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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from _____________ to _______________
Commission File Number: 0-21231
MATRIX CAPITAL CORPORATION
--------------------------------------------
(Exact name of registrant as specified in its charter)
Colorado 84-1233716
- ------------------------------- --------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1380 Lawrence Street, Suite 1410
Denver, Colorado 80204
-------------------------------------- ---------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (303) 595-9898
Securities registered pursuant to Section 12(b) of the Act:
None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0001 per share.
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 this Form 10-K or any
amendment to this Form 10-K.
Yes No
--- ---
As of March 5, 1997, 6,681,031 shares of common stock were outstanding. The
aggregate market value of common stock held by nonaffiliates of the registrant
based on the closing price of such stock on the Nasdaq National Market on March
4, 1997 was $38,010,033. For purposes of this computation, all executive
officers, directors and 10% beneficial owners of registrant are deemed to be
affiliates. Such determination should not be deemed an admission that such
executive officers, directors and 10% beneficial owners are affiliates.
DOCUMENTS INCORPORATED BY REFERENCE:
The Company's definitive proxy statement in connection with the Annual Meeting
of the Shareholders to be held May 1, 1997, to be filed with the Commission
pursuant to Regulation 14A, is incorporated by reference into Part III of this
report.
PAGE
----
PART I
ITEM 1. BUSINESS. 3
ITEM 2. PROPERTIES. 16
ITEM 3. LEGAL PROCEEDINGS. 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS. 18
ITEM 6. SELECTED FINANCIAL DATA. 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. 20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. 35
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE. 35
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. 36
ITEM 11. EXECUTIVE COMPENSATION. 36
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT. 36
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. 36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K. 37
PART I
ITEM 1. BUSINESS
--------
GENERAL
Matrix Capital Corporation (the "Company") is a specialized financial
services company that, through its subsidiaries, (the "Subsidiaries") focuses on
mortgage merchant banking by purchasing and selling residential mortgage loans
and residential mortgage servicing rights; offering brokerage, consulting and
analytical services to other financial services companies and financial
institutions; servicing residential mortgage portfolios for investors;
originating residential mortgages; providing real estate management and
disposition services. The Company also provides self-directed qualified
retirement plans, individual retirement accounts, custodial and directed trust
accounts, and broker dealer services to individuals and deferred contribution
plans. The Company is a unitary thrift holding company that was incorporated in
Colorado in June 1993. Its principal executive offices are located at 1380
Lawrence Street, Suite 1410, Denver, Colorado 80204, and its telephone number is
(303) 595-9898.
THE SUBSIDIARIES
The Company's core business operations are conducted through the following
operating Subsidiaries:
UNITED FINANCIAL. United Financial, Inc. ("United Financial") provides
brokerage and consulting services to financial institutions and financial
services companies in the mortgage banking industry. These services include the
brokering and analysis of residential mortgage loan servicing rights, corporate
and mortgage loan servicing portfolio valuations (which includes the complex
valuation and analysis required under Statement of Financial Accounting
Standards No. 122, Accounting for Mortgage Servicing Rights ("FAS 122")), and,
to a lesser extent, consultation and brokerage services in connection with
mergers and acquisitions of mortgage banking entities. United Financial provides
brokerage services to several of the nation's largest financial institutions,
such as Banc One Mortgage Corporation, Chase Manhattan Mortgage Corporation, and
Mellon Mortgage Corporation. During 1995 and 1996, United Financial brokered the
sale of 103 and 92 mortgage loan servicing portfolios totaling $32.6 billion and
$26.4 billion in outstanding mortgage loan principal balances, respectively. As
a result of this volume of brokerage activity, the Company has access to a wide
array of information relating to the mortgage banking industry, including
emerging market trends, prevailing market prices, pending regulatory changes,
and changes in levels of supply and demand. Consequently, the Company is able to
identify certain types of mortgage servicing portfolios that are well suited to
its particular servicing platform and unique corporate structure.
MATRIX FINANCIAL. Matrix Financial Services Corporation ("Matrix Financial")
acquires residential mortgage loan servicing rights on a nationwide basis
through purchases in the secondary market, services the loans underlying these
rights, and originates mortgage loans through its wholesale loan origination
network. As of December 31, 1996, Matrix Financial serviced 50,599 borrower
accounts representing $2.6 billion in principal balances (including $140.0
million in subservicing for non-affiliates of the Company), the majority of
which were seasoned loans having lower principal and higher custodial escrow
balances than newly originated mortgage loans. As a servicer of mortgage loans,
Matrix Financial is required to establish custodial escrow accounts for the
deposit of borrowers' payments, which may include principal, interest, taxes and
insurance. These payments are held at Matrix Capital Bank ("Matrix Bank"). At
December 31, 1996, the custodial escrow accounts related to the Company's
servicing portfolio maintained at Matrix Bank were $27.4 million in the
aggregate. For the calendar year 1996, Matrix Financial originated $583.3
million in wholesale mortgage loans through its regional production offices
located in Atlanta, Denver, and Phoenix. The loans originated by Matrix
Financial on a wholesale basis are typically sold in the secondary market.
MATRIX BANK. With its main office in Las Cruces, New Mexico and a full
service branch in Sun City, Arizona, Matrix Bank serves its local communities by
providing a broad range of personal and business depository services, offering
residential loans, and providing, on a limited basis, consumer loans and
commercial real estate loans. In addition, in January 1997, a branch was
established in Evergreen, Colorado that primarily will originate residential
real estate construction loans and commercial loans in the Colorado market.
Matrix Bank also holds the non-interest bearing custodial escrow deposits
related to the residential mortgage loan servicing portfolio serviced by Matrix
Financial. These custodial escrow deposits, as well as other traditional
deposits, are used to fund bulk purchases of mortgage loan portfolios throughout
the United States, a substantial portion of which are subserviced by Matrix
Financial following their purchase. As of December 31, 1996, Matrix Bank was
deemed to be "well-capitalized" under applicable regulatory standards.
3
UNITED SPECIAL SERVICES. United Special Services, Inc. ("USS") provides real
estate management and disposition services to financial services companies and
financial institutions. In addition to the unaffiliated clients currently served
by USS, Matrix Financial uses USS exclusively in handling the disposition of its
foreclosed real estate. USS also provides limited collateral valuation opinions
to clients, such as the Federal Home Loan Mortgage Corporation ("FHLMC"), that
are interested in assessing the value of the collateral underlying mortgage
loans, as well as to clients such as Matrix Bank and other third-party mortgage
loan buyers evaluating potential bulk purchases of mortgage loans.
UNITED CAPITAL MARKETS. United Capital Markets, Inc. ("UCM") is a wholly
owned subsidiary of the Company, formed in December 1996. UCM will focus on risk
management services for institutional clients. It will provide a professional
outsourcing alternative to in-house risk management departments or Wall Street
derivative products. The focus will be on interest rate and prepayment risk as
it relates to specific client objectives. The strategy will include modeling
asset risk, setting up and trading individual hedge accounts and mirroring
accounting practice and management goals. Although many asset classes will be
considered for management and advice, mortgage servicing rights (sometimes
referred to herein as MSRs') will be the initial focus. UCM is managed by former
senior executives from nationally recognized investment banks and the mortgage
banking industry with many years of experience in risk management and hedging
strategies. UCM generated no revenues in 1996 and there can be no assurance that
its operations will generate significant revenues during 1997 or future years.
THE VINTAGE GROUP INC. On February 5, 1997 the Company completed its
acquisition of The Vintage Group Inc. ("Vintage"). Vintage's subsidiaries,
Sterling Trust Company ("Sterling Trust") and First Matrix Investment Services
Corp. ("First Matrix") are located in Waco, and Arlington, Texas, respectively.
Sterling Trust was incorporated in 1984 as a Texas independent, non-bank trust
company specializing in self-directed qualified retirement plans, individual
retirement accounts, custodial, and directed trust accounts. As of December 31,
1996, Sterling Trust had in excess of 23,000 accounts with assets under
administration of over $1.1 billion. First Matrix is a NASD broker/dealer that
provides services to individuals and deferred contribution plans. The purchase
price was $11.25 million, which was paid through the issuance of 779,592 shares
of common stock of the Company. The transaction was accounted for as a
pooling of interests.
BROKERAGE AND CONSULTING SERVICES
BROKERAGE SERVICES. United Financial operates as a national,
full-service mortgage servicing broker. It is capable of analyzing, packaging,
marketing and closing servicing portfolio and selected corporate merger and
acquisition transactions. United Financial markets its services to all types and
sizes of market participants, thereby developing diverse relationships. United
Financial has provided brokerage services to each of the following clients
during the last 12 months:
Banc One Mortgage Corporation Knutson Mortgage
Bank of America Mellon Mortgage Corporation
Chase Manhattan Mortgage Corporation NVR Mortgage Finance, Inc.
First of America Loan Services, Inc. Principal Residential Mortgage, Inc.
Firstar Bank Resource Bancshares Mortgage Group
The Company believes that the client relationships developed by United
Financial through its national network of contacts with commercial banks,
mortgage companies, savings associations, and other institutional investors
represent a significant competitive advantage and form the basis for United
Financial's national market presence. These contacts also enable United
Financial to identify prospective clients for other Subsidiaries and make
referrals where appropriate.
The secondary market for purchasing and selling mortgage servicing rights
has become increasingly more active since its inception during the early 1980s.
While servicing rights are the primary asset of most mortgage companies, other
institutions such as commercial banks and savings associations also build
portfolios of mortgage servicing rights, which can serve as significant sources
of non-interest income. Most institutions that own mortgage servicing rights
have found that careful management of these assets is necessary due to their
susceptibility to interest rate cycles, changing prepayment patterns of mortgage
loans, and fluctuating earnings rates achieved on custodial escrow balances.
With the implementation of FAS 122, which requires companies to capitalize
originated mortgage servicing rights, management of mortgage servicing assets
has become even more critical. These managerial efforts, combined with interest
rate sensitivity of the assets and the growth strategies of market participants,
create constantly changing supply and demand and, therefore, price levels in the
secondary market for mortgage servicing rights.
4
The sale and transfer of mortgage servicing rights occurs in a market that
is inefficient and often requires an intermediary to facilitate matching buyers
and sellers. Prices are unpublished and closely guarded by market participants,
unlike most other major financial secondary markets. This lack of pricing
information complicates an already difficult process of differentiating between
servicing product types, evaluating regional, economic and socioeconomic trends
and predicting the impact of interest rate movements. Due to its significant
contacts, United Financial has access to information on the availability of
mortgage servicing portfolios and helps bring together interested buyers and
sellers.
CONSULTING AND ANALYTIC SERVICES. The analytics group of United Financial
has developed expertise in helping companies implement and, on an ongoing basis,
track their FAS 122 valuations and analyses. Expansion into the FAS 122
valuations arena represented a logical progression for United Financial. In
connection with the consulting services performed by United Financial on pools
of mortgage servicing rights held for sale by United Financial's clients, United
Financial performed many of the same types of analyses required by FAS 122.
Therefore, United Financial was able to enhance its existing valuation models
and create a software program that could be customized to fit its customers'
many different needs and unique situations in performing FAS 122 analyses. In
addition, United Financial has the infrastructure and management information
system capabilities necessary to undertake the complex analyses required by FAS
122. Many of the companies affected by the implementation of FAS 122 have
determined to outsource this function to a third party rather than dedicate the
resources necessary to develop systems for and perform their own FAS 122
valuations. To provide an additional consulting service to the mortgage banking
industry, the Company formed UCM in December 1996. FAS 122 requires that
servicing portfolios be valued at lower of cost or market. As a result, the
management of the servicing asset has become a critical component to the holders
of mortgage servicing rights. Due to the of risk of companies incurring an
impairment of their servicing portfolio, the need to hedge has become much more
prevalent. UCM will market to many of the same companies as United Financial and
will focus its efforts on providing hedging strategies for institutional clients
servicing portfolios. Management believes that providing these consulting and
analytic services enhances the Company's ability to attract and retain client
relationships.
RESIDENTIAL LOAN SERVICING ACTIVITIES
RESIDENTIAL MORTGAGE LOAN SERVICING. Matrix Financial and Matrix Bank each
has its own mortgage servicing portfolio, but the Company conducts its servicing
activities exclusively through Matrix Financial. Matrix Bank's mortgage
servicing rights are subserviced under a contract with Matrix Financial. At
December 31, 1996, Matrix Financial serviced approximately $2.6 billion of
mortgage loans, including $424.0 million for Matrix Bank and $140.0 million
subserviced for non-affiliates of the Company.
Servicing mortgage loans involves a contractual right to receive a fee for
processing and administering loan payments. This processing involves collecting
monthly mortgage payments on behalf of investors, reporting information to those
investors on a monthly basis and maintaining custodial escrow accounts for the
payment of principal and interest to investors and property taxes and insurance
premiums on behalf of borrowers. These payments are held in custodial escrow
accounts at Matrix Bank, where the money can be invested by the Company in
interest-earning assets at returns that historically have been greater than
could be realized by the Company using the custodial escrow deposits as
compensating balances to reduce the effective borrowing cost on existing
warehouse credit facilities.
As compensation for its mortgage servicing activities, the Company receives
servicing fees usually ranging from 0.25% to 0.75% per annum of the loan
balances serviced, plus any late charges collected from delinquent borrowers and
other fees incidental to the services provided. At December 31, 1996, the
Company's weighted average servicing fee was 0.40 %. In the event of a default
by the borrower, the Company receives no servicing fees until the default is
cured.
Servicing is provided on mortgage loans on a recourse or nonrecourse basis.
The Company's policy is to accept only a limited number of servicing assets on a
recourse basis. As of December 31, 1995 and 1996, on the basis of outstanding
principal balances only 0.7% and 0.4%, respectively, of the mortgage servicing
contracts owned by the Company involved recourse servicing. To the extent that
servicing is done on a recourse basis, the Company is exposed to credit risk
with respect to the underlying loan in the event of a repurchase. Additionally,
many of the nonrecourse mortgage servicing contracts owned by the Company
require the Company to advance all or part of the scheduled payments to the
owner of the mortgage loan in the event of a default by the borrower. Many
owners of mortgage loans also require the servicer to advance insurance premiums
and tax payments on schedule even though sufficient escrow funds may not be
available. The Company, therefore, must bear the funding costs associated with
making such advances. If the delinquent loan does not become current, these
advances are typically recovered at the time of the foreclosure sale.
Foreclosure expenses are
5
generally not fully reimbursable by the Federal National Mortgage Association
("FNMA"), FHLMC or the Government National Mortgage Association ("GNMA"), for
whom the Company provides significant amounts of mortgage loan servicing.
Mortgage servicing rights represent a contract right to service and not a
beneficial ownership interest in underlying mortgage loans. Failure to service
the loans in accordance with contract requirements may lead to the termination
of the servicing rights and the loss of future servicing fees. To date, there
have been no terminations of mortgage servicing rights by any mortgage loan
owners because of the Company's failure to service the loans in accordance with
its contractual obligations.
In order to track information on its servicing portfolio, the Company
utilizes a data processing system provided by Alltel Information Services, Inc.
("Alltel"), one of the largest mortgage banking service bureaus in the United
States. Management believes that this system gives the Company sufficient
capacity to support anticipated expansion of its residential mortgage loan
servicing portfolio.
The following table sets forth certain information regarding the composition
of the Company's mortgage servicing portfolio (excluding loans subserviced for
others) as of the dates indicated:
AS OF DECEMBER 31,
----------------------------------------------
1994 1995 1996
------------- ------------- --------------
(IN THOUSANDS)
FHA--insured/VA guaranteed residential............. $ 28,630 $ 37,135 $ 318,145
Conventional loans................................. 980,003 1,544,808 2,171,016
Other loans........................................ 33,152 14,442 15,875
------------ ------------ -----------
Total mortgage servicing portfolio............ $ 1,041,785 $ 1,596,385 $ 2,505,036
============ ============ ===========
Fixed rate loans................................... $ 669,933 $ 1,073,803 $ 1,986,599
Adjustable rate loans.............................. 371,852 522,582 518,437
------------ ------------ -----------
Total mortgage servicing portfolio............. $ 1,041,785 $ 1,596,385 $ 2,505,036
============ ============ ===========
The following table shows the delinquency statistics for the mortgage loans
serviced by the Company (excluding loans subserviced for others) compared with
national average delinquency rates as of the dates presented:
AS OF DECEMBER 31,
------------------------------------------------------------------------------------------------------
1994 1995 1996
-------------------------------- -------------------------------- ----------------------------------
NATIONAL NATIONAL NATIONAL
COMPANY AVERAGE(1) COMPANY AVERAGE(2) COMPANY AVERAGE(3)
------------------ ---------- ------------------- ---------- --------------------- ----------
PERCENTAGE PERCENTAGE PERCENTAGE
NUMBER OF PERCENTAGE NUMBER OF PERCENTAGE NUMBER OF PERCENTAGE
OF SERVICING OF OF SERVICING OF OF SERVICING OF
LOANS PORTFOLIO(4) LOANS LOANS PORTFOLIO(4) LOANS LOANS PORTFOLIO(4) LOANS
------ ------------ ---------- ------- ------------ ----------- ------- ------------ -----------
Loans delinquent for:
30-59 days.............. 648 3.28 % 2.76 % 843 3.37 % 3.07 % 2,607 5.45 % 3.04 %
60-89 days.............. 223 1.13 0.67 195 0.78 0.70 667 1.40 0.71
90 days and over........ 287 1.46 0.74 166 0.67 0.71 684 1.43 0.62
----- ---- ---- ----- ---- ---- ----- ---- ----
Total delinquencies..... 1,158 5.87 % 4.17 % 1,204 4.82 % 4.48 % 3,958 8.28 % 4.37 %
===== ==== ==== ===== ==== ==== ===== ==== ====
Foreclosures............ 236 1.20 % 0.86 % 277 1.11 % 0.87 % 264 .55 % 1.03 %
- ----------
(1) Source: Mortgage Bankers Association, "Delinquency Rates of 1- to 4-Unit
Residential Mortgage Loans" (Seasonally Adjusted) (March 7, 1995 report).
(2) Source: Mortgage Bankers Association, "Delinquency Rates of 1- to 4-Unit
Residential Mortgage Loans" (Seasonally Adjusted) (March 14, 1996 report).
(3) Source: Mortgage Bankers Association, "Delinquency Rates of 1- to 4-Unit
Residential Mortgage Loans" (Seasonally Adjusted) (March 6, 1997 report).
(4) Delinquencies and foreclosures generally exceed the national average due to
high rates of delinquencies and foreclosures on certain bulk loan and bulk
servicing portfolios acquired by the Company at a discount. In the fourth
quarter of 1996, the Company acquired a seasoned servicing portfolio which
had higher delinquencies primarily in the 30 day category. The higher
delinquencies were considered in the pricing of the portfolio.
