment
based upon management's estimate of time and effort spent in the respective
activity. As such, the resulting income from continuing operations is an
estimate of the contribution margin of each business activity to the Company.
F-58
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 27 COMMITMENTS AND CONTINGENCIES
Certain premises are leased under various noncancellable operating leases
with terms expiring at various times through 2005, exclusive of renewal
option periods. The annual aggregate minimum rental commitments under these
leases are summarized as follows:
1997 $ 1,118
1998 1,137
1999 1,194
2000 1,210
2001 1,302
2002-2005 4,083
--------
Minimum lease payments $ 10,044
--------
--------
Rent expense for the years ended December 31, 1996, 1995 and 1994 was $1,563,
$1,601 and $2,402, respectively, which are net of sublease rentals of $0,
$68, and $339, respectively.
At December 31, 1996 the Company was committed to land up to $5,744 under
outstanding unused lines of credit. The Company also had commitments to (i)
originate $105,490 of loans secured by multi-family residential buildings,
(ii) originate $19,849 of mortgage loans secured by office buildings and
(iii) originate $55,949 of loans secured by hotel properties and (iv)
originate $12,840 of loans secured by land. In connection with its 1993
acquisition of Berkeley Federal Savings Bank, the Company has a recourse
obligation of $3,486 on single family residential loans sold to the Federal
Home Loan Mortgage Corporation ("FHLMC"). The Company, through its
investment in subordinated securities and REMIC residuals, which had a
carrying value of $76,699 at December 31, 1996, supports senior classes of
securities having an outstanding principal balance of $1,453,575.
At December 31, 1995 the Company was committed to lend up to $9,884 under
outstanding unused lines of credit. The Company also had commitments to (i)
originate multi-family construction loans with aggregate principal balances
of $8,907, (ii) purchase $4,800 of residential discounted loans, (iii)
originate $5,390 of loans secured by office buildings, and (iv) originate
$25,424 of mortgage loans secured by hotel properties. In connection with its
acquisition of Berkeley Federal Savings Bank, the Company had a recourse
obligation of $4,163 on single family residential loans sold to the Federal
Home Loan Mortgage Corporation. The Company, through its investment in
subordinated securities which had a carrying value of $70,264 at December 31,
1995, supports senior classes of securities having an outstanding principal
balance of $868,835.
F-59
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
On October 29, 1996, Ocwen Financial Services, Inc., a wholly-owned
subsidiary of Ocwen, entered into an asset purchase agreement ("Asset
Purchase Agreement") to acquire Admiral Home Loan ("Admiral"), a California
corporation engaged in the origination of loans to credit-impaired borrowers
secured by first mortgage liens on single-family residential real property,
both through the wholesale acquisition of such loans originated by mortgage
brokers and through its retail offices, and selling of such originated loans,
servicing released, to third parties. Under the Asset Purchase Agreement, as
amended, Ocwen has agreed to pay $ 6,750 to acquire an 80% interest in the
assets of Admiral. Closing of the acquisition is expected to occur during the
second quarter of 1997.
The Company is subject to various pending legal proceedings. Management is
of the opinion that the resolution of these claims will not have a material
effect on the consolidated financial statements.
F-60
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 28 PARENT COMPANY ONLY FINANCIAL INFORMATION
CONDENSED STATEMENTS OF FINANCIAL CONDITION:
December 31,
--------------------
1996 1995
-------- --------
Assets
Cash and cash equivalents.......................... $ 32,348 $ 1,028
Securities available for sale, at market value..... 13,062 -
Investment in bank subsidiary...................... 221,094 117,300
Investments in non-bank subsidiaries............... 31,907 35,660
Loan portfolio, net................................ 12,365 520
Investment in real estate.......................... 9,680 -
Income taxes receivable............................ 10,003 -
Prepaid expenses and other assets.................. 5,424 4,240
--------- ---------
$ 335,883 $ 158,748
--------- ---------
--------- ---------
Liabilities
Notes payable...................................... $ 125,000 $ 8,627
Other liabilities.................................. 7,287 10,574
--------- ---------
Total liabilities................................ 132,287 19,201
--------- ---------
Stockholders' Equity
Total stockholders' equity......................... 203,596 139,547
--------- ---------
$ 335,883 $ 158,748
--------- ---------
--------- ---------
CONDENSED STATEMENTS OF OPERATIONS:
Years Ended December 31,
-------------------------------
1996 1995 1994
------ ------ ------
Interest income.......................... $ 1,400 $ 401 $ 42
Non-interest income...................... 511 8 67
-------- -------- --------
1,911 409 109
Interest expense......................... (4,406) (654) (678)
Non-interest expense..................... (1,131) (277) (401)
-------- -------- --------
Loss before income taxes............... (3,626) (522) (970)
Income tax benefit....................... 2,925 1,533 1,197
-------- -------- --------
Income (loss) before equity in net income
of subsidiaries........................ (701) 1,011 227
Equity in net income of bank subsidiary.. 49,186 24,773 51,650