6
During periods of declining interest rates, prepayments of mortgage loans
increase as homeowners seek to refinance at lower interest rates, resulting in a
decrease in the value of the servicing portfolio. Mortgage loans with higher
interest rates are more likely to result in prepayments. The following table
sets forth certain information regarding the number and aggregate principal
balance of the mortgage loans serviced by the Company, including both fixed and
adjustable rate loans (excluding loans subserviced for others), at various
mortgage interest rates:
AS OF DECEMBER 31,
------------------------------------------------------------------------------------------------------------------
1994 1995 1996
---------------------------------- ---------------------------------------- ------------------------------------
PERCENTAGE PERCENTAGE PERCENTAGE
NUMBER AGGREGATE OF AGGREGATE NUMBER AGGREGATE OF AGGREGATE NUMBER AGGREGATE OF AGGREGATE
OF PRINCIPAL PRINCIPAL OF PRINCIPAL PRINCIPAL OF PRINCIPAL PRINCIPAL
RATE LOANS BALANCE BALANCE LOANS BALANCE BALANCE LOANS BALANCE BALANCE
---- ------ --------- ------------ ------- ------------- ------------ -------- ----------- -------------
(DOLLARS IN THOUSANDS)
Less than 7.00%. 2,113 $ 162,274 15.58 % 2,781 $ 218,914 13.71 % 3,545 $ 145,720 5.82 %
7.00%--7.99%... 3,798 204,024 19.58 7,386 576,255 36.10 12,269 726,800 29.01
8.00%--8.99%... 4,894 261,630 25.11 7,160 442,634 27.73 14,011 838,215 33.46
9.00%--9.99%... 4,314 200,025 19.20 4,460 191,549 12.00 9,567 413,598 16.51
10.00%--10.99%.. 2,179 142,504 13.68 2,005 125,544 7.86 6,322 301,837 12.05
11.00%--11.99%.. 756 33,772 3.24 519 24,220 1.52 1,144 45,111 1.80
12.00% and over. 1,667 37,556 3.61 647 17,269 1.08 924 33,755 1.35
------ ---------- ------- ------ ----------- ------ ------ ----------- ------
Total......... 19,721 $1,041,785 100.00 % 24,958 $ 1,596,385 100.00 % 47,782 $ 2,505,036 100.00 %
====== =========== ======= ====== =========== ====== ====== =========== ======
Loan administration fees decrease as the principal balance on the
outstanding loan decreases and as the remaining time to maturity of the loan
shortens. The following table sets forth certain information regarding the
remaining maturity of the mortgage loans serviced by the Company (excluding
loans subserviced for others) as of the dates shown:
AS OF DECEMBER 31,
------------------------------------------------
1994
------------------------------------------------
PERCENTAGE
NUMBER PERCENTAGE UNPAID UNPAID
OF OF NUMBER PRINCIPAL PRINCIPAL
MATURITY LOANS OF LOANS AMOUNT AM0UNT
- -------- ------ --------- --------- ------------
(DOLLARS IN THOUSANDS)
1--5 years..................... 2,116 10.73 % $ 43,818 4.21 %
6--10 years.................... 5,538 28.08 125,648 12.06
11--15 years.................... 4,131 20.95 155,598 14.94
16--20 years.................... 1,529 7.75 92,028 8.83
21--25 years.................... 3,989 20.23 322,703 30.98
More than 25
years......................... 2,418 12.26 301,990 28.98
------ ------ ---------- ------
Total......................... 19,721 100.00 % $1,041,785 100.00 %
====== ====== ========== ======
AS OF DECEMBER 31,
---------------------------------------------------
1995
---------------------------------------------------
PERCENTAGE
NUMBER PERCENTAGE UNPAID UNPAID
OF OF NUMBER PRINCIPAL PRINCIPAL
MATURITY LOANS OF LOANS AMOUNT AM0UNT
- -------- ------- --------- ----------- -------------
(DOLLARS IN THOUSANDS)
1--5 years.................... 3,077 12.33 % 60,496 3.79 %
6--10 years................... 4,898 19.62 118,928 7.45
11--15 years................... 5,263 21.09 302,332 18.94
16--20 years................... 2,608 10.45 168,166 10.53
21--25 years................... 4,880 19.55 472,613 29.61
More than 25
years........................ 4,232 16.96 473,850 29.68
------ ------ ----------- ------
Total........................ 24,958 100.00 % $ 1,596,385 100.00
====== ====== =========== ======
AS OF DECEMBER 31,
-------------------------------------------------
1996
-------------------------------------------------
PERCENTAGE
NUMBER PERCENTAGE UNPAID UNPAID
OF OF NUMBER PRINCIPAL PRINCIPAL
MATURITY LOANS OF LOANS AMOUNT AM0UNT
- -------- ------- --------- ----------- ------------
(DOLLARS IN THOUSANDS)
1--5 years................... 5,020 10.51 % $ 77,136 3.08 %
6--10 years.................. 8,784 18.39 184,629 7.37
11--15 years.................. 6,418 13.43 340,282 13.58
16--20 years.................. 14,066 29.44 566,862 22.63
21--25 years.................. 7,006 14.66 545,336 21.77
More than 25
years....................... 6,488 13.57 790,791 31.57
------ ------ ---------- ------
Total....................... 47,782 100.00 % $2,505,036 100.00 %
====== ====== ========== ======
The following table sets forth the geographic distribution of the mortgage
loans (including delinquencies) serviced by the Company (excluding loans
subserviced for others) by state:
AS OF DECEMBER 31,
------------------------------------------------
1994
------------------------------------------------
PERCENTAGE PERCENTAGE
OF OF
NUMBER AGGREGATE AGGREGATE TOTAL
OF PRINCIPAL PRINCIPAL DELINQS.
STATE LOANS BALANCE BALANCE BY STATE(1)
- ----- ----- ----------- ---------- ------------
(DOLLARS IN THOUSANDS)
CA(2).......................... 2,822 $ 343,135 32.94 % 29.24 %
TX(2).......................... 945 25,721 2.47 6.64
NY............................. 943 36,831 3.54 7.49
MD............................. 1,828 104,384 10.02 4.80
AZ............................. 4,132 145,980 14.01 7.49
MA............................. 353 21,625 2.08 3.53
Other(3)....................... 8,698 364,109 34.94 40.81
------ ----------- ------ -----
Total.......................... 19,721 $ 1,041,785 100.00 % 100.00 %
====== =========== ====== ======
AS OF DECEMBER 31,
-----------------------------------------------------
1995
-----------------------------------------------------
PERCENTAGE PERCENTAGE
OF OF
NUMBER AGGREGATE AGGREGATE TOTAL
OF PRINCIPAL PRINCIPAL DELINQS.
STATE LOANS BALANCE BALANCE BY STATE(1)
- ----- ----- --------- ---------- ------------
(DOLLARS IN THOUSANDS)
CA(2).......................... 4,948 $ 533,590 33.42 % 39.04 %
TX(2).......................... 4,291 265,242 16.62 7.31
NY............................. 532 32,620 2.04 3.49
MD............................. 1,628 93,495 5.86 4.65
AZ............................. 3,787 139,038 8.71 7.89
MA............................. 890 83,593 5.24 2.82
Other(3)....................... 8,882 448,807 28.11 34.80
------ ----------- ------- ------
Total.......................... 24,958 $ 1,596,385 100.00 % 100.00 %
====== =========== ======= ======
AS OF DECEMBER 31,
-----------------------------------------------
1996
-----------------------------------------------
PERCENTAGE PERCENTAGE
OF OF
NUMBER AGGREGATE AGGREGATE TOTAL
OF PRINCIPAL PRINCIPAL DELINQS.
STATE LOANS BALANCE BALANCE BY STATE(1)
- ----- ----- ------------ ---------- ------------
(DOLLARS IN THOUSANDS)
CA(2)......................... 6,971 $ 680,075 27.15 % 14.60%
TX(2)......................... 12,257 410,892 16.40 37.34
NY............................ 2,396 214,228 8.55 3.87
MD............................ 2,415 133,298 5.32 2.17
AZ............................ 3,265 128,251 5.12 4.17
MA............................ 953 81,170 3.24 1.37
Other(3)...................... 19,525 857,122 34.22 36.48
------ ----------- ------ ------
Total......................... 47,782 $ 2,505,036 100.00 % 100.00 %
====== =========== ====== ======
- --------------
(1) In terms of number of loans outstanding.
(2) The concentration in California and Texas does not reflect a business
strategy of the Company but rather the pursuit of specific opportunities.
(3) No other state accounted for greater than 5.0%, based on aggregate principal
balances, of the Company's mortgage loan servicing portfolio as of December
31, 1996.
7
ACQUISITION OF SERVICING RIGHTS. The Company acquires substantially all of
its mortgage servicing rights in the secondary market. The secondary market for
purchasing and selling mortgage servicing rights is inefficient in several
respects, including the lack of a centralized exchange for conducting trading,
the lack of definitive market prices, and the lack of conformity in modeling
assumptions. The industry expertise of United Financial's and Matrix Financial's
employees allows the Company to capitalize upon these inefficiencies when
acquiring mortgage servicing rights. Prior to completing any such acquisition,
the Company analyzes a wide range of characteristics of each portfolio
considered for purchase. This analysis includes projecting revenues and expenses
and reviewing geographic distribution, interest rate distribution, loan-to-value
ratios, outstanding balances, delinquency history, and other pertinent
statistics. Due diligence is performed either by Matrix Financial's employees or
a designated independent contractor on a representative sample of the mortgages
involved. The purchase price is based on the present value of the expected
future cash flow, calculated by using a discount rate and loan prepayment
assumptions that management considers to be appropriate to reflect the risk
associated with the investment.
SERVICING SALES. The Company periodically sells its purchased mortgage
servicing portfolios and generally sells all of its originated mortgage loan
servicing rights. Such sales increase revenue, as reflected in loan origination
income and gain on sale of servicing, and generate cash at the time of sale, but
reduce future servicing fee income. Originated mortgage servicing rights were
sold on a bulk and flow basis on loans having an aggregate principal amount of
$89.0 million and $303.3 million during the years ended December 31, 1995 and
1996, respectively. Periodically, the Company may also sell purchased mortgage
servicing rights to restructure its portfolio or generate revenues. Purchased
mortgage servicing rights were sold on loans having an aggregate principal
amount of $31.8 million and $646.0 million during the years ended December 31,
1995 and 1996, for net gains of $1.2 million and $3.2 million, respectively.
The Company anticipates that it will continue to adhere to its policy of
selling substantially all of its originated mortgage servicing rights. The
Company also may sell purchased mortgage servicing rights. Management intends to
base decisions regarding future mortgage servicing sales upon the Company's cash
requirements, purchasing opportunities, capital needs, earnings and the market
price for mortgage servicing rights. During a quarter in which a sale occurs,
reported income will tend to be greater than if such sale had not occurred
during that quarter. Prices obtained for mortgage servicing rights vary
depending on servicing fee rates, anticipated prepayment rates, average loan
balances, remaining time to maturity, servicing costs, custodial escrow
balances, delinquency and foreclosure experience, and purchasers' required rates
of return.
In the ordinary course of selling mortgage servicing rights, the Company, in
accordance with industry standards, makes certain representations and warranties
to purchasers of mortgage servicing rights. If a loan defaults when there has
been a breach of representations or warranties and the Company has no
third-party recourse, the Company may become liable for the unpaid principal and
interest on defaulted loans. In such a case, the Company may be required to
repurchase the mortgage loan and bear any subsequent loss on the loan. In
connection with any purchases by the Company of mortgage servicing rights, the
Company also is exposed to liability to the extent that an originator or seller
of the servicing rights is unable to honor its representations and warranties.
During 1995 and 1996, the Company recognized losses of $205,000 and $150,000
respectively, on loan repurchases resulting from a particular servicing
portfolio purchased by the Company. The Company does not anticipate any
additional material losses with respect to this or any other servicing portfolio
due to breaches of representations and warranties; however, there can be no
assurance that the Company will not experience such losses.
PURCHASE AND SALE OF BULK LOAN PORTFOLIOS
LOAN PURCHASES. In addition to its traditional mortgage loan origination and
servicing-related activities, the Company makes bulk purchases of mortgage loans
through Matrix Bank. The Company believes that its structure provides advantages
over its competitors in the purchase of bulk mortgage loan packages. United
Financial, through its networking within the mortgage banking industry, is able
to refer to Matrix Bank mortgage banking companies that are interested in
selling mortgage loan portfolios. The direct contacts reduce the number of
portfolios that must be purchased through competitive bid situations, thereby
reducing the cost associated with the acquisition of bulk mortgage loan
portfolios.
Because the Company services mortgage loans for more than 200 private
investors, including banks, savings associations, and insurance companies, it is
presented with opportunities to purchase the underlying mortgages. In many
cases, the mortgage loans increase in value solely due to the increased
liquidity provided by uniting ownership of the
8
mortgage servicing rights with the underlying mortgage loans. As servicer,
Matrix Financial possesses information about the quality and performance history
related to each of these loans, and, in many cases, the Company acts as
custodian for the legal and credit documents on the underlying loans. With such
information available, the Company is in a position to negotiate advantageous
pricing on loans, which provides the Company an opportunity to resell the
mortgage loans at a higher price (an "arbitrage" opportunity). Controlling
ownership of the mortgage servicing and the underlying mortgage loan provides
the Company maximum arbitrage opportunity in a sale. During the years ended
December 31, 1995 and 1996, the Company made bulk purchases of approximately
$91.8 million and $159.0 million in mortgage loans, respectively.
TYPES OF LOANS PURCHASED. The Company reviews many loan portfolios for
prospective acquisition. The Company primarily focuses on acquiring seasoned
first lien priority loans secured primarily by one-to-four single family
residential properties valued at less than $350,000. The purchased loan
portfolios typically include both fixed and adjustable rate mortgage loans.
Mortgage loan portfolios are purchased from various sellers who, in some cases,
have originated the loans; but in most cases such sellers have acquired the loan
portfolios in bulk purchases.
The Company considers several factors prior to the purchase. Among others,
the Company considers the product type, the current loan balance, the current
interest rate environment, the seasoning of the mortgage loans, payment
histories, geographic location of the underlying collateral, price, the current
liquidity of the Company, and the product mix in its existing mortgage loan
portfolio.
In many cases, the mortgage loan portfolios that the Company acquires are
purchased at a discount to par. Some of the loans in these portfolios are
considered performing loans that have had payment problems in the past or have
had document deficiencies. These types of portfolios afford the Company an
arbitrage opportunity if the purchase discount on such portfolios accurately
reflects the additional risks associated with purchasing these types of loans.
Loan document deficiencies are identified in the due diligence process and, to
the extent practical, are cured by the Company prior to reselling the loans. The
Company also analyzes the payment history on each mortgage loan portfolio. Many
prior problems may be a result of inefficient servicing or may be attributable
to several servicing transfers of the loans over a short period of time. Because
many considerations may impact pricing or yield, each loan package evaluated is
priced based on the specific underlying loan characteristics. The Company
purchased fewer loan portfolios at a discount in 1996 versus historical levels.
The higher prices paid in 1996 resulted primarily from the Company acquiring
loan portfolios believed to have better payment histories and fewer document
deficiencies on average.
DUE DILIGENCE. The Company performs comprehensive due diligence on each
mortgage loan portfolio that the Company desires to purchase on a bulk basis.
These procedures consist of analyzing a representative sample of the mortgage
loans in the portfolio and are typically performed by Company employees, but
occasionally are outsourced to third party contractors. The underwriter takes
into account many factors in analyzing the sample of mortgage loans in the
subject portfolio, including the general economic conditions in the geographic
area or areas in which the underlying residential properties are situated, the
loan-to-value ratios on the underlying loans, the payment histories of the
borrowers, and other pertinent statistics. In addition, the underwriter attempts
to verify that each sample loan conforms to the standards for loan documentation
set by FNMA and FHLMC and, in cases where a significant portion of the sample
loans contains non-conforming documentation, the Company assesses the additional
risk involved in purchasing such loans. Once the underwriting and due diligence
process is complete, the Company categorizes each loan pool into one of four
categories. This process helps the Company determine whether the mortgage loan
portfolio meets the Company's investment criteria and, if it does, the range of
pricing that the Company feels is appropriate.
LOAN SALES. Substantially all of the mortgage loans in the Company's loan
portfolio are classified as held for sale. The Company continually monitors the
secondary market for purchases and sales of mortgage loan portfolios and
typically undertakes a sale of a particular loan portfolio held by the Company
in an attempt to "match" an anticipated bulk purchase of a particular mortgage
loan portfolio or to generate current period earnings and cash flow. To the
extent that the Company is unsuccessful in matching its purchases and sales of
mortgage loans, the Company may have excess capital at Matrix Bank, resulting in
less than optimum leverage and capital ratios. During the years ended December
31, 1995 and 1996, the Company made bulk sales of approximately $70.2 million
and $79.0 million in loans, for gains on sale of bulk mortgage loans of $3.3
million and $3.4 million, respectively.
9
RESIDENTIAL MORTGAGE LOAN ORIGINATION
WHOLESALE ORIGINATIONS. The Company originates residential mortgage loans
primarily on a wholesale basis through Matrix Financial. For the years ended
December 31, 1995 and 1996, Matrix Financial originated a total of $388.9
million and $583.3 million in wholesale residential mortgage loans,
respectively.
Matrix Financial's source of mortgage loan originations is its wholesale
division, which originates mortgage loans through approved independent mortgage
loan brokers that qualify to participate in Matrix Financial's program through a
formal application process that includes an analysis of the broker's financial
condition and sample loan files, as well as the broker's reputation, general
lending expertise and references. As of December 31, 1996, Matrix Financial had
approved relationships with approximately 500 mortgage loan brokers. From Matrix
Financial's offices in Atlanta, Denver and Phoenix, the sales staff solicit
mortgage loan brokers throughout the Southeastern and Rocky Mountain areas of
the United States for loan packages that meet Matrix Financial's criteria.
Mortgage loans submitted by brokers are funded after being underwritten by
Matrix Financial.
Mortgage loan brokers act as intermediaries between borrowers and Matrix
Financial in arranging mortgage loans. Matrix Financial, as an approved FNMA,
FHLMC and GNMA seller/servicer, provides such brokers access to the secondary
market for the sale of mortgage loans that they otherwise cannot access because
they do not meet the applicable seller/servicer net worth requirements. Matrix
Financial attracts and maintains relationships with mortgage loan brokers by
offering a variety of services and products.
By concentrating on wholesale mortgage banking services through independent
mortgage loan brokers, Matrix Financial is able to originate mortgage loans in a
cost-effective manner. Historically, retail mortgage loan origination has
involved higher fixed overhead costs such as offices, furniture, computer
equipment and telephones, as well as additional personnel costs such as sales
representatives and loan processors. By limiting the number of offices and
personnel needed to generate business, Matrix Financial has transferred the
overhead burden of mortgage origination to the independent mortgage loan brokers
that originate the loans. As a result, Matrix Financial can match its
origination costs more directly to loan origination volume so that a substantial
portion of its costs are variable rather than fixed.
In June 1996, the Company implemented a program to supplement its product
offerings made through its wholesale loan origination networks by adding
products tailored to borrowers who are unable or unwilling to obtain mortgage
financing from conventional mortgage sources. The borrowers who need this type
of loan product often have impaired or unsubstantiated credit histories and/or
unverifiable income and require or seek a high degree of personalized services
and swift response to their loan applications. As a result, these borrowers
generally are not averse to paying higher interest rates that the Company will
charge for this loan product type as compared with the interest rates charged by
conventional lending sources. The Company has established classifications with
respect to the credit profiles of these borrowers. The classifications range
from A-minus through D depending upon a number of factors, including the
borrower's credit history and employment status. To date, the operations of the
B/C Lending Division have not been material to those of the Company.
RETAIL ORIGINATIONS. On a limited basis, and primarily in order to serve the
communities in which it operates, Matrix Bank originates residential loans on a
retail basis through its branches in Las Cruces, New Mexico and Sun City,
Arizona. In early 1997, the Bank opened a lending branch in Evergreen, Colorado,
which is anticipated to increase the amount of Matrix Bank's retail
originations. This location will primarily originate residential construction
loans and some commercial loans in the local market place. It is anticipated
that the construction loans will be converted to permanent mortgage loans and
funded through Matrix Bank. The retail loans originated by Matrix Bank consist
of a broad range of residential (both at fixed and at adjustable rates) and
consumer loan products and on a more limited basis, consumer loan products and
commercial real estate loans.
QUALITY CONTROL. The Company has a loan quality control process designed to
ensure sound lending practices and compliance with FNMA, FHLMC, and applicable
private investor guidelines. Prior to funding any wholesale or retail loan, the
Company performs a pre-funding quality control audit that consists of the
verification of a borrower's credit and employment and utilizes a detailed
checklist. Subsequent to funding, the Company on a monthly basis selects 10% of
all closed loans for a detailed audit conducted by its own personnel or a
third-party service provider. The quality control process entails performing a
complete underwriting review and independent reverification of all employment
information, tax returns, source of down payment funds, bank accounts, and
credit. Furthermore, 10% of the audited loans are chosen for an independent
field review and standard factual credit report. All discovered deficiencies in
these audits are reported
10
to senior management of the Company to determine trends and additional training
needs. All resolvable issues are addressed and cured by the Company. Any loans
that fail to meet applicable investment criteria of an investor are reported to
such investor, which could result in a requirement by the investor for the
Company to repurchase the loan. The Company also performs a quality control
audit on all early payment defaults, first payment defaults, and 60-day
delinquent loans; the findings are reported to the appropriate investor and/or
senior management.
SALE OF LOAN ORIGINATIONS. The Company generally sells the loans that it
originates. In the future, however, it is anticipated that Matrix Bank will hold
for investment certain mortgage loans that it has originated. Under ongoing
programs established with FNMA and FHLMC, conforming conventional loans may be
sold on a cash basis or pooled by the Company and exchanged for securities
guaranteed by FNMA or FHLMC. These securities are then sold by Matrix Financial
and Matrix Bank to national or regional broker/dealers. Mortgage loans sold to
FNMA or FHLMC are sold on a nonrecourse basis so that foreclosure losses are
generally borne by FNMA or FHLMC and not by the Company.
The Company also sells nonconforming mortgage loans on a nonrecourse basis
to other secondary market investors. These loans are typically first lien
mortgage loans that do not meet all of the agencies' underwriting guidelines,
and are originated instead for other institutional investors with whom the
Company has previously negotiated purchase commitments, and for which the
Company occasionally pays a fee. This practice would also apply to the sale of
residential mortgage loans originated through the Company's B/C Lending
Division.
The Company sells mortgage loans on a servicing-retained or servicing-
released basis. Certain purchasers of mortgage loans require that the loan be
sold to them servicing released. In all other cases the decision is left to the
Company. Generally, the Company sells conforming loans on a servicing-retained
basis and nonconforming loans on a servicing-released basis. See "--Residential
Loan Servicing Activities."
In connection with the Company's mortgage loan originations and sales, the
Company makes customary representations and warranties, similar in nature and
scope to those provided in connection with sales of mortgage servicing rights.
To date, they have not resulted in any significant repurchases of loans by the
Company or any pending or threatened claims by the purchasers against the
Company. However, there can be no assurance that losses will not occur in the
future due to the representations and warranties issued.
The sale of mortgage loans may generate a gain or loss for the Company.
Gains or losses result primarily from two factors. First, the Company may make a
loan to a borrower at a price that is higher or lower than it would receive if
it immediately sold the loan in the secondary market. These price differences
occur primarily as a result of competitive pricing conditions in the primary
loan origination market. Second, gains or losses may result from the changes in
interest rates that result in changes in the market value of the mortgage loans
from the time that the price commitment is given to the borrower until the time
that the mortgage loan is sold to the investor.
In order to hedge against the interest rate risk resulting from these timing
differences, the Company historically has committed to sell all closed
originated mortgage loans held for sale and a portion of the mortgage loans that
are not yet closed but for which the interest rate has been established
("pipeline loans"). The Company adjusts its net commitment position daily either
by entering into new commitments to sell or by buying back commitments to sell
depending upon its projection of the portion of the pipeline loans that it
expects to close. These projections are based on numerous factors, including
changes in interest rates and general economic trends. The accuracy of the
underlying assumptions bears directly upon the effectiveness of the Company's
use of forward commitments and subsequent profitability. At December 31, 1995,
the Company had approximately $93.1 million in pipeline and funded loans offset
with mandatory forward commitments of approximately $64.7 million and
non-mandatory forward commitments of approximately $15.3 million. At, December
31, 1996, the Company had approximately $62.6 million in pipeline and funded
loans offset with mandatory forward commitments of approximately $49.1 million
and non-mandatory forward commitments of approximately $8.1 million. The
inherent value of the forward commitments is considered in the determination of
the lower of cost or market in valuing the Company's pipeline and funded loans
at any given time. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Comparison of Results of Operations for the
Years Ended December 31, 1996 and 1995--Loan Origination."
11
REAL ESTATE MANAGEMENT AND DISPOSITION SERVICES
USS, which began operations in June 1995, provides real estate management
and disposition services to customers across the United States. In addition to
the unaffiliated clients currently served by USS, Matrix Financial uses USS
exclusively in handling the disposition of its foreclosed real estate. Having
USS provide this service as opposed to Matrix Financial transforms the
disposition process into a revenue generator for the Company, since USS
typically collects a fee of 1% of the value of the foreclosed real estate from
the real estate broker involved in the sale transaction. USS is able to provide
this disposition service on an outsourced basis and at no additional cost to the
mortgage loan servicer, since USS collects its fee from the real estate broker.
USS is able to pass the cost of the disposition on to the real estate broker
because of the volume it generates. In addition, USS provides limited collateral
valuation opinions to clients such as FHLMC who are interested in assessing the
value of the underlying collateral on non-performing mortgage loans, as well as
to clients such as Matrix Bank and other third-party mortgage loan originators
and buyers interested in evaluating potential bulk purchase of mortgage loans.
To date, the operations of USS have not been material to those of the Company.
SAVINGS BANK ACTIVITIES
With branches in Las Cruces, New Mexico and Sun City, Arizona, Matrix Bank
serves its local communities by providing a broad range of personal and business
depository services, offering residential and consumer loans and providing, on a
more limited basis, commercial real estate loans. In May 1996, a subsidiary of
Matrix Bank, Sterling Finance Co., Inc. ("Sterling"), purchased substantially
all of the assets of a Denver-based originator and seller of sub-prime
automobile retail installment sales contracts. On December 31, 1996, Matrix Bank
sold the fixed assets of Sterling Finance Co., Inc. to a third party buyer and
ceased operations. In conjunction with contractual obligations associated with
selling loans into the secondary market, Matrix Bank repurchased approximately
$2.5 million of installment loans and repossessed automobiles that Sterling sold
to outside investors. These assets will be disposed of or serviced under the
direction of Matrix Bank. In January 1997, a loan production branch was
established in Evergreen, Colorado that will primarily originate residential
real estate construction loans and commercial loans in the Colorado market. For
a discussion of the depository services offered by Matrix Bank, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." For a discussion of the historical
loan portfolio of the Company, including that of Matrix Bank, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Asset
and Liability Management--Lending Activities."
SELF-DIRECTED TRUST ACTIVITIES
Sterling Trust provides services for self-directed individual retirement
accounts, qualified business retirement plans, personal custodial accounts, and
a variety of corporate trust and escrow arrangements. Sterling Trust actively
markets its services on a nationwide basis to the financial services industry,
specifically broker/dealers, registered representatives, insurance agents, tax
professionals, financial planners and advisors, and investment product sponsors.
At December 31, 1996, Sterling Trust Co. was administering assets in excess of
$1.1 billion. Historically, approximately 6% to 8% of the assets under
administration are maintained in money market accounts. Sterling retains no
discretion with respect to the investment of trust assets, and executes no
investment transaction until so instructed by the client or the client's
designated representative. In February 1997, Sterling Trust Co. moved
approximately $80.0 million of money market balances from a third party
institution to Matrix Capital Bank.
COMPETITION
The industries in which the Company competes are highly competitive. The
Company competes for the acquisition of mortgage loan servicing rights and bulk
loan portfolios mainly with mortgage companies, savings associations, commercial
banks, and other institutional investors. The Company believes that it has
competed successfully for the acquisition of mortgage loan servicing rights and
bulk loan portfolios by relying on the advantages provided by its unique
corporate structure and the secondary marketing expertise of the employees in
each Subsidiary.
Competition in mortgage loan and mortgage servicing rights brokerage and
consulting arises mainly from other mortgage banking consulting firms, national
and regional investment banking companies, and accounting firms. Management
believes that the distinction among market participants is based primarily on
customer service. United Financial competes for its brokerage and consulting
activities by recruiting qualified and experienced sales people, by
12
developing innovative sales techniques, by providing financing opportunities to
its customers through its affiliation with Matrix Bank, and by seeking to
provide a higher level of service than is furnished by its competitors.
Competition in originating mortgage loans arises mainly from other mortgage
companies, savings associations, and commercial banks. The distinction among
market participants is based primarily on price and, to a lesser extent, the
quality of customer service and name recognition. Aggressive pricing policies of
the Company's competitors, especially during a declining period of mortgage loan
originations, could in the future result in a decrease in the Company's mortgage
loan origination volume and/or a decrease in the profitability of the Company's
loan originations, thereby reducing the Company's revenues and net income. The
Company competes for loans by offering competitive interest rates and product
types, and by seeking to provide a higher level of personal service to mortgage
brokers and borrowers than is furnished by competitors. However, the Company
does not have a significant market share of the lending markets in which it
conducts operations.
Management believes that Matrix Bank's most direct competition for deposits
comes from local financial institutions. The distinction among market
participants is based primarily on price and, to a lesser extent, the quality of
customer service and name recognition. Matrix Bank's cost of funds fluctuates
with general market interest rates. During certain interest rate environments,
additional significant competition for deposits may be expected from corporate
and governmental debt securities, as well as money market mutual funds. Matrix
Bank competes for conventional deposits by emphasizing quality of service,
extensive product lines, and competitive pricing.
Sterling Trust faces considerable competition in all of the services and
products which it offers. The main competition comes from the other
self-directed trust companies. However, Sterling Trust also faces competition
from other trust companies and trust divisions of other financial institutions.
Sterling's niche has been, and will continue to be providing high quality
customer service and servicing niche retirement products. In an effort to
increase market share, Sterling Trust will endeavor to provide superior service,
expand its marketing efforts, provide competitive pricing, and continue to
diversify its product mix.
EMPLOYEES
At December 31, 1996, the Company had 192 employees. Management believes
that its relations with its employees are good. Neither Matrix Capital nor any
of the Subsidiaries is a party to any collective bargaining agreement.
REGULATION AND SUPERVISION
Set forth below is a brief description of various laws and regulations
affecting the operations of the Company. The description of laws and regulations
contained herein does not purport to be complete and is qualified in its
entirety by reference to applicable laws and regulations. Any change in
applicable laws, regulations or regulatory policies may have a material effect
on the business, operations and prospects of the Company.
MATRIX CAPITAL. The Company is a unitary thrift holding company within the
meaning of the Home Owners' Loan Act of 1933, as amended ("HOLA"). As such,
Matrix Capital has registered with the OTS and is subject to OTS regulation,
examination, supervision and reporting requirements. In addition, the OTS has
enforcement authority over Matrix Capital and its non-savings institution
subsidiaries. Among other things, this authority permits the OTS to restrict or
prohibit activities that are determined to be a serious risk to Matrix Bank. In
addition, Matrix Bank must notify the OTS at least 30 days before making any
distribution to Matrix Capital.
As a unitary thrift holding company, Matrix Capital generally is not
restricted under existing laws as to the types of business activities in which
it may engage, provided that Matrix Bank continues to be a "qualified thrift
lender" under HOLA ("QTL"). Upon any nonsupervisory acquisition by Matrix
Capital of another savings association or savings bank that meets the QTL test
and is deemed to be a savings institution by OTS, Matrix Capital would become a
multiple thrift holding company (if the acquired institution is held as a
separate subsidiary) and would be subject to extensive limitations on the types
of business activities in which it could engage. HOLA limits the activities of a
multiple thrift holding company and its uninsured institution subsidiaries
primarily to activities permissible for bank holding companies under Section
4(c)(8) of the Bank Holding Company Act of 1956, as amended (the "BHC Act"),
subject to the prior approval of the OTS, and activities authorized by OTS
regulation.
13
Legislation has been proposed that would impose limits on the nonbanking
activities of companies that acquire savings associations. It is anticipated
that Matrix Capital's holding company status would be "grandfathered" under such
legislation, but there can be no assurance that Matrix Capital would be exempt
from such limits. Furthermore, any available grandfathering might not continue
to be available to Matrix Capital as a result of a possible merger of the
federal regulatory agencies. Several proposals have been introduced in Congress
over a number of years with increasing frequency and interest in such a merger.
If the OTS and Office of the Comptroller of the Currency were merged, as one
proposal would require, the federal thrift charter would actually be eliminated.
If adopted, such a proposal would require that Matrix Bank become a national
bank and would subject it to regulation as such. One effect of such a
requirement would be that Matrix Capital could not engage in activities not
permitted for national banks. In addition, the ability to branch interstate
would become subject to the restrictions of the Riegle-Neal Interstate Banking
and Branching Efficiency Act of 1994 ("Riegle Act"). Accordingly, any
out-of-state branches of Matrix Bank in existence upon the effectiveness of such
a proposal that are not permissible under the Riegle Act and, if not
grandfathered, could be required to be divested. There are also some benefits to
such a charter conversion. For example, Matrix Bank would not, under regulations
currently applicable to national banks, be subject to the QTL test.
MORTGAGE BANKING OPERATIONS. The rules and regulations applicable to the
Company's mortgage banking operations establish underwriting guidelines that,
among other things, include anti-discrimination provisions, require provisions
for inspections, appraisals, and credit reports on prospective borrowers and fix
maximum loan amounts. Moreover, lenders, such as the Company, are required
annually to submit to the HUD, FNMA and FHLMC audited financial statements, and
each regulatory entity maintains its own financial guidelines for determining
net worth and eligibility requirements. The Company's affairs are also subject
to examination by HUD, FNMA and FHLMC at any time to assure compliance with the
applicable regulations, policies and procedures. Mortgage loan origination
activities are subject to, among others, the Equal Credit Opportunity Act,
Federal Truth-in-Lending Act and the Real Estate Settlement Procedures Act of
1974, as amended, and the regulations promulgated thereunder that prohibit
discrimination and require the disclosure of certain basic information to
mortgagors concerning credit terms and settlement costs.
Additionally, there are various state and local laws and regulations
affecting the Company's operations. The Company is licensed in those states in
which it does business requiring such a license where the failure to be licensed
would have a material adverse effect on the Company, its business or assets.
Conventional mortgage operations also may be subject to state usury statutes.
FEDERAL SAVINGS BANK OPERATIONS. Matrix Bank is subject to extensive
regulation, examination and supervision by the OTS, as its chartering authority
and primary regulator, and by the FDIC, which insures its deposits up to
applicable limits. Such regulation and supervision (i) establishes a
comprehensive framework of activities in which Matrix Bank can engage (ii)
limits the ability of Matrix Bank to extend credit to any given borrower, (iii)
imposes specified liquidity requirements, (iv) specifically restricts the
transactions in which Matrix Bank may engage with its affiliates, (v) requires
Matrix Bank to meet a "Qualified Thrift Lender" test that imposes a level of
portfolio assets in which Matrix Bank must invest (primarily residential
mortgages and related investments, (vi) places limitations on capital
distributions by savings associations such as Matrix Bank, including cash
dividends, (vii) imposes assessments to the OTS to fund its operations, (viii)
establishes a continuing and affirmative obligation, consistent with Matrix
Bank's safe and sound operation, to help meet the credit needs of the entire
community, including low and moderate income neighborhoods, (ix) requires Matrix
Bank to maintain certain non-interest bearing reserves against its transaction
account, (x) establishes various capital categories resulting in various levels
of regulatory scrutiny applied to the institutions in a particular category, and
(xi) establishes standards for safety and soundness. The regulatory structure is
designed primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities. Any change in
such regulations, whether by the OTS, the FDIC or the Congress could have a
material impact on the Bank and its operations.
Insurance of Accounts and Regulation by the FDIC. Matrix Bank is a member of
the SAIF, which is administered by the FDIC. Savings deposits are insured up to
$100,000 per insured member (as defined by law and regulation) by the FDIC. Such
insurance is backed by the full faith and credit of the United States. As
insurer, the FDIC imposes deposit insurance assessments and is authorized to
conduct examinations of and to require reporting by the FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the FDIC. The FDIC also may initiate enforcement actions against savings
associations and may terminate the deposit insurance if it determines that the
institution has engaged or is engaging in unsafe or unsound practices, or is in
an unsafe or unsound condition.
14
FDICIA required the FDIC to implement a risk-based deposit insurance
assessment system. Pursuant to this requirement, the FDIC has adopted a
risk-based assessment system under which all SAIF insured depository
associations are placed into one of nine categories and assessed insurance
assessments based upon their level of capital and supervisory evaluation. Under
this system, associations classified as well capitalized and considered healthy
pay the lowest assessment while associations that are less than adequately
capitalized and considered of substantial supervisory concern pay the highest
assessment. In addition, under FDICIA, the FDIC may impose special assessments
on SAIF members to repay amounts borrowed from the United States Treasury or for
any other reason deemed necessary by the FDIC. The FDIC may increase assessment
rates, on a semiannual basis, if it determines that the reserve ratio of the
SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured
deposits. In setting these increased assessments, the FDIC must seek to restore
the reserve ratio to that designated reserve level, or such higher reserve ratio
as established by the FDIC. Matrix Bank's current assessment is .064% of
deposits, which is the lowest rate.
By contrast, financial institutions that are members of the Bank Insurance
Fund ("BIF"), which has higher reserves, experienced lower deposit insurance
assessments. The disparity in deposit insurance assessments between SAIF and BIF
members was exacerbated by the statutory requirement that both the SAIF and the
BIF funds be recapitalized to a 1.25% reserved deposits ratio and that a portion
of most thrift's deposit insurance assessments be used to service bonds issued
by the Financial Corporation ("FICO"). BIF reached the required reserve ratio in
1995. As a result, financial institutions that have deposits insured by the SAIF
were subject to a potential competitive disadvantage as compared to BIF members.
To address this rate disparity, on September 30, 1996, the President signed
legislation intended to enable SAIF to reach the designated reserve ratio. The
legislation provides for a one-time special assessment of .657% to be imposed
upon all SAIF deposits as of March 31, 1995. Based on the company's SAIF
deposits as of March 31, 1995, the cost of the one-time special assessment was
approximately $450,000 (pre-tax). This amount was accrued in the third quarter
of 1996 and paid in the fourth quarter of 1996.
The legislation also provides for BIF members to service a growing portion
of the FICO bond payments. Until January 1, 2000, annual assessments of .013% of
BIF deposits and .064% of SAIF deposits will service the annual payments due on
the FICO bonds. Accordingly, Matrix Bank's portion of the payment on the FICO
bonds is .064% of the deposits. The legislation provides for subsequent full pro
rata sharing of FICO bond payments by BIF and SAIF institutions. The legislation
called for a merger of the SAIF and BIF as of January 1, 1999, but only if the
thrift charter has been eliminated.
The financing corporations created by FIRREA and the Competitive Equality
Banking Act of 1987 are also empowered to assess premiums on savings
associations to help fund the liquidation or sale of troubled associations. Such
premiums cannot, however, exceed the amount of SAIF assessments and are paid in
lieu thereof.
MATRIX BANK'S CAPITAL RATIOS. The following table indicates Matrix Bank's
regulatory capital ratios at December 31, 1996:
AS OF
DECEMBER 31, 1996
-------------------------
CORE RISK-BASED
CAPITAL CAPITAL
---------- ---------
(DOLLARS IN THOUSANDS)
Shareholder's equity/GAAP capital..................... $ 11,367 $ 11,367
Additional capital items:
General valuation allowances...................... -- 1,039
---------- ----------
Regulatory capital as reported to the OTS............. 11,367 12,406
Minimum capital requirement as reported to the OTS.... 7,875 8,979
---------- ----------
Regulatory capital--excess............................. $ 3,492 $ 3,427
========== ==========
Capital ratios........................................ 5.77 % 11.05 %
Well-capitalized requirement.......................... 5.00 % 10.00 %
FEDERAL HOME LOAN BANK SYSTEM. Matrix Bank is a member of the Federal Home
Loan Bank ("FHLB") system, which consists of 12 regional FHLBs. The FHLB
provides a central credit facility primarily for member associations and
15
administers the home financing credit function of savings associations. FHLB
advances must be secured by specified types of collateral and may only be
obtained for the purpose of providing funds for residential housing finance. The
FHLB funds its operations primarily from proceeds derived from the sale of
consolidated obligations of the FHLB system. Matrix Bank, as a member of the
FHLB system, must acquire and hold shares of capital stock in FHLB in an amount
at least equal to 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the FHLB, whichever is greater. Matrix Bank was
in compliance with this requirement with an investment in FHLB stock at December
31, 1996 of $2.9 million.
REGULATION OF SUB-PRIME AUTOMOBILE LENDING. On December 31, 1996, Matrix
Bank sold the assets of Sterling to a third party buyer. However, during the
time that Matrix Bank owned Sterling, it purchased approximately $18.5 million
automobile retail installment contracts and sold them into the secondary market,
subject to certain recourse provisions. In conjunction with the contractual
obligations associated with those sales, Matrix Bank had, as of December 31,
1996, repurchased approximately $2.5 million of installment loans and
repossessed automobiles that Sterling sold to outside investors. Matrix Bank
bears the risk of additional repurchases subject to certain terms and conditions
of the various sale agreements which are primarily restricted to fraud. The
loans will be disposed of or serviced under the direction of Matrix Bank. The
automobile lending activities are subject to various federal and state laws and
regulations. Consumer lending laws generally require licensing of the lender and
purchasers of loans and adequate disclosure of loan terms and impose limitations
on the terms of consumer loans and on collection policies and creditor remedies.
Federal consumer credit statutes primarily require disclosures of credit terms
in consumer finance transactions. In general, the Company's sub-prime automobile
lending activities were conducted under licenses issued by individual states and
were also subject to the provisions of the federal Consumer Credit Protection
Act and its related regulations. Due to the consumer-oriented nature of the
industry in which Sterling operated and uncertainties with respect to the
application of various laws and regulations in certain circumstances, industry
participants are named from time to time as defendants in litigation involving
alleged violations of federal and state consumer lending or other similar laws
and regulations. A significant judgment against Sterling in connection with any
litigation could have a material adverse affect on the Company's financial
condition and results of operations. In addition, if it were determined that a
material number of loans purchased by Sterling involved violations of applicable
lending laws or fraudulent actions by the automobile dealers, the Company's
financial condition and results of operations could be materially adversely
affected.
REGULATION OF STERLING TRUST COMPANY. Sterling Trust Company provides
custodial services and directed (nondiscretionary) trustee services. Sterling
Trust was chartered under the laws of the State of Texas as a Texas trust
company is subject to supervision, regulation and examination by the Texas
Department of Banking.
ITEM 2. PROPERTIES
The executive and administrative offices of the Company, United Financial
and USS are located at 1380 Lawrence Street, Suite 1410, Denver, Colorado 80204.
The lease on these premises extends through January 1999 and the current annual
rent is approximately $120,000. The Company also owns a building in Phoenix,
that houses the majority of Matrix Financial's operations. This building was
purchased by the Company in 1994 and is subject to third party mortgage
indebtedness. See Note 4 to the Consolidated Financial Statements included
elsewhere herein. The Company utilizes approximately 18,000 of the 30,000 square
feet in this building, and the balance is leased to an affiliated company at
current market rates. The Company also leases two smaller office facilities in
Atlanta and Denver, where Matrix Financial conducts its wholesale loan
origination activities.
Matrix Bank owns an approximately 30,000 square foot building in Las Cruces,
New Mexico. Of this 30,000 square feet, approximately 9,200 square feet serve as
the headquarters for Matrix Bank. Substantially all of the remaining footage is
rented to unaffiliated third-party tenants at market rates. Matrix Bank also
owns a newly opened 1,800 square foot detached branch in Las Cruces and an
approximately 3,000 square foot branch in Sun City, Arizona. In January, 1997,
Matrix Bank opened an approximately 1,500 square foot loan origination branch in
Evergreen, Colorado. The lease on the Evergreen property provides for a one-year
term at an annual cost of $24,000.
Sterling Trust occupies approximately 11,300 square feet in Waco, Texas,
under a lease agreement that is in place until June 30, 2001, at a monthly rent
payment of $13,553. The lease agreement provides for renewal options and
allocation of certain expenses the lessee would reimburse over a specified
amount during the life of the lease.
16
First Matrix is located in Arlington, Texas and operates in a 1,446 square
foot office suite. The current lease requires a monthly payment of $1,265 and
matures on April 30, 1997. A 24 month renewal option is available at current
market rates which the Company anticipates renewing.
The Company believes that all of its present facilities are adequate for its
current needs and that additional space is available for future expansion upon
acceptable terms.
ITEM 3. LEGAL PROCEEDINGS
Matrix Financial is a defendant in two lawsuits, Limper v. Matrix Financial
Services Corporation (Court of Common Pleas, Ottawa County, Ohio, January 29,
1996), and Mogavero v. Matrix Financial Services Corporation (United States
District Court for the District of Massachusetts, June 17, 1996) that purport to
cover a nationwide class of plaintiffs and involve similar facts and legal
claims. In both cases, the plaintiffs allege that Matrix Financial breached the
terms of plaintiffs' promissory notes and mortgages by imposing certain fax and
payoff statement fees at the time the plaintiffs prepaid their loans. The
plaintiffs claim that such fees constitute unauthorized charges in violation of
the terms of the notes, and demand restitution and attorneys' fees. In addition,
the plaintiffs in Mogavero seek treble damages for Matrix Financial's alleged
violation of 18 U.S.C. ss.1964.
Matrix Financial has entered into an agreement, which is subject to court
approval, to settle the Limper action and the Mogavero action. The settlement
agreement provides for the administration of the settlement in the Limper action
and the dismissal of the Mogavero action. Accordingly, a settlement order of
dismissal was entered in the Mogavero action on November 13, 1996.
The Court in the Limper action granted preliminary approval of the
settlement in January 1997. Accordingly, as provided by the settlement
agreement, Matrix Financial established a settlement fund of $640,000. The costs
of notice and class administration, attorneys' fees, and recovery to class
members are all to come from the settlement fund. Notice to class members was
mailed in January 1997 and published in February 1997. The final approval
hearing for the settlement is scheduled for April 10, 1997. The Company
established a reserve in the third quarter of 1996 to account for this
contingency.
The Company is involved from time to time in routine litigation incidental
to its business. However, other than described above, the Company believes that
it is not a party to any material pending litigation that, if decided adversely
to the Company, would have a significant adverse effect on the Company's
consolidated financial condition, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, $.0001 par value ("Common Stock"), is traded
on the Nasdaq National Market under the symbol "MTXC." The initial public
offering of Common Stock occurred on October 18, 1996.
1996
------------------
High Low
-------- -------
Fourth Quarter (beginning October 18, 1996) $ 15.88 $ 10.00
On March 4, 1997, the closing price of the Common Stock was $13.50 per
share. Also as of that date the approximate number of holders of record of the
Company's Common Stock was 76. This number does not include beneficial owners
who hold their shares in a depository trust in "street" name.
Since its organization in June 1993, the Company has not paid any dividends
on its Common Stock, except for an aggregate of $88,000 in dividends paid to the
shareholders of the Company in 1993. The Company expects that it will retain all
available earnings generated by its operations for the development and growth of
its business and does not anticipate paying any cash dividends in the
foreseeable future. Any future determination as to dividend policy will be made
at the discretion of the Board of Directors of the Company and will depend on a
number of factors, including the future earnings, capital requirements,
financial condition and future prospects of the Company and such other factors
as the Board of Directors may deem relevant. Under the terms of the Company's
13% Senior Subordinated Notes issued in August 1995 (the "13% Senior
Subordinated Notes") and the Company's bank stock loan issued in March 1997, the
Company's ability to pay cash dividends to its shareholders is limited. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." In addition, the ability of Matrix
Financial and Matrix Bank to pay dividends to the Company may be restricted in
certain instances, including covenants under Matrix Financial's existing
warehouse facilities and certain other debt covenants of the Company.
During 1996, the Company issued the following unregistered securities in
reliance on the exemption from registration set forth in Section 4(2) of the
Securities Act of 1933, as amended. In October 1996, the Company granted options
exercisable for a total of 10,000 shares of Common Stock to the two nonemployee
directors of the Company, 5,000 shares of Common Stock to an advisory director
of the Company, 75,000 shares of Common Stock to three executive officers of the
Company, and 39,600 shares of Common Stock to various non-executive employees of
the Company. All such options are exercisable at $10.00 per share, which was the
fair market value of the Common Stock on the date of grant of such options. The
Company also issued warrants exercisable for an aggregate of 75,000 shares of
its common stock to its primary underwriters upon the closing of the Company's
initial public offering. The warrants are excercisable from time to time during
the four years after the one year anniversary of their date of grant, and are
not transferable during the first year after their grant. The exercise price of
the shares of common stock underlying such warrant is $12.00 per share.
18
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
SELECTED CONSOLIDATED FINANCIAL AND OPERATING INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected financial data should be read in conjunction with the
Consolidated Financial Statements and Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
AS OF AND FOR THE
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------
1992 1993(1) 1994 1995 1996
-------------- ------------- -------------- -------------- ----------------
OPERATING DATA
Net interest income (loss) before
provision for loan and
valuation losses.................... $ (554) $ 944 $ 3,989 $ 3,536 $ 6,002
Provision for loan and valuation
losses............................. -- 15 216 401 143
-------- --------- --------- --------- ----------
Net interest income (loss) after
provision for loan and valuation
losses............................. (554) 929 3,773 3,135 5,859
-------- --------- --------- --------- ----------
Non-interest income:
Loan administration............... 6,025 6,427 6,926 7,749 8,827
Brokerage......................... 1,842 2,132 4,017 4,787 4,364
Gain on sale of loans............. 546 2,361 1,590 3,272 3,369
Gain on sale of mortgage
servicing rights................. 348 38 684 1,164 3,232
Loan origination(2)............... -- 221 1,294 2,069 1,561
Other............................. 186 466 487 781 1,118
-------- --------- --------- --------- ----------
Total non-interest income....... 8,947 11,645 14,998 19,822 22,471
Non-interest expense................ 8,281 10,464 14,279 17,136 22,951
-------- --------- --------- --------- ----------
Income before income taxes.......... 112 2,110 4,492 5,821 5,379
Income taxes(3)..................... -- 404 1,846 2,260 2,106
-------- --------- --------- --------- ----------
Net income.......................... $ 112 $ 1,706 $ 2,646 $ 3,561 $ 3,273 (4)
======== ========= ========= ========= ==========
Net income per common and common
equivalent share(5)................. $ .71 $ .91 $ .76
Pro forma net income(6)............. $ 67 $ 1,266
Pro forma net income per common and
common equivalent share(6).......... $ .02 $ .35
Weighted average common and common
equivalent shares outstanding...... 3,442,501 3,596,251 3,750,001 3,927,629 4,297,448
Cash dividends...................... $ -- $ 88 $ -- $ -- $ --
BALANCE SHEET DATA
Total assets........................ $ 10,140 $ 95,747 $ 112,051 $ 184,732 $ 272,863
Total loans (excluding allowance
for loan and valuation losses)...... 497 77,034 90,068 147,608 213,400
Allowance for loan and valuation
losses............................. -- 538 728 943 1,039
Nonperforming loans(7).............. -- 853 3,314 5,538 3,903
Mortgage servicing rights........... 6,200 1,818 6,183 13,817 23,680
Foreclosed real estate(7)........... 69 726 543 835 788
Deposits............................ -- 45,517 41,910 48,877 90,179
Custodial escrow balances........... -- 31,794 24,687 27,011 37,881
FHLB borrowings..................... -- -- 14,600 19,000 51,250
Borrowed money...................... 5,347 8,791 18,438 65,093 42,431
Total shareholders' equity.......... 1,369 3,030 5,676 9,338 30,802
OPERATING RATIOS AND OTHER SELECTED
DATA
Return on average assets(8)........ 1.13 % 4.98 % 2.69 % 2.38 % 1.57 %
Return on average equity(8)........ 7.73 88.44 58.49 51.38 24.90
Average equity to average assets(8) 14.57 5.63 4.60 4.63 6.29
Net interest margin(8)(9).......... -- 4.15 4.63 2.81 3.43
Operating efficiency ratio(10)..... 98.67 83.22 76.07 74.64 81.01
Total amount of loans purchased.... $ -- $ 32,231 $ 80,048 $ 91,774 $ 159,015
Balance of owned servicing
portfolio (end of period).......... $ 855,506 $ 1,007,286 $ 1,041,785 $ 1,596,385 $ 2,505,036
Wholesale loan origination volume.. $ -- $ 126,200 $ 183,130 $ 388,937 $ 583,279
19
AS OF AND FOR THE
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1992 1993(1) 1994 1995 1996
-------- --------- --------- --------- ----------
LOAN PERFORMANCE RATIOS
Nonperforming loans/total loans(7)..... -- % 1.11 % 3.68 % 3.75 % 1.83 %
Nonperforming assets/total assets(7)... -- 1.65 3.44 3.45 1.90
Net loan charge offs/average
loans(8).............................. -- 0.18 0.03 0.15 0.03
Allowance for loan and valuation
losses/total loans(11)................ -- 0.70 0.81 0.64 0.49
Allowance for loan and valuation
losses/nonperforming loans(11)........ -- 63.07 21.97 17.03 26.62
- ----------
(1) The Company acquired all of the outstanding capital stock of Matrix Bank on
September 23, 1993. The operations of Matrix Bank have been included in the
consolidated operations of the Company from the date of acquisition.
(2) On January 1, 1995, the Company adopted FAS 122. Since FAS 122 prohibits
retroactive application, the historical accounting results for 1995 and
1996 are not directly comparable to the results for prior periods.
(3) Prior to the formation of Matrix Capital in June 1993, Matrix Financial and
United Financial had elected for certain periods to be taxed under the
provisions of subchapter "s" of the Code and accordingly did not pay income
taxes on their respective earnings; instead the shareholders of Matrix
Financial and United Financial were liable for such taxes. As a result,
there is no income tax provision for earnings during the periods in which
subchapter "s" treatment had been elected.
(4) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Comparison of Results of Operations for the Years
Ended December 31, 1996 and 1995--Loan Origination Income" for a discussion
of the impact on net income of a secondary marketing loss incurred in March
1996.
(5) Net income per common and common equivalent share is based on the weighted
average number of common shares outstanding during each period and the
dilutive effect, if any, of stock options and warrants outstanding. There
are no other dilutive securities.
(6) Pro forma net income and pro forma net income per share are presented for
periods in which the Company was not a taxable entity as a result of its
subchapter "s" election. The pro forma net income assumes an effective tax
rate of 40%. Pro forma net income per share is computed by dividing pro
forma net income by the weighted average number of shares of Common Stock
and Common Stock equivalents outstanding during the year.
(7) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Asset and Liability Management--Nonperforming
Assets" for a discussion of the impact of certain bulk purchases of
mortgage loan portfolios on the level of nonperforming loans and foreclosed
real estate, and the effect of repurchasing sub-prime automobile loans.
(8) Calculations are based on average daily balances where available and
monthly averages otherwise.
(9) Net interest margin has been calculated by dividing net interest income
before loan and valuation loss provision by average interest-earning
assets.
(10) The operating efficiency ratio has been calculated by dividing non-interest
expense by operating income (net interest income plus non-interest income).
(11) The allowance for loan and valuation losses does not include a $600,000
liability reserve account to cover potential losses associated with sub-
prime auto loans repurchased by Matrix Bank. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--
Nonperforming Assets".
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS
-------------
The following management's discussion and analysis of the financial
condition and results of operations of the Company should be read in conjunction
with the preceding "Selected Consolidated Financial and Operating Information."
Additionally, the Company's Consolidated Financial Statements and the Notes
thereto, as well as other data included herein, should be read and analyzed in
combination with the analysis below.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996 AND
1995
NET INCOME; RETURN ON AVERAGE EQUITY. Net income decreased $288,000, or
8.1%, to $3.3 million for the year ended December 31, 1996 as compared to $3.6
million for the year ended December 31, 1995. Return on average equity decreased
to 24.9% for the year ended December 31, 1996 as compared to 51.4% for the year
ended December 31, 1995.
20
The decrease in return on average equity was primarily due to the Company's
policy of retaining all of its earning, the issuance of 2,012,500 shares of
additional stock in the fourth quarter, the one time expense for the SAIF
capitalization, the first quarter secondary marketing loss, the reserve for the
probable settlement of certain outstanding litigation and the recourse losses
related to the sub-prime autos repurchased at Sterling. See "--Loan Origination"
for a discussion of the secondary marketing loss. See "--Asset Liability
Management--Nonperforming Assets" for a discussion of the loss relating to the
disposition of Sterling.
NET INTEREST INCOME. Net interest income before provision for loan and
valuation losses increased $2.5 million, or 69.7%, to $6.0 million for the year
ended December 31, 1996, as compared to $3.5 million for the year ended December
31, 1995. The increase for the year ended December 31, 1996 was attributable to
the increase in the Company's yield on interest earning assets, which increased
to 9.42% for the year ended December 31, 1996, as compared to 8.52% for the year
ended December 31, 1995, and a decrease in the cost of interest-bearing
liabilities, which decreased to 6.59% for the year ended December 31, 1996, as
compared to 7.14% for the year ended December 31, 1995. The increase in the
Company's yield on interest-earning assets was primarily attributable to an
increase in the yield on the Company's adjustable rate loan portfolio, the
amortization and payoffs of loans which had significant discounts, and the
origination of higher yielding consumer loans. The decrease in the cost of
interest-bearing liabilities was attributable to the lower cost of borrowed
funds. The Company's net interest margin increased to 3.43% for the year ended
December 31, 1996, as compared to 2.81% for the year ended December 31, 1995.
The Company's average interest-earning assets increased $49.2 million, or 39.1%,
to $175.1 million for the year ended December 31, 1996, as compared to $125.9
million for the year ended December 31, 1995. This increase was attributable
primarily to the increase in the size of the Company's loan portfolio held for
sale. For a tabular presentation of the changes in net interest income due to
changes in volume of interest-earning assets and changes in interest rates, see
"--Analysis of Changes in Net Interest Income Due to Changes in Interest Rates
and Volumes."
PROVISION FOR LOAN AND VALUATION LOSSES. Provision for loan and
valuation losses decreased $258,000, or 64.3%, to $143,000 for the year ended
December 31, 1996 as compared to $401,000 for the year ended December 31, 1995.
This decrease was primarily attributable to the improvement in the portion of
the Company's residential loan portfolio classified as non-accrual. For a
discussion of the Company's allowance for loan and valuation losses as it
relates to nonperforming assets, see "--Asset and Liability
Management-Nonperforming Assets."
LOAN ADMINISTRATION. Loan administration fees increased $1.1 million, or
13.9%, to $8.8 million for the year ended December 31, 1996, as compared to $7.7
million for the year ended December 31, 1995. This increase was primarily
attributable to the increase in the average outstanding principal balance
underlying the Company's mortgage servicing rights portfolio for the year ended
December 31, 1996, as compared to the year ended December 31, 1995. Loan
administration fees are affected by factors that include the size of the
Company's residential mortgage loan servicing portfolio, the servicing spread,
the timing of payment collections, and the amount of ancillary fees collected.
The mortgage loan servicing portfolio owned increased by $908.7 million, or
56.9%, to $2.5 billion for the year ended December 31, 1996, as compared to $1.6
billion for the year ended December 31, 1995, with the majority of the increase
occurring in the fourth quarter of 1996.
BROKERAGE FEES. Brokerage fees decreased $423,000, or 8.8%, to $4.4
million for the year ended December 31, 1996, as compared to $4.8 million for
the year ended December 31, 1995. This decrease is a direct result of the amount
of the residential mortgage servicing portfolios brokered by United Financial.
The balance of residential mortgage servicing portfolios brokered by United
Financial, in terms of aggregate unpaid principal balances on the underlying
loans, decreased $6.2 billion, or 19.0%, to $26.4 billion the year ended
December 31, 1996, as compared to $32.6 billion for the year ended December 31,
1995. The decrease was primarily due to the amount of servicing brokered in the
first quarter of 1996 as mortgage banking firms and financial institutions
deferred servicing sales pending their review of the impact of FAS 122 on their
portfolios.
GAIN ON SALE OF LOANS AND MORTGAGE BACKED SECURITIES. Gain on the sale
of loans and mortgage backed securities increased $97,000, or 3.0%, to $3.4
million the year ended December 31, 1996, as compared to $3.3 million for the
year ended December 31, 1995. Gain on sale of loans can fluctuate significantly
from quarter to quarter and from year to year based on a variety of factors,
such as the current interest rate environment, the supply of loan portfolios in
the market, the mix of loan portfolios available in the market, the type of loan
portfolios the Company purchases, and the particular loan portfolios the Company
elects to sell. The Company's strategy has been and will continue to be to match
its purchases and sales while managing its desired growth.
21
GAIN ON SALE OF MORTGAGE SERVICING RIGHTS. Gain on the sale of mortgage
servicing rights increased $2.0 million, or 177.7%, to $3.2 million for the year
ended December 31, 1996, as compared to $1.2 million for the year ended December
31, 1995. In terms of aggregate outstanding principal balances of mortgage loans
underlying such servicing rights, the Company sold $646.0 million in purchased
mortgage servicing rights for the year ended December 31, 1996 as compared to
$31.8 million for the year ended December 31, 1995. A portion of the servicing
rights sold in 1996 pertained to mortgage servicing portfolios that the Company
combined with the related loan participation interests, and then sold as one
asset. The servicing portfolio sold in 1995 consisted of loans with non-standard
payment accrual methodologies, including the Rule of 78's and daily simple
interest accruals, and were secured by second liens. The sales in 1996 were
consummated primarily to generate additional cash flow in order to acquire more
desirable residential servicing portfolios and to generate revenues.
LOAN ORIGINATION. Loan origination income decreased $508,000, or 24.6%,
to $1.6 million for the year ended December 31, 1996, as compared to $2.1
million for the year ended December 31, 1995, even though the Company
experienced an increase in wholesale residential mortgage loan production of
$194.4 million, or 50.0%, to $583.3 million for the year ended December 31,
1996, as compared to $388.9 million for the year ended December 31, 1995. This
decrease was primarily attributable to a $1.9 million secondary marketing loss
that occurred in March 1996. The secondary marketing loss was attributable to
the failure of a former officer of Matrix Financial to adhere to the established
hedging policies. As a result, certain closed loans were not adequately hedged
which resulted in a $1.9 million loss when interest rates increased dramatically
in March 1996, thereby causing the funded loans and pipeline commitments to
decline in market value. Had the policies been followed, the Company would still
have recognized a loss, albeit significantly smaller, since it is difficult for
the Company to be completely hedged when interest rates rapidly and
significantly change. The Company has implemented several management and
reporting changes to help ensure that the hedging policies established by Matrix
Financial's board of directors are adhered to so as to mitigate secondary losses
in volatile interest rate markets. Loan origination income includes all mortgage
loan fees, secondary marketing activity on new loan originations, servicing
release premiums on new originations sold, net of outside origination costs.
NONINTEREST EXPENSE. Noninterest expense increased $5.8 million, or
33.9% to $23.0 million for the year ended December 31, 1996, as compared to
$17.1 million for the year ended December 31, 1995. This increase was primarily
due to the one time SAIF assessment of $450,000 (pre-tax), reserve for the
probable settlement of certain outstanding litigation, expenses related to new
operating subsidiaries and expenses related to the operating loss and recourse
losses on sub-prime automobile installment contracts sold by Sterling and the
ceasing of its operations in December 1996. The following table details the
major components of noninterest expense for the periods indicated:
YEAR ENDED
DECEMBER 31,
---------------------
1995 1996
---------- ----------
(IN THOUSANDS)
Compensation and employee benefits ................................. $ 8,586 $ 10,604
Amortization of mortgage servicing rights .......................... 1,817 2,432
Occupancy and equipment............................................. 1,124 1,415
Professional fees................................................... 660 468
Data processing..................................................... 529 604
Other............................................................... 4,420 7,428
------- -------
Total........................................................... $ 17,136 $ 22,951
======= =======
Compensation and employee benefits increased $2.0 million, or 23.5% to
$10.6 million for the year ended December 31, 1996, as compared to $8.6 million
for the year ended December 31, 1995. This increase was the result of the
expansion of the Company's business lines in 1996, including the opening of two
new branches of Matrix Bank, the formation of two new operating subsidiaries,
and the increased amount of wholesale mortgage loan originations (i.e.,
employees in the mortgage loan origination area are typically compensated on a
commission basis). The Company had an increase of 29 employees, or 17.8%, to 192
employees at year end December 31, 1996, as compared to 163 employees at year
end December 31, 1995. The Company also employed an additional 20 employees
during portions of 1996 at Sterling.
Amortization of mortgage servicing rights increased $615,000, or 33.8%,
to $2.4 million for the year ended December 31, 1996, as compared to $1.8
million for the year ended December 31, 1995. Amortization of mortgage
22
servicing rights fluctuates based on the size of the Company's mortgage
servicing portfolio and the prepayment rates experienced with respect to the
underlying mortgage loan portfolio.
The remainder of noninterest expense, which includes occupancy and
equipment expenses, professional fees, data processing costs and other expenses
increased $3.2 million, or 47.3%, to $9.9 million for the year ended December
31, 1996, as compared to $6.7 million for the year ended December 31, 1995. The
increase was primarily attributable to the one-time SAIF assessment, the reserve
for the probable settlement of certain outstanding litigation, expansion of both
existing and new business lines, the formation of two operating subsidiaries,
the opening of two bank branches, and the recourse losses on automobile
installment contracts sold by Sterling and the ceasing of operations in December
1996.
PROVISION FOR INCOME TAXES. Provision for income taxes decreased
$154,000, or 6.8%, to $2.1 million for the year ended December 31, 1996, as
compared to $2.3 million for the year ended December 31, 1995. The decrease was
due to the decline in pre-tax income. The two periods had comparable effective
income tax rates of 39.2% and 38.8% respectively.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995 AND
1994
NET INCOME; RETURN ON AVERAGE EQUITY. Net income increased $915,000, or
34.6%, to $3.6 million for the year ended December 31, 1995, as compared to $2.6
million for the year ended December 31, 1994. Return on average equity decreased
to 51.4% for the year ended December 31, 1995, as compared to 58.5% for the year
ended December 31, 1994. The decrease in return on average equity was primarily
due to the Company's policy of retaining all of its earnings, which increased
the Company's equity base.
NET INTEREST INCOME. Net interest income before provision for loan and
valuation losses decreased $453,000, or 11.4%, to $3.5 million for the year
ended December 31, 1995, as compared to $4.0 million for the year ended December
31, 1994. The decrease for the year ended December 31, 1995 was attributable
primarily to the increase in the Company's cost of interest-bearing liabilities,
which increased to 7.14% for the year ended December 31, 1995, as compared to
5.16% for the year ended December 31, 1994. The increase in the cost of
interest-bearing liabilities was primarily related to borrowings used to fund
the increase in the mortgage loan originations. The Company's mortgage loan
originations are funded through borrowings based on short-term interest rates.
The interest rate spread between short-term interest rates and long-term
interest rates generally was lower during the year ended December 31, 1995, as
compared to the year ended December 31, 1994. The decrease occurred primarily
because the cost of interest-bearing liabilities increased more rapidly than the
yield on interest-earning assets. The effect of smaller spreads between
long-term interest rates and short-term interest rates means generally that the
Company earns less net interest income on its wholesale mortgage loan
originations which, in turn, reduces its net interest margin (net interest
income before provision for loan losses divided by average interest-earning
assets). The Company's net interest margin decreased to 2.81% for the year ended
December 31, 1995, as compared to 4.63% for the year ended December 31, 1994.
The effect of the lower interest rate margin was partially offset by an increase
in the Company's average interest-earning assets. The Company's average
interest-earning assets increased $39.8 million, or 46.3%, to $125.9 million for
the year ended December 31, 1995, as compared to $86.1 million for the year
ended December 31, 1994. This increase was attributable primarily to the
increase in the size of the Company's loan portfolio held for sale. For a
tabular presentation of the changes in net interest income due to changes in
volume of interest-earning assets and changes in interest rates, see "--Analysis
of Changes in Net Interest Income Due to Changes in Interest Rates and Volumes."
PROVISION FOR LOAN AND VALUATION LOSSES. The provision for loan and
valuation losses increased $185,000, or 85.6%, to $401,000 for the year ended
December 31, 1995, as compared to $216,000 for the year ended December 31, 1994.
This increase was attributable primarily to the corresponding increase in the
size of the Company's loan portfolio. For a discussion of the Company's
allowance for loan and valuation losses as it relates to nonperforming assets,
see "--Asset and Liability Management--Nonperforming Assets."
LOAN ADMINISTRATION. Loan administration fees increased $823,000, or 11.9%,
to $7.7 million for the year ended December 31, 1995, as compared to $6.9
million for the year ended December 31, 1994. This increase was attributable
primarily to the increase in the average outstanding principal balance
underlying the Company's mortgage servicing rights portfolio for the year ended
December 31, 1995, as compared to the year ended December 31, 1994.
BROKERAGE FEES. Brokerage fees increased $770,000, or 19.2%, to $4.8 million
for the year ended December 31, 1995, as compared to $4.0 million for the year
ended December 31, 1994. The increase was primarily attributable to an
23
increase in the volume of residential mortgage servicing portfolios brokered by
United Financial. The balance of residential mortgage servicing portfolios
brokered by United Financial, in terms of aggregate unpaid principal balances on
the underlying loans, increased $3.7 billion, or 12.8%, to $32.6 billion for the
year ended December 31, 1995, as compared to $28.9 billion for the year ended
December 31, 1994.
GAIN ON SALE OF LOANS AND MORTGAGE-BACKED SECURITIES. Gain on sale of
mortgage loans and mortgage-backed securities increased by $1.7 million, or
105.8%, to $3.3 million for the year ended December 31, 1995, as compared to
$1.6 million for the year ended December 31, 1994. The increase was attributable
primarily to the type of loan portfolios that the Company purchased during 1995.
The Company's strategy has been and will continue to be to match its purchases
and sales while managing its desired growth. Therefore, the increase of $1.7
million in gain on loan sales was attributable to the Company's loan purchases,
which affect the mix, and to a limited extent the amount of the loan portfolios
that the Company sold.
GAIN ON SALE OF MORTGAGE SERVICING RIGHTS. Gain on sale of mortgage
servicing rights increased $480,000, or 70.2%, to $1.2 million for the year
ended December 31, 1995, as compared to $684,000 for the year ended December 31,
1994. This increase resulted primarily from one particular sale of mortgage
servicing rights with aggregate unpaid principal balances of $16.2 million,
resulting in a gain of $1.0 million. The servicing portfolio sold consisted of
loans with non-standard payment accrual methodologies, including the Rule of 78s
and daily simple interest accruals, and were secured by second liens. The sale
allowed the Company to deploy the cash generated to purchase new servicing
portfolios considered by the Company to be more conforming in nature and,
thereby, enhance the efficiencies of the Company's servicing operations.
LOAN ORIGINATION. Loan origination income increased $775,000, or 59.9%, to
$2.1 million for the year ended December 31, 1995, as compared to $1.3 million
for the year ended December 31, 1994. The increase of $775,000 was primarily the
result of the increase in new loan origination volume experienced by Matrix
Financial during 1995. The new loan origination volume increased $205.8 million,
or 112.4%, to $388.9 million for the year ended December 31, 1995, as compared
to $183.1 million for the year ended December 31, 1994.
NONINTEREST EXPENSE. Noninterest expense increased $2.8 million, or 20.0%,
to $17.1 million for the year ended December 31, 1995, as compared to $14.3
million for the year ended December 31, 1994. This increase was primarily a
result of the continued expansion and diversification of the Company's
operations during 1995. The following table details the major components of
noninterest expense for the periods indicated:
YEAR ENDED
DECEMBER 31,
---------------------
1994 1995
---------- ----------
(IN THOUSANDS)
Compensation and employee benefits................................... $ 7,719 $ 8,586
Amortization of mortgage servicing rights............................ 1,185 1,817
Occupancy and equipment.............................................. 1,067 1,124
Professional fees.................................................... 485 660
Data processing...................................................... 492 529
Other................................................................ 3,331 4,420
------- -------
Total............................................................ $ 14,279 $ 17,136
======= =======
Compensation and employee benefits increased $867,000, or 11.2%, to $8.6
million for the year ended December 31, 1995, as compared to $7.7 million for
the year ended December 31, 1994. The majority of the increase was directly
related to the increase in the brokerage volume at United Financial and the loan
origination volume at Matrix Financial. The majority of employees engaged in
these activities are paid on a commission basis. The brokerage volume increased
$3.7 billion, or 12.8%, and the loan originations increased $205.8 million, or
112.4%, resulting in an increase in compensation of approximately $800,000. The
remainder of the increase is attributable to the Company's development and
expansion of both existing and new business lines during 1995, which also
resulted in the expansion of the Company's employee base. The Company had a
total of 163 employees at December 31, 1995, as compared to 153 at December 31,
1994.
24
Amortization of mortgage servicing rights increased $632,000, or 53.3%, to
$1.8 million for the year ended December 31, 1995, as compared to $1.2 million
for the year ended December 31, 1994. This increase was due to the growth in the
Company's average outstanding balance of servicing rights, but was partially
offset by the slower rate of prepayments experienced during the year ended
December 31, 1995, as compared to the year ended December 31, 1994.
The remaining non-interest expense, including occupancy and equipment
expenses, professional fees, data processing costs, and other expenses, such as
telephone, postage, advertising and insurance, increased $1.3 million, or 25.3%,
to $6.7 million for the year ended December 31, 1995, as compared to $5.4
million for the year ended December 31, 1994. The increase was the result of the
development and expansion of both existing and new business lines.
PROVISIONS FOR INCOME TAXES. Provisions for income taxes increased $414,000,
or 22.4%, to $2.3 million for the year ended December 31, 1995, as compared to
$1.8 million for the year ended December 31, 1994. The increase was due to the
increase in pre-tax income. The two periods had comparable effective tax rates
of 39% and 41%, respectively.
AVERAGE BALANCE SHEET
The following table sets forth for the periods and as of the dates indicated
information regarding the Company's average balances of assets and liabilities
as well as the dollar amounts of interest income from interest-earning assets
and interest expense on interest-bearing liabilities and the resultant yields or
costs. Ratio, yield and rate information are based on average daily balances
where available; otherwise, average monthly balances have been used. Nonaccrual
loans are included in the calculation of average balances for loans for the
periods indicated.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------------
1994 1995 1996
---------------------------- ----------------------------- -----------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------- ----------- -------- ------- ----------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Interest-earning assets:.
Loans receivable, net of
discounts.....................$ 79,393 $ 6,681 8.42 % $ 121,206 $ 10,412 8.59 % $ 162,648 $ 15,733 9.67 %
Mortgage-backed securities..... -- -- -- -- -- -- 4,653 351 7.54
Interest-earning deposits...... 5,974 299 5.01 3,381 232 6.86 5,191 255 4.91
FHLB stock..................... 716 35 4.89 1,321 86 6.51 2,585 153 5.92
-------- ------ ------- --------- -------- ------ --------- -------- -------
Total interest-earning assets. 86,083 7,015 8.15 125,908 10,730 8.52 175,077 16,492 9.42
Noninterest earning assets:
Cash........................... 1,618 2,046 2,543
Allowance for loan and
valuation losses.............. (690) (836) (964)
Premises and equipment......... 3,639 4,909 6,540
Other assets................... 7,624 17,611 25,704
-------- --------- ---------
Total noninterest-earning
assets....................... 12,191 23,730 33,823
-------- --------- ---------
Total assets..................$ 98,274 $ 149,638 $ 208,900
======== ========= =========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest-bearing liabilities:
Passbook accounts..............$ 2,788 72 2.58 $ 2,394 85 3.55 $ 2,389 82 3.45
Money market and negotiable
order of withdrawal
("NOW") accounts.............. 9,481 271 2.86 8,320 292 3.51 11,964 468 3.91
Certificates of deposit........ 29,273 1,138 3.89 33,332 1,807 5.42 54,824 3,210 5.85
FHLB borrowings................ 3,071 213 6.94 17,662 1,113 6.30 35,838 2,039 5.69
Borrowed money................. 14,008 1,332 9.51 39,021 3,897 9.98 54,171 4,691 8.66
-------- ------ ------- --------- -------- ------ --------- -------- -------
Total interest-bearing
liabilities.................. 58,621 3,026 5.16 100,729 7,194 7.14 159,186 10,490 6.59
-------- ------ ------- --------- -------- ------ --------- -------- -------
Noninterest-bearing liabilities:
Demand deposits (including
custodial escrow balances).... 30,559 35,794 27,934
Other liabilities.............. 4,570 6,184 8,633
-------- --------- ---------
Total noninterest bearing
liabilities................... 35,129 41,978 36,567
Shareholders' equity........... 4,524 6,931 13,147
-------- --------- ---------
Total liabilities and
shareholders' equity.........$ 98,274 $ 149,638 $ 208,900
======== ========= =========
Net interest income before
provision for loan
and valuation losses............ $ 3,989 $ 3,536 $ 6,002
====== ======= =======
Interest rate spread............. 2.99 % 1.38 % 2.83 %
======= ====== ======
Net interest margin.............. 4.63 % 2.81 % 3.43 %
======= ====== ======
Ratio of average
interest-earning assets to
average interest-bearing
liabilities..................... 146.8 % 125.00 % 109.98 %
======= ====== ======
25
ANALYSIS OF CHANGES IN NET INTEREST INCOME DUE TO CHANGES IN INTEREST RATES AND
VOLUMES
The following table presents the dollar amount of changes in interest income
and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the increase or decrease
related to changes in balances and changes in interest rates. For each category
of interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (i.e., changes in
volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate
multiplied by old volume). For purposes of this table, changes attributable to
both rate and volume, which cannot be segregated, have been allocated
proportionately to the change due to volume and the change due to rate.
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1995 VS 1994 1996 VS 1995
------------------------------- ---------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO CHANGE IN DUE TO CHANGE IN
------------------------------- ---------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
---------- ---------- --------- --------- ---------- -----------
(IN THOUSANDS)
Interest-earning assets:
Loans receivable, net of discounts........... $ 3,519 $ 212 $ 3,731 $ 3,561 $ 1,760 $ 5,321
Mortgage-backed securities................... -- -- -- -- 351 351
Interest-earning deposits.................... (130) 63 (67) 124 (101) 23
FHLB stock................................... 30 21 51 82 (15) 67
------- ------- -------- ------ ------- --------
Total interest-earning assets.............. 3,419 296 3,715 3,767 1,995 5,762
------- ------- -------- ------ ------- --------
Interest-bearing liabilities:
Passbook accounts............................ (10) 23 13 -- (3) (3)
Money market and NOW accounts................ (33) 54 21 128 48 176
Certificates of deposit...................... 158 512 670 1,165 238 1,403
FHLB advances................................ 1,012 (112) 900 1,145 (219) 926
Borrowed money............................... 2,378 186 2,564 1,513 (719) 794
------- ------- -------- ------ ------- --------
Total interest-bearing liabilities......... 3,505 663 4,168 3,951 (655) 3,296
------- ------- -------- ------ ------- --------
Change in net interest income before
provision for loan and valuation losses........ $ (86) $ (367) $ (453) $ (184) $ 2,650 $ 2,466
======== ======= ======== ======= ======= ========
ASSET AND LIABILITY MANAGEMENT
GENERAL. The Company structures its operations to derive the majority of its
revenues and earnings from noninterest income. However, a portion of the
Company's revenues and net income is derived from net interest income and,
accordingly, the Company strives to manage its interest-earning assets and
interest-bearing liabilities to generate what management believes to be an
appropriate contribution from net interest income. Asset and liability
management seeks to control the volatility of the Company's performance due to
changes in interest rates. The Company constantly attempts to achieve an
appropriate relationship between rate sensitive assets and rate sensitive
liabilities. The Company has responded to interest rate volatility by developing
and implementing asset and liability management strategies designed to increase
its noninterest income and improve the match between interest-earning assets and
interest-bearing liabilities. These strategies include:
. Utilizing mortgage servicing rights as a source of noninterest income and
as a countermeasure against the decline in the value of mortgage loans
during a rising interest rate environment. Increases in interest rates
tend to increase the value of mortgage servicing rights because of the
resulting decrease in prepayment rates on the underlying loans;
. Increasing the noninterest bearing custodial escrow balances related to
the Company's mortgage servicing rights;
. Increasing focus on lines of business that are less interest rate
sensitive, such as brokerage activities, consulting services, self-
directed trust services, and real estate disposition;
. Maintaining a wholesale loan origination operation. Wholesale originations
provide a form of hedge against the balance of mortgage loan servicing
rights. In a decreasing interest rate environment, the value of the
servicing portfolio tends to decrease due to increased prepayments of the
underlying loans. During this same period, however, the volume of loan
originations generally increases;
26
. Originating and purchasing adjustable rate mortgages and selling newly
originated fixed rate residential mortgages in the secondary market;
. Increasing emphasis on the origination of construction and commercial
real estate lending, which tend to have higher interest rates with
shorter loan maturities than residential mortgage loans;
. Increasing retail deposits, which are less susceptible to changes in
interest rates than other funding sources; and
. Pursuing strategic acquisitions that provide fee-based income or generate
liabilities that are less expensive or less interest rate sensitive than
retail deposits or borrowings from third party institutions to fund the
Companies investing activities
LENDING ACTIVITIES. The major interest earning asset of the Company is the
loan portfolio. Consequently, a significant part of the Company's asset and
liability management is monitoring the composition of the Company's loan
portfolio, including the corresponding maturities. The table below sets forth
the composition of the Company's loan portfolio by loan type as of the dates
indicated. The amounts in the table below are shown net of discounts and other
deductions.
AS OF DECEMBER 31,
-------------------------------------------------------------------------------
1993 1994 1995 1996
------------------ ------------------- ------------------ ------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
-------- ------- ------ ------- ------ ------- ------- --------
(DOLLARS IN THOUSANDS)
Residential...................... $ 65,858 86.10 % $ 80,010 89.56 % $ 136,741 93.23 % $198,736 93.59 %
Multi-family and commercial real
estate......................... 7,813 10.21 7,518 8.41 7,544 5.15 8,734 4.11
Construction..................... 125 0.16 106 0.12 78 0.05 1,061 0.50
Consumer......................... 3,238 4.23 2,434 2.72 3,245 2.21 4,869 2.29
------- ------ ------- ------ --------- ------ ------ -----
Total loans.................. 77,034 100.70 90,068 100.81 147,608 100.64 213,400 100.49
Less allowance for loan and
valuation losses............. 538 0.70 728 0.81 943 0.64 1,039 0.49
-------- ------ -------- ------ --------- ------ -------- ------
Loans receivable, net............ $ 76,496 100.00 % $ 89,340 100.00 % $ 146,665 100.00 % $212,361 100.00 %
======== ====== ======== ====== ========= ====== ======== ======
The following table presents the aggregate maturities of loans in each major
category of the Company's loan portfolio as of December 31, 1996. Loans held for
sale are classified as maturing within one year. Actual maturities may differ
from the contractual maturities shown below as a result of renewals and
prepayments or the timing of loan sales.
AS OF DECEMBER 31, 1996
--------------------------------------------
LESS THAN ONE TO OVER FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
--------- ---------- --------- -------
(IN THOUSANDS)
Residential.................................... $ 186,324 $ 618 $11,794 $ 198,736
Multi-family and commercial real estate........ 5 108 8,621 8,734
Construction................................... 1,061 -- -- 1,061
Consumer....................................... 1,159 2,446 1,264 4,869
--------- --------- ------- ---------
Total loans................................ $ 188,549 $ 3,172 $21,679 $ 213,400
========= ========= ======= =========
NONPERFORMING ASSETS. As part of asset and liability management, the
Company monitors nonperforming assets ("NPAs") on a monthly basis. NPAs consist
primarily of nonaccrual loans and foreclosed real estate. Loans are placed on
nonaccrual when full payment of principal or interest is in doubt or when they
are past due 90 days as to either principal or interest. Foreclosed real estate
arises primarily through foreclosure on mortgage loans owned. The following
table sets forth the Company's NPAs as of the dates indicated:
27
AS OF DECEMBER 31,
---------------------------------------------------------
1993 1994 1995 1996
----------- ----------- ----------- ------------
(DOLLARS IN THOUSANDS)
Nonaccrual mortgage loans....................... $ 657 $ 3,275 $ 5,523 $ 3,031
Nonaccrual consumer loans....................... 196 39 15 872
----------- ---------- ----------- ------------
Total nonperforming loans................... 853 3,314 5,538 3,903
Foreclosed real estate.......................... 726 543 835 788
Repossessed automobiles......................... -- -- -- 506
----------- ----------- ----------- ------------
Total nonperforming assets.................. $ 1,579 $ 3,857 $ 6,373 $ 5,197
=========== =========== =========== ============
Total nonperforming assets to total assets...... 1.65% 3.44 % 3.45 % 1.90 %
Total nonperforming loans to total loans........ 1.11% 3.68 % 3.75 % 1.83 %
Ratio of allowance for loan and valuation losses
to total non-performing loans............... 63.07% 21.97 % 17.03 % 26.62 %
Interest income on non-performing loans not
included in interest income................... $ 23 $ 140 $ 156 $ 120
As of December 31, 1996, the Company had no accruing loans that were
contractually past due 90 days or more. The higher levels of mortgage nonaccrual
loans during 1994 and 1995 were primarily attributable to purchases by Matrix
Bank of bulk residential loan portfolios in those years. As part of its business
strategy, Matrix Bank purchases loans at a discount that have had delinquencies
in the past. Due to the past delinquency problems, there is often an increase in
delinquencies after the loans are purchased as a result of the servicing being
transferred to the Company. The Company's experience has been that it generally
takes 90 to 120 days after the servicing transfer to see an improvement in the
delinquency statistics. The decrease in the mortgage nonaccrual loans at
December 31, 1996 is attributable to the improvement of the loans that had past
delinquency problems and the credit quality of the loan portfolios the Company
acquired in 1996. In 1996, Matrix Bank acquired loans with less delinquency
problems and/or document deficiencies, which also resulted in a decrease in the
nonaccrual loans.
The increase in the nonaccrual consumer loans pertains to sub-prime auto
loans that the Company repurchased pursuant to limited representations and
warranties included in loan sale agreements. The Company has a separate reserve
of $600,000 included in other liabilities for anticipated losses relating to the
repurchased sub-prime auto loans at December 31, 1996. Included in repossessed
assets for 1996 is $506,000 of automobiles that the Company was required to
repurchase pursuant to the same limited representations and warranties. The
balance of the repossessed assets have been written down to the anticipated
recoverable amount. The Company sold the fixed assets of Sterling Finance in
December 1996 and it is anticipated it will originate no additional sub-prime
automobile contracts.
The prior delinquency and anticipated future delinquencies are taken into
consideration in the pricing of the loans acquired. The Company generally
purchases such loans at discounts and, in some instances, receives recourse or
credit enhancement from the seller to further reduce the Company's risk of loss
associated with the loans' nonaccrual status. At December 31, 1996, $2.8
million, or 72.50%, of the nonaccrual loans were loans that were residential
loans purchased in bulk loan portfolios and remain classified as "held for
sale." Total loans held for sale at December 31, 1996, were $182.8 million, of
which $2.8 million or 1.5% were nonaccrual loans. However, against the $182.8
million of total loans held for sale, the Company has $2.8 million of purchase
discounts plus an additional $1.8 million of credit enhancements related to
specific segments of the loan portfolio.
The percentage of the allowance for loan and valuation losses to nonaccrual
loans varies widely due to the nature of the Company's portfolio of mortgage
loans, which are collateralized primarily by residential real estate. The
Company analyzes the collateral for each nonperforming mortgage loan to
determine potential loss exposure. In conjunction with other factors, this loss
exposure contributes to the overall assessment of the adequacy of the allowance
for loan and valuation losses. See "--Comparison of Results of Operations for
the Years Ended December 31, 1996 and 1995."
28
ANALYSIS OF ALLOWANCE FOR LOAN AND VALUATION LOSSES. The following table
sets forth information regarding changes in the Company's allowance for loan and
valuation losses for the periods indicated. The table includes the allowance for
both the loans held for investment and the loans held for sale.
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1993 1994 1995 1996
----------- -------- ------- --------
(DOLLARS IN THOUSANDS)
Balance at beginning of period................................. $ -- $ 538 $ 728 $ 943
Charge-offs:
Real estate-mortgage....................................... 33 26 198 64
Real estate-construction................................... -- -- 35 --
Consumer................................................... -- -- 7 6
--------- --------- --------- ---------
Total charge-offs...................................... 33 26 240 70
Recoveries:
Real estate-mortgage....................................... -- -- 5 8
Consumer................................................... -- -- 49 15
--------- --------- --------- ---------
Total recoveries....................................... -- -- 54 23
--------- --------- --------- ---------
Net charge-offs................................................ 33 26 186 47
Allowance for loan losses established in connection with the
acquisition of Matrix Bank................................. 556 -- -- --
--------- --------- --------- ---------
Provision for loan losses charged to operations................ 15 216 401 143
--------- --------- --------- ---------
Balance at end of period....................................... $ 538 $ 728 $ 943 $ 1,039
========= ========= ========= =========
Ratio of net charge-offs to average loans...................... .18 % .03 % .15 % .03 %
========= ========= ========= =========
Average loans outstanding during the period.................... $ 18,608 $ 79,393 $ 121,206 $ 162,648
========= ========= ========= =========
The allowance for loan and valuation losses is increased by the provision
for loan and valuation losses (which is charged to operations) for particular
loans where management considers ultimate collection to be questionable. The
allowance for loan and valuation losses is calculated, in part, based on
historical loss experience. In addition, management takes into consideration
other factors such as certain qualitative evaluations of individual classified
assets, trends in the portfolio, geographic and portfolio concentrations, new
products or markets, evaluations of the changes in the historical loss
experience component, and projections of this component into the current and
future periods based on current knowledge and conditions. Due to the nature of
the Company's loan portfolio, substantially all of the allowance for loan and
valuation losses relates to residential loans. The ratio of the allowance for
loan and valuation losses to total loans was .81%, .64% and .49% at December 31,
1994, 1995, and 1996, respectively. The allowance for loan and valuation losses
is reduced by loans charged off, net of recoveries.
RISK SENSITIVE ASSETS AND LIABILITIES. A traditional indicator of interest
rate risk is gap analysis. Gap analysis focuses on the difference (or gap)
between available repricing opportunities for assets and liabilities within
defined time periods. If the dollar amount of interest rate sensitive assets is
closely matched with the dollar amount of interest rate sensitive liabilities in
a given period, then the changes in interest income and interest expense over
this time frame should also be closely matched.
The following table sets forth the estimated maturity or repricing, and the
resulting interest rate gap, of the Company's interest-earning assets and
interest-bearing liabilities as of December 31, 1996. The amounts in the table
are derived from internal data of the Company and could be significantly
affected by external factors such as changes in prepayment assumptions, early
withdrawals of deposits, and competition. Loans held for sale are classified as
maturing within one year due to the Company's expectation of selling its loans
held for sale within one year.
29
ESTIMATED MATURITY OR REPRICING
----------------------------------------------------------------------------
THREE MONTHS TO
LESS THAN THREE LESS THAN ONE TO OVER
MONTHS ONE YEAR FIVE YEARS FIVE YEARS TOTAL
--------------- --------------- ---------- ----------- -----------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Fixed-rate loans............... $ 34,182 $ 48,288 $ 2,950 $ 5,426 $ 90,846
Adjustable-rate loans.......... 27,659 80,709 14,186 -- 122,554
Interest-earning deposits...... 9,499 -- -- -- 9,499
FHLB stock..................... 2,871 -- -- -- 2,871
-------- ------------ ----------- -------- ---------
Total interest-earning assets 74,211 128,997 17,136 5,426 225,770
Interest-bearing liabilities:
Passbook, NOW and money market
accounts..................... 16,944 -- -- -- 16,944
Certificates of deposit over
$100,000..................... 1,688 2,689 1,080 -- 5,457
Other certificates of deposit.. 13,458 36,772 17,548 -- 67,778
FHLB borrowings................ 51,250 -- -- -- 51,250
Short term borrowings.......... 31,504 -- -- -- 31,504
Other borrowings............... 101 738 7,460 2,628 10,927
-------- ------------ ----------- -------- ---------
Total interest-bearing
liabilities............... 114,945 40,199 26,088 2,628 183,860
-------- ------------ ----------- -------- ---------
Interest rate gap................ $ (40,734) $ 88,798 $ (8,952) $ 2,798 $ 41,910
======== ============ =========== ======== =========
Cumulative interest rate gap..... $ (40,734) $ 48,064 $ 39,112 $ 41,910
Gap/assets ratio................. (18.04) % 39.33 % (3.97) % 1.24 %
Cumulative gap/assets ratio...... (18.04) % 21.29 % 17.32 % 18.56 %
Gap analysis attempts to capture interest rate risk, which is attributable
to the mismatching of interest rate sensitive assets and liabilities. The actual
impact of interest rate movements on the Company's net interest income may
differ from that implied by any gap measurement, depending on the direction and
magnitude of the interest rate movements, the repricing characteristics of
various on and off-balance sheet instruments, as well as competitive pressures.
These factors are not fully reflected in the foregoing gap analysis and, as a
result, the gap report may not provide a complete assessment of the Company's
interest rate risk.
The generally positive cumulative gap value means that over the periods
indicated the assets of the Company will reprice slightly faster than the
Company's liabilities. This means generally that, in a rising interest rate
environment, net interest income can be expected to increase and that, in a
declining interest rate environment, net interest income can be expected to
decrease.
SHORT-TERM BORROWINGS. A primary function of asset and liability management
is to assure adequate liquidity. In addition to cash and cash equivalents, the
Company relies heavily on short-term borrowing capabilities for liquidity and as
funding vehicle. The primary sources for short-term borrowing are the FHLB for
Matrix Bank and unaffiliated financial institutions for Matrix Financial. See
"--Liquidity and Capital Resources."
30
The following table sets forth a summary of the short-term borrowings of the
Company during 1994, 1995, and 1996 and as of the end of each such period:
AVERAGE WEIGHTED WEIGHTED
AMOUNT AMOUNT MAXIMUM AVERAGE AVERAGE
OUTSTANDING OUTSTANDING OUTSTANDING INTEREST INTEREST
AT DURING THE AT ANY RATE DURING RATE AT
YEAR END YEAR(1) MONTH END THE YEAR (%) YEAR END (%)
------------- ------------ ----------- ------------- -------------
At or for the year ended December 31, 1994: (DOLLARS IN THOUSANDS)
FHLB borrowings.................. $ 14,600 $ 3,071 $ 15,000 6.94 % 6.50 %
Revolving lines of credit........ 9,890 4,917 11,042 9.29 9.21
Repurchase agreements............ 2,529 4,320 6,157 8.03 7.18
At or for the year ended December 31, 1995:
FHLB borrowings.................. 19,000 17,662 33,000 6.30 6.30
Revolving lines of credit........ 46,833 22,842 46,833 7.57 7.30
Repurchase agreements............ 570 4,559 14,129 8.97 8.70
At or for the year ended December 31, 1996:
FHLB borrowings.................. 51,250 35,838 53,650 5.69 5.84
Revolving lines of credit........ 31,504 35,489 60,804 7.17 6.50
Repurchase agreements............ -- 991 4,962 12.58 --
- ---------
(1) Calculations are based on daily averages where available and monthly
averages otherwise.
PIPELINE MANAGEMENT. In the ordinary course of business, the Company makes
commitments to originate residential mortgage loans and holds originated loans
until delivery to an investor. Inherent in this business are risks associated
with changes in interest rates and the resulting change in the market value of
the pipeline loans. The Company mitigates this risk through the use of mandatory
and nonmandatory forward commitments to sell loans. As of December 31, 1996, the
Company had $62.6 million in pipeline and funded loans offset with mandatory
forward commitments of $49.1 million and nonmandatory forward commitments of
$8.1 million. The inherent value of the forward commitments is considered in the
determination of the lower of cost or market for such loans.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the ability of the Company to generate funds to support asset
growth, satisfy disbursement needs, maintain reserve requirements and otherwise
operate on an ongoing basis. To date, Matrix Capital's principal source of
funding for its investing activities has been secured senior debt provided by
unaffiliated financial institutions, the issuance of the 13% Senior Subordinated
Notes in August 1995, a bank stock loan and the Company's initial public
offering. As of December 31, 1996, Matrix Capital Corporation had $6.4
million in indebtedness outstanding. The borrowed funds have been used
historically as capital injections to Matrix Bank and Matrix Financial, as well
as to acquire the office building in Phoenix where Matrix Financial maintains
its headquarters. See "Properties."
The trend experienced over the reported periods of cash used by the
Company's operating activities results primarily from the growth that Matrix
Financial has experienced in its origination activities and the growth that
Matrix Bank has experienced in its whole loan purchasing activity. The growth in
the loan originations experienced by the Company has been due to a conscious
effort to increase loan originations and, to a lesser extent, market conditions.
The Company does not anticipate significant increases in loan origination
activities other than increases directly related to market conditions.
Nevertheless, the Company anticipates the trend of a net use of cash from
operations to continue for the foreseeable future. This anticipation results
from the expected growth at Matrix Bank, which management believes will consist
primarily of increased activity in the purchasing of loan portfolios. The
Company anticipates such growth will be funded through retail deposits,
custodial escrow deposits, directed trust deposits and FHLB borrowings.
The Company's principal source of funding for its servicing acquisition
activities consists of line of credit facilities provided to Matrix Financial by
unaffiliated financial institutions. In prior years, including the year ended
December 31, 1996, Matrix Financial relied on various sources for funding its
servicing acquisition activities, including servicing acquisition lines, the
sale of mortgage servicing rights that were accounted for as financings, and
capital contributions from the Company. As of December 31, 1996, Matrix
Financial's servicing acquisition facilities aggregated $13.5 million, of which
$12.0 million was available to be utilized after deducting drawn amounts.
Borrowings under the servicing acquisition lines of credit are secured by
mortgage servicing rights owned by Matrix Financial, bear interest at the
federal
31
funds rate plus a negotiated margin and are due at the earlier of the maturity
of the mortgage servicing rights or amortized over five to six years from the
date of borrowing. At December 31, 1996, $1.5 million was outstanding under the
servicing acquisition line and the interest rate on funds outstanding under this
facility at December 1996 was 8.05%.
The Company's principal source of funding for its loan origination business
consists of warehouse lines of credit and sale/repurchase facilities provided to
Matrix Financial by financial institutions and brokerage firms. As of December
31, 1996, Matrix Financial's warehouse lines of credit aggregated $50.0 million,
of which $18.5 million was available to be utilized. Borrowings under the
warehouse lines of credit are secured by all of the mortgage loans funded with
warehouse loan proceeds and bear interest at the federal funds rate plus a
negotiated margin. At December 31, 1996, $31.5 million was outstanding under the
warehouse lines of credit at a weighted average interest rate of 6.50%. As of
December 31, 1996, Matrix Financial's sale/repurchase facilities aggregated
$20.0 million, with no balances outstanding. Borrowings under the
sale/repurchase facilities are secured by all of the mortgage loans funded with
sale/repurchase facility proceeds and bear interest at either the prime rate or
the LIBOR rate plus a negotiated margin (depending on the facility).
The Company's principal source of funding for the working capital needs of
Matrix Financial consists of working capital facilities provided to Matrix
Financial by unaffiliated financial institutions. As of December 31, 1996,
Matrix Financial's working capital facilities aggregated $2.5 million, of which
$2.5 million was available. The amount of credit available for working capital
borrowings is a sublimit of the warehouse lines of credit, and therefore, any
amounts borrowed are netted against the amount of credit available from the
warehouse lines of credit. Borrowings under the working capital facilities are
secured by mortgage servicing rights, eligible servicing advance receivables,
and eligible delinquent mortgage loans and bear interest at the federal funds
rate plus a negotiated margin. At December 31, 1996, no amounts were outstanding
under the working capital facilities.
The amounts outstanding as stated above under Matrix Financial's servicing
acquisition facility, warehouse lines of credit, sale/repurchase facility, and
working capital facility were significantly reduced as a result of the Company's
completion of its initial public offering. The net proceeds raised from the
public offering were used to reduce balances outstanding on revolving credit
facilitities. With the acquisition of additional residential mortgage loan
servicing portfolios subsequent to the offering, the Company expects to fully
utilize all of its credit facilities.
On January 31, 1997, the Company renegotiated its revolving credit
facilities for warehouse lending, servicing acquisitions and working capital.
With this renegotiation, the aggregate amount of warehouse lines of credit
facilities was increased to $60.0 million, the aggregate amount of the servicing
acquisition facility was increased to $30.0 million, and the aggregate amount of
the working capital facility was increased to $10.0 million. The $10.0 million
working capital facility became a separate component to the revolving credit
facilities, and is no longer a sublimit to the warehouse line of credit. The new
credit facility agreement requires Matrix Financial to maintain (i) total
shareholder's equity of at least $10.0 million plus 100% of capital contributed
after January 1, 1997, plus 50% of cumulative quarterly net income, (ii)
adjusted net worth, as defined, of at least $12.0 million, (iii) a servicing
portfolio of at least $2.0 billion and (iv) principal debt of term line
borrowings of no more than the lesser of 70% of the appraised value of the
mortgage servicing portfolio or 1.25% of the unpaid principal balance of the
mortgage servicing portfolio.
In March 1997, the Company refinanced its bank stock loan and increased the
credit available under the loan by an additional $6.0 million. The new bank
stock loan has two components of the loan, a $2.0 million term loan, which was
used to refinance the bank stock loan in place at December 31, 1996, and a
revolving line of credit of $6.0 million. In March of 1998, the balance of the
revolving line of credit will be converted to a term loan. The additional
proceeds from the loan will be used as capital at Matrix Bank. The new bank
stock loan requires the Company to maintain (i) total stockholders' equity of
$27.5 million plus 100% of all future equity contributions, plus 50% of
cumulative quarterly net income (ii) dividends less than 50% of the Company's
net cash income after adjustments and (iii) total adjusted debt to stockholders'
equity less than 4 : 1.
In August 1995, the Company issued $2.9 million in aggregate principal
amount of 13% Senior Subordinated Notes. Interest on the 13% Senior Subordinated
Notes is payable semi-annually on January 15 and July 15, and the 13% Senior
Subordinated Notes mature on July 15, 2002, with earlier mandatory redemptions
of $727,500, or 25% of the 13% Senior Subordinated Notes, scheduled on July 15,
1999, 2000, and 2001, respectively. The Company is restricted from paying cash
dividends under the 13% (which adjusted to 14% in February 1997) Senior
Subordinated Notes. However, the Company may pay cash dividends in an amount
equal to 50% of the consolidated net income of the Company as long as there has
been no default under the terms of the 13% Senior Subordinated
32
Notes and as long as the dividend does not exceed 10% of the consolidated net
worth of the Company. The Company may redeem the 13% Senior Subordinated Notes,
in whole or in part, at any time on or after July 15, 1998; at a redemption
price equal to (i) 102% of par through July 14, 1999 and, thereafter, at par,
plus (ii) all accrued but unpaid interest.
Matrix Bank's primary source of funds for use in lending, purchasing bulk
loan portfolios, investing and other general purposes are retail deposits,
custodial escrow balances, FHLB borrowings, sales of loan portfolios and
proceeds from principal and interest payments on loans. Contractual loan
payments and deposit inflows and outflows are a generally predictable source of
funds, while loan prepayments and loan sales are significantly influenced by
general market interest rates and economic conditions. Borrowings on a
short-term basis are used as a cash management vehicle to compensate for
seasonal or other reductions in normal sources of funds. Matrix Bank utilizes
advances from the FHLB as its primary source for borrowings. At December 31,
1996, Matrix Bank had overnight borrowings from the FHLB of $51.3 million. The
custodial escrow balances held by Matrix Bank fluctuate based upon the mix and
size of the related servicing rights portfolios. For a tabular presentation of
the Company's short-term borrowings, see "--Short-term Borrowings."
Matrix Bank offers a variety of deposit accounts having a range of interest
rates and terms. Matrix Bank's deposits principally consist of demand deposits
and certificates of deposit. The flow of deposits is influenced significantly by
general economic conditions, changes in prevailing interest rates, and
competition. Matrix Bank's retail deposits are obtained primarily from areas in
which it is located and, therefore, its retail deposits are concentrated
primarily in Las Cruces and Sun City. Matrix Bank relies principally on customer
service, marketing programs, and its relationships with customers to attract and
retain these deposits. Matrix Bank currently does not solicit or accept brokered
deposits. In pricing deposit rates, management considers profitability, the
matching of term lengths with assets, the attractiveness to customers and rates
offered by competitors. Matrix Bank intends to continue its efforts to attract
deposits as a primary source of funds to support its lending and investing
activities.
In January 1996, Matrix Bank opened a retail branch in Sun City, Arizona.
The Company has been successful in attracting deposits at the Sun City location
and this success has been the primary reason for the increased deposit growth
that the Company has experienced for the year ended December 31, 1996. In
October 1996, Matrix Bank opened a second retail branch in Las Cruces. The
following table sets forth the average balances for each major category of
Matrix Bank's deposit accounts and the weighted average interest rates paid for
interest-bearing deposits for the periods indicated:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
1994 1995 1996
------------------------ ------------------------ -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
---------- --------- ---------- ---------- ---------- ------------
(DOLLARS IN THOUSANDS)
Passbook accounts...... $ 2,788 2.58 % $ 2,394 3.55 % $ 2,389 3.45 %
NOW accounts........... 2,131 1.69 2,460 2.11 2,813 2.24
Money market accounts.. 7,350 3.20 5,860 4.10 9,151 4.43
Time deposits.......... 29,273 3.89 33,332 5.42 54,824 5.85
-------- ----- ---------- ---- --------- ------
Total deposits..... $ 41,542 3.57 % $ 44,046 4.96 % $ 69,177 5.43 %
========== ===== ========== ==== ========= ======
The following table sets forth the amount of Matrix Bank's certificates of
deposit that are greater than $100,000 by time remaining until maturity as of
December 31, 1996:
AS OF DECEMBER 31, 1996
-------------------------------
WEIGHTED
AMOUNT AVERAGE
RATE PAID
-------------- ---------------
(DOLLARS IN THOUSANDS)
Three months or less......................................... $ 1,687 5.63 %
Over three months through six months......................... 1,815 5.85
Over six months through twelve months........................ 874 5.94
Over twelve months........................................... 1,081 6.21
--------- ---------
Total.................................................... $ 5,457 5.86 %
========= =========
The Company actively monitors Matrix Bank's compliance with regulatory
capital requirements. Historically Matrix Bank has increased it core capital
through the retention of a portion of its earnings. Matrix Bank's future growth
is expected to be achieved through deposit growth, borrowings from the FHLB, and
custodial deposits from affiliates which
33
is anticipated to require additional capital. The capital requirements related
to the anticipated growth will in part be fulfilled through retaining of
earnings, increasing the Company's bank stock loan and the use of a portion of
the proceeds raised from the sale of common stock which was completed in the
fourth quarter of 1996. See "Regulation and Supervision--Matrix Bank's Capital
Ratios."
Matrix Bank and Matrix Financial are restricted from paying dividends to
Matrix Capital due to restrictions of certain debt agreements and regulatory
requirements. At December 31, 1996, the Company was in compliance with all debt
covenants. See "Regulation and Supervision."
In June 1996, the Company purchased 154 acres of land for $1.3 million in
cash for the purpose of developing 750 residential and multi-family lots in Ft.
Lupton, Colorado. The purchase was completed with operating funds of the Company
and a loan from a third-party financial institution. As part of the acquisition,
the Company entered into a Residential Facilities Development Agreement (the
"Development Agreement") with the City of Ft. Lupton. The Development Agreement
is a residential and planned unit development agreement providing for the
orderly planning, engineering and development of a golf course and surrounding
residential community. The City of Ft. Lupton is responsible for the development
of the golf course and the Company is responsible for the development of the
surrounding residential lots.
The Development Agreement sets forth a mandatory obligation on the part of
the Company to pay the City of Ft. Lupton pledged enhancement assessments of
$600,000. These pledged enhancement assessments require the Company to pay the
city a $2,000 fee each time the Company sells a developed residential lot. The
Company is obligated to pay a minimum of $60,000 in assessment fees per year
beginning in the year 1998 through the year 2007. The Company also entered into
a development management agreement with a local developer to complete the
development of the land. The terms of the agreement specify that the Company is
to earn a preferred rate of return on its investment and, once the initial
amount of its investment has been returned plus the preferred rate of return,
the remaining profits are split equally. The development management agreement
obligates the Company to provide up to an additional $500,000 of funds for
development. The Company has no other financial obligations to the developer
beyond the $500,000.
It is anticipated that the Company will obtain a loan from an unaffiliated
financial institution for a portion of the future development costs. The Company
expects development to begin during the second quarter of 1997.
INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related data presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation. Unlike most industrial companies,
substantially all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
prices of goods and services. The Company discloses the estimated fair market
value of its financial instruments in accordance with Statement of Financial
Accounting Standards No. 107. See Note 14 to the Consolidated Financial
Statements included elsewhere herein.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1996, the FASB issued Statement of Financial Accounting
Standards No. 125, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities ("FAS 125"). This statement provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities and is effective for the above that
occur after December 31, 1996. Transactions covered by FAS 125 include
securitizations, sales of partial interests in financial assets, repurchase
agreements, securities lending, pledges of collateral, loan syndications and
participations, sales of receivables with recourse, servicing of mortgages and
other loans, and in-substance defeasances. The statement uses a "financial
components" approach that focuses on control to determine the proper accounting
for financial asset transfers. Under that approach, after financial assets are
transferred, an entity would recognize on the balance sheet all assets it
controls and liabilities it has incurred. It would remove from the balance sheet
those assets it no longer controls and liabilities it has satisfied. If the
entity has surrendered control over the transferred assets, the transaction
would be considered a sale. Control is considered surrendered only if the assets
are isolated from the transferor; the
34
transferee has the right to pledge or exchange the assets or is a qualifying
special-purpose entity; and the transferor does not maintain effective control
over the assets through an agreement to repurchase or redeem them. If those
conditions do not exist, the transfer would be accounted for as a secured
borrowing. The Company will adopt FAS 125 in the first quarter of 1997 and,
based on current circumstances, does not believe the effect of adoption will be
material to its consolidated financial statements.
FORWARD LOOKING STATEMENTS
Certain information contained in this annual report constitutes
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, which can be identified by the use of forward-looking terminology
such as "may," "will," "expect," "anticipate," "estimate," or "continue" or the
negative thereof or other variations thereon or comparable terminology. The
statements in "Risk Factors" contained in the Company's current report on Form
8-K, filed with the Securities and Exchange Commission on March 25, 1997,
constitute cautionary statements identifying important factors, including
certain risks and uncertainties, with respect to such forward-looking statements
that could cause actual results to differ materially from those reflected in
such forward-looking statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See index to financial statements, beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
35
PART III
ITEMS 10 THROUGH 13.
The information for these items has been omitted inasmuch as the registrant
will file a definitive proxy statement with the Commission pursuant to the
Regulation 14A within 120 days of the close of the fiscal year ended December
31, 1996.
36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) and (a) (2) Financial statements and financial statement
schedules See "Item 8- Financial Statements and Supplementary
Information."
(b) Reports on Form 8-K
See Form 8-K filed by the Company, dated February 20, 1997 and
Form 8-K filed by the Company, dated
March 25, 1997.
(c) Exhibits
See Exhibit Index, beginning on page 39.
(d) Financial Statement Schedules
None.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 25th day of
March, 1997.
Matrix Capital Corporation
By: /s/
-------------------------
Guy A. Gibson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title Date
---------- ----- ----
/s/ President, Chief Executive March 25, 1997
- --------------------------------- Officer and a Director
Guy A. Gibson (Principal Executive Officer)
/s/ Chairman of the Board March 25, 1997
- ---------------------------------
Richard V. Schmitz
/s/ Vice Chairman of the Board March 25, 1997
- ---------------------------------
D. Mark Spencer
/s/ Director March 25, 1997
- ---------------------------------
Thomas M. Piercy
/s/ Senior Vice President and March 25, 1997
- --------------------------------- Chief Financial Officer,
David W. Kloos and a Director
(Principal Accounting and
Financial Officer)
/s/ Director March 25, 1997
- ---------------------------------
Stephen Skiba
/s/ Director March 25, 1997
- ---------------------------------
David A. Frank
38
INDEX TO EXHIBITS
3.1 + Amended and Restated Articles of Incorporation of the Registrant
(3.1)
3.2 + Bylaws, as amended, of the Registrant (3.2)
4.1 + Specimen certificate for Common Stock of the Registrant (4.1)
4.2 + o Amended and Restated 1996 Stock Option Plan (4.2)
4.3 ++o Employee Stock Purchase Plan, as amended (4.1)
4.4 + Form of Common Stock Purchase Warrant by and between the Registrant
and Piper Jaffray, Inc. (4.4)
4.5 + Form of Common Stock Purchase Warrant by and between the Registrant
and Keefe, Bruyette & Woods, Inc. (4.5)
10.1 + Note and Agency Agreement, dated as of August 1, 1995, by and
between the Registrant and PHS Mortgage, Inc. as agent (10.1)
10.2 + First Amendment to Note and Agency Agreement, dated as of August 2,
1995, by and between the Registrant and PHS Mortgage, Inc., as
agent (10.2)
10.3 + Form of 13% Senior Subordinated Note (10.3)
10.4 + o Executive Employment Agreement, dated as of January 1, 1996, by and
between the Registrant and David Kloos (10.4)
10.5 + o Employment Agreement, dated as of January 1, 1995, between Matrix
Capital Bank and Gary Lenzo and as amended January 1, 1996
(10.5)
10.6 + Loan Agreement, dated as of October 2, 1995, by and between Matrix
Diversified, Inc. and the Registrant (10.6)
10.7 + Multiple Advance Term Loan Agreement, dated as of June 27, 1994, by
and between Matrix Capital Corporation and CorTrust Bank (10.8)
10.8 + Multiple Advance Fixed Rate Term Loan Promissory Note, dated as of
June 30, 1994, from Matrix Capital Corporation, as maker, to
CorTrust Bank, as payee (10.9)
10.9 + Mortgage Loan Purchase and Servicing Agreement, dated as of August
1, 1993, by and between Argo Federal Savings Bank, FSB, and
Matrix Financial Services Corporation (10.11)
10.10 + Mortgage Loan Repurchase Agreement, dated as of March 30, 1995, by
and between PaineWebber Real Estate Securities, Inc. and Matrix
Financial Services Corporation (10.27)
10.11 + Multiple Advance Fixed Rate Term Loan Promissory Note, dated as of
October 19, 1994, from Matrix Capital Corporation, as maker, to
CorTrust, as payee (10.29)
10.12 + Assignment and Assumption Agreement, dated as of June 28, 1996, by
and among Mariano C. DeCola, William M. Howdon, R. James
Nicholson and Matrix Funding Corp. (10.30)
10.13 + Development Management Agreement, dated as of June 28, 1996, by and
among Fort Lupton, L.L.C. and Matrix Funding Corp. (10.31)
10.14 + Assignment and Assumption of PUD Agreement, dated as of June 28,
1996, by and among Fort Lupton, L.L.C. and Matrix Funding Corp.
(10.32)
10.15 + Lease, dated as of October 1, 1995, by and between the Registrant
and Matrix Financial Services Corporation (10.33)
10.16 + Promissory Note, dated as of December 31, 1995, from D. Mark
Spencer, as maker, to the Registrant, as payee (10.35)
10.17 + Fort Lupton Golf course Residential and Planned Unit Development
Agreement, dated as of November 28, 1995 (10.36)
10.18 + Loan Agreement, dated as of December 10, 1994, by and between the
Registrant and Bankers' Bank of the West (10.37)
10.19 + Continuing Guaranty of D. Mark Spencer, dated as of December 10,
1994 (10.38)
10.20 + Continuing Guaranty of Richard V. Schmitz, dated as of December 10,
1994 (10.39)
10.21 + Continuing Guaranty of Guy A. Gibson, dated as of December 10, 1994
(10.40)
10.22 + Loan Agreement, dated as of June 21, 1996, by and between Matrix
Funding Corporation and The First Security Bank (10.41)
10.23 + Loan Agreement, dated as of June 29, 1995, by and between the
Registrant and Bank One, Arizona, N.A. (10.42)
39
10.24 + Promissory Note, dated as of June 29, 1995, from the Registrant to
Bank One, Arizona, N.A. (10.43)
10.25 + Deed of Trust, Assignment of Rents, Security Agreement and Fixture
Filing, dated as of June 29, 1995, from the Registrant to
Arizona Trust Deed Corporation, as trustee (10.44)
10.26 + Loan Agreement, dated July 10, 1992, by and between American
Strategic Income Portfolio Inc. and Matrix Financial Services
Corporation (10.45)
10.27 + Promissory Note, dated as of July 10, 1992, by Matrix Financial
Services Corporation, as maker, to American Strategic Income
Portfolio, Inc., as payee (10.46)
10.28 +++ Agreement and Plan of Merger, dated as of November 22, 1996, by and
among the Registrant, The Vintage Group, Inc. and
Matrix/Vintage Acquisition, Inc. (10.1)
10.29 +++ Asset Purchase and Exchange Agreement, dated as of February 4, 1997,
by and among the Registrant and STC Holdings, Inc. (10.2)
10.30 * Lease, dated as of October 1, 1996, by and between the Registrant
and Creative Networks, LLC
10.31 * Revolving Subordinated Loan Agreement, dated as of October 18,
1996, by and between Matrix Financial Services Corporation and
the Registrant
10.32 * Amended and Restated Loan Agreement, dated as of January 31, 1997,
by and between Matrix Financial Services Corporation, as
borrower, and Bank One, Texas, N.A., as agent, and certain
lenders, as lenders
10.33 * Amended and Restated Warehouse Note, dated as of January 31, 1997,
from Matrix Financial Services Corporation, as borrower, and
Bank One, Texas, N.A., as lender
10.34 * Amended and Restated Swing Note, dated as of January 31, 1997, from
Matrix Financial Services Corporation, as borrower, and Bank
One, Texas, N.A., as lender
10.35 * Amended and Restated Working-Capital Note, dated as of January 31,
1997, from Matrix Financial Services Corporation, as borrower,
and Bank One, Texas, N.A., as lender
10.36 * Amended and Restated Term-Line Note, dated as of January 31, 1997,
from Matrix Financial Services Corporation, as borrower, and
Bank One, Texas, N.A., as lender
10.37 * Amended and Restated Guaranty, dated as of January 31, 1997, from
the Registrant to Bank One, Texas, N.A.
10.38 * o Employment Agreement, dated as of February 4, 1997, by and between
the Registrant and Paul Skretny
10.39 * Credit Agreement, dated as of March 12, 1997, by and between Matrix
Capital Corporation, as borrower, and Bank One, Texas, N.A., as
agent, and certain lenders, as lenders
10.40 * Term Note, dated as of March 12, 1997, from Matrix Capital
Corporation, as borrower, and Bank One, Texas, N.A., as lender
10.41 * Revolving Note, dated as of March 12, 1997, from Matrix Capital
Corporation, as borrower, and Bank One, Texas, N.A., as lender
10.42 * Guaranty Form, dated as of March 12, 1997, from each of the
Registrant's significant subsidiaries to Bank One, Texas,
N.A.,as agent
11 * Statement regarding computation of per share earnings
21 * Subsidiaries of the Registrant
27 * Financial Data Schedule
- ------------------------
* Filed herewith
+ Incorporated by reference from the exhibit number shown in parenthesis
from the Registrant's registration statement on Form S-1 (No. 333-
10223), filed by the Registrant with the Commission.
40
++ Incorporated by reference from the exhibit number shown in parenthesis
form the Registrant's quarterly report on Form 10-Q for the quarter
ended September 30, 1996, filed by the Registrant with the Commission.
+++ Incorporated by reference from the exhibit number shown in parenthesis
form the Registrant's current report on Form 8-K, filed with the
Commission on February 20, 1997.
o Management contract or compensatory plan or arrangement
41
INDEX TO FINANCIAL STATEMENTS
Consolidated Financial Statements of Matrix Capital Corporation
PAGE
----
Report of Independent Auditors.......................................... F-2
Consolidated Balance Sheets - December 31, 1995 and 1996................ F-3
Consolidated Statements of Income - for the years ended
December 31, 1994, 1995 and 1996 ................................ F-4
Consolidated Statements of Shareholders' Equity - for the years ended
December 31, 1994, 1995 and 1996................................. F-5
Consolidated Statements of Cash Flows - for the years ended
December 31, 1994, 1995 and 1996................................. F-6
Notes to Consolidated Financial Statements - December 31, 1996.......... F-7
F-1
Report of Independent Auditors
Shareholders and Board of Directors
Matrix Capital Corporation
We have audited the accompanying consolidated balance sheets of Matrix Capital
Corporation (Company) as of December 31, 1995 and 1996, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1996. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company at December 31, 1995 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1995 the
Company changed its method of accounting for mortgage servicing rights as a
result of adopting Statement of Financial Accounting Standards No. 122,
Accounting for Mortgage Servicing Rights.
/s/ Ernst & Young LLP
Phoenix, Arizona
March 6, 1997
F-2
Matrix Capital Corporation
Consolidated Balance Sheets
(Dollars In thousands)
DECEMBER 31
1995 1996
---------------------
ASSETS
Cash $ 1,381 $ 2,319
Interest earning deposits 5,586 9,499
Loans held for sale, net 127,090 182,801
Loans held for investment, net 19,575 29,560
Mortgage servicing rights, net 13,817 23,680
Other receivables 5,609 9,353
Federal Home Loan Bank of Dallas stock 1,954 2,871
Premises and equipment, net 5,904 7,279
Deferred income tax benefit - 54
Other assets 3,816 5,447
---------------------
Total assets $184,732 $272,863
=====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits $ 48,877 $ 90,179
Custodial escrow balances 27,011 37,881
Drafts payable 8,817 5,961
Payable for purchase of mortgage
servicing rights 1,312 8,044
Federal Home Loan Bank of Dallas
borrowings 19,000 51,250
Borrowed money 65,093 42,431
Other liabilities 4,409 5,292
Income taxes payable 875 1,023
---------------------
Total liabilities 175,394 242,061
Commitments and contingencies
Shareholders' equity:
Preferred stock, par value $.0001;
authorized 5,000,000 shares; no shares
outstanding
Common stock, par value $.0001;
authorized 50,000,000 shares; issued
and outstanding 3,888,939 and
5,901,439 shares at December 31, 1995
and 1996, respectively - 1
Additional paid in capital 2,626 20,816
Retained earnings 6,712 9,985
---------------------
Total shareholders' equity 9,338 30,802
---------------------
Total liabilities and shareholders'
equity $184,732 $272,863
=====================
See accompanying notes.
F-3
Matrix Capital Corporation
Consolidated Statements of Income
(Dollars In thousands except per share information)
YEAR ENDED DECEMBER 31
1994 1995 1996
----------------------------------
INTEREST INCOME
Loans and mortgage backed securities $ 6,681 $ 10,412 $ 16,084
Interest earning deposits 334 318 408
----------------------------------
Total interest income 7,015 10,730 16,492
INTEREST EXPENSE
Savings and time deposits 1,210 1,892 3,292
Demand and money market deposits 271 292 468
FHLB borrowings 213 1,113 2,039
Borrowed money 1,332 3,897 4,691
----------------------------------
Total interest expense 3,026 7,194 10,490
----------------------------------
Net interest income before provision
for loan and valuation losses 3,989 3,536 6,002
Provision for loan and valuation losses 216 401 143
----------------------------------
Net interest income 3,773 3,135 5,859
NONINTEREST INCOME
Loan administration 6,926 7,749 8,827
Brokerage 4,017 4,787 4,364
Gain on sale of loans and mortgage
backed securities 1,590 3,272 3,369
Gain on sale of mortgage servicing
rights 684 1,164 3,232
Loan origination 1,294 2,069 1,561
Other 487 781 1,118
----------------------------------
Total noninterest income 14,998 19,822 22,471
NONINTEREST EXPENSES
Compensation and employee benefits 7,719 8,586 10,604
Amortization of mortgage servicing
rights 1,185 1,817 2,432
Occupancy and equipment 1,067 1,124 1,415
Professional fees 485 660 468
Data processing 492 529 604
Losses related to recourse sales - - 787
Federal Deposit Insurance Corporation
premiums 176 155 635
Other general and administrative 3,155 4,265 6,006
----------------------------------
Total noninterest expense 14,279 17,136 22,951
----------------------------------
Income before income taxes 4,492 5,821 5,379
Provision for income taxes 1,846 2,260 2,106
----------------------------------
Net income $ 2,646 $ 3,561 $ 3,273
==================================
Net income per common and common
equivalent share $.71 $.91 $.76
==================================
Weighted average common and common
equivalent shares 3,750,001 3,927,629 4,297,448
==================================
See accompanying notes.
F-4
Matrix Capital Corporation
Consolidated Statements of Shareholders' Equity
(Dollars In thousands)
COMMON STOCK ADDITIONAL
-------------------- PAID IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
---------------------------------------------------
Balance at December 31, 1993 3,750,001 $ - $ 2,525 $ 505 $ 3,030
Net income - - - 2,646 2,646
---------------------------------------------------
Balance at December 31, 1994 3,750,001 - 2,525 3,151 5,676
Issuance of stock for services 138,938 - 101 - 101
Net income - - - 3,561 3,561
---------------------------------------------------
Balance at December 31, 1995 3,888,939 - 2,626 6,712 9,338
Issuance of stock, net of issuance
costs of $1,934 2,012,500 1 18,190 - 18,191
Net income - - - 3,273 3,273
---------------------------------------------------
Balance at December 31, 1996 5,901,439 $ 1 $20,816 $9,985 $30,802
===================================================
See accompanying notes.
F-5
Matrix Capital Corporation
Consolidated Statements of Cash Flows
(Dollars In thousands)
YEAR ENDED DECEMBER 31
1994 1995 1996
----------------------------------
OPERATING ACTIVITIES
Net income $ 2,646 $ 3,561 $ 3,273
Adjustments to reconcile net income to
net cash used by operating activities:
Depreciation and amortization 414 743 893
Provision for loan losses 216 401 143
Amortization of mortgage servicing
rights 1,185 1,817 2,432
Noncash compensation expense - 101 -
Accretion of premium on deposits (68) (28) (7)
Deferred income taxes 286 212 (54)
Gain on sale of loans and mortgage
backed securities (1,590) (3,272) (3,369)
Gain on sale of mortgage servicing
rights (684) (1,164) (3,232)
Losses related to recourse sales - - 787
Loans originated for sale, net of loans
sold (4,681) (38,591) 8,099
Loans purchased for sale (80,048) (91,774) (159,015)
Proceeds from sale of loans purchased
for sale 62,727 70,159 57,395
Gain on sale of premises and equipment - - (78)
Originated mortgage servicing rights,
net - (885) (441)
Increase in other receivables and other
assets (2,116) (3,685) (750)
Increase in other liabilities and
income taxes payable 684 307 (2,315)
----------------------------------
Net cash used by operating activities (21,029) (62,098) (96,239)
INVESTING ACTIVITIES
Loans originated and purchased for
investment (423) (2,919) (15,048)
Principal repayments on loans 10,962 17,517 22,982
Purchase of Federal Home Loan Bank of
Dallas stock (536) (814) (917)
Purchases of premises and equipment (1,804) (1,910) (2,181)
Purchase of land under development - - (1,431)
Purchase of revenue anticipation
warrants - - (818)
Purchase of residential homes - - (1,003)
Acquisition of mortgage servicing rights (3,920) (9,654) (10,410)
Proceeds from sale of mortgage
servicing rights 677 1,769 8,410
Proceeds from sale of available for
sale securities - - 21,548
----------------------------------
Net cash provided by investing
activities 4,956 3,989 21,132
FINANCING ACTIVITIES
Net increase (decrease) in deposits (3,539) 6,995 41,309
Net increase (decrease) in custodial
escrow balances (7,107) 2,324 10,870
Increase in revolving lines and
repurchase agreements, net 20,409 39,384 17,151
Repayments of notes payable (605) (3,865) (13,923)
Proceeds from notes payable 2,893 12,933 6,924
Proceeds from senior subordinated notes - 2,910 -
Repayment of financing arrangements (639) (307) (564)
Proceeds from issuance of common stock - - 18,191
----------------------------------
Net cash provided by financing
activities 11,412 60,374 79,958
----------------------------------
Increase (decrease) in cash and cash
equivalents (4,661) 2,265 4,851
Cash and cash equivalents at beginning
of year 9,363 4,702 6,967
----------------------------------
Cash and cash equivalents at end of year $ 4,702 $ 6,967 $ 11,818
==================================
SUPPLEMENTAL DISCLOSURE OF NONCASH
ACTIVITY
Payable for purchase of mortgage
servicing rights $ 1,763 $ 1,312 $ 8,044
==================================
Drafts payable $ - $ 8,817 $ 5,961
==================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Cash paid for interest expense $ 2,949 $ 6,489 $ 10,598
==================================
Cash paid for income taxes $ 1,702 $ 1,530 $ 2,016
==================================
See accompanying notes.
F-6
Matrix Capital