Equity in net income (loss)of non-bank
subsidiaries........................... 1,657 (317) (4,538)
-------- -------- --------
Net income........................... $ 50,142 $ 25,467 $ 47,339
-------- -------- --------
-------- -------- --------
F-61
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
CONDENSED STATEMENTS OF CASH FLOWS:
For the years ended December 31,
----------------------------------
1996 1995 1994
------ ------ ------
Cash flows from operating activities:
Net income............................. $ 50,142 $ 25,467 $ 47,339
Adjustments to reconcile net income
to net cash provided (used) by
operating activities:
Equity in income of bank subsidiary (49,186) (24,773) (51,650)
Equity in (income) loss of non-bank
subsidiaries..................... (1,657) 317 4,538
Increase in other assets........... 4,067 (2,254) (1,351)
Increase in income taxes receivable (10,003) - (596)
Increase (decrease) in accrued
expenses, payables and other
liabilities...................... (3,286) 5,209 2,023
--------- --------- ---------
Net cash provided (used) by operating
activities......................... (9,923) 3,966 303
--------- --------- ---------
Cash flows from investing activities:
Purchase of securities available
for sale............................. (13,125) - -
Maturities of and principal payments
received on securities available
for sale............................. 63 - -
Net distributions from (investments in)
bank subsidiary...................... (49,707) 39,216 802
Net distributions from (investments in)
non-bank subsidiaries................ 5,410 (10,450) 11,491
Purchase of real estate held for
investment........................... (9,680) - -
Purchase of loans held for investment.. (11,845) (520) -
--------- --------- ---------
Net cash provided (used) by investing
activities......................... (78,884) 28,246 12,293
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes and
debentures........................... 125,000 7,615 -
Payment of debt issuance costs......... (5,252) - -
Repayment of notes payable............. (8,628) - (13,566)
Loans to executive officers, net....... (3,832) - -
Exercise of common stock options....... 12,993 1,420 -
Repurchase of common stock options and
common stock......................... (177) (42,129) (74)
Other.................................. 23 - -
--------- --------- ---------
Net cash provided (used) by financing
activities......................... 120,127 (33,094) (13,640)
--------- --------- ---------
F-62
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
Net increase (decrease) in cash and
cash equivalents..................... 31,320 (882) (1,044)
Cash and cash equivalents at beginning
of year.............................. 1,028 1,910 2,954
--------- --------- ---------
Cash and cash equivalents at end of
year................................. $ 32,348 $ 1,028 $ 1,910
--------- --------- ---------
--------- --------- ---------
F-63
OCWEN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 and 1994
(Dollars in thousands except share data)
NOTE 29 QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Quarters Ended
-------------------------------------------------
December 31, September 30, June 30, March 31,
1996 1996 1996 1996
------------ ------------- -------- ---------
Interest income............ $ 50,292 $ 44,145 $ 51,501 $ 47,956
Interest expense........... (33,907) (27,217) (27,131) (27,905)
Provision for loan losses.. (3,611) (4,469) (4,979) (9,391)
--------- --------- --------- ---------
Net interest income after
provision for loan
losses................... 12,774 12,459 19,391 10,660
Non-interest income........ 10,815 15,104 8,378 2,978
Non-interest expense....... (22,540) (21,489) (14,164) (11,385)
Equity in earnings of
investment in joint
venture.................. 33,103 4,139 1,078 -
--------- --------- --------- ---------
Income before income taxes. 34,152 10,213 14,683 2,253
Income taxes (expense)
benefit.................. (9,092) (157) (2,686) 776
--------- --------- --------- ---------
Net income................. $ 25,060 $ 10,056 $ 11,997 $ 3,029
--------- --------- --------- ---------
--------- --------- --------- ---------
Earnings per share......... $ 0.93 $ 0.37 $ 0.45 $ 0.11
Quarters Ended
-------------------------------------------------
December 31, September 30, June 30, March 31,
1995 1995 1995 1995
------------ ------------- -------- ---------
Interest income............ $ 44,916 $ 32,489 $ 33,840 $ 26,030
Interest expense........... (26,692) (22,688) (18,110) (16,570)
Provision for loan losses.. (1,121) - - -
--------- --------- --------- ---------
Net interest income after
provision for loan
losses................... 17,103 9,801 15,730 9,460
Gain on sale of branches... 5,430 - - -
Gain on sale of hotel...... 4,658 - - -
Non-interest income........ 8,081 4,084 6,380 2,547
Non-interest expense....... (13,407) (10,274) (13,130) (8,762)
--------- --------- --------- ---------
Income before income taxes
and discontinued
operations............... 21,865 3,611 8,980 3,245
Income taxes (expense)
benefit.................. (4,660) 858 (1,172) 412
Discontinued operations,
net...................... - (4,536) (1,586) (1,550)
--------- --------- --------- ---------
Net income (loss).......... $ 17,205 $ (67) $ 6,222 $ 2,107
--------- --------- --------- ---------
--------- --------- --------- ---------
Earnings per share:
Earnings before discontinued
operations............. $ 0.67 $ 0.17 $ 0.30 $ 0.11
Earnings (loss) after
discontinued operations $ 0.67 $ - $ 0.24 $ 0.06
F-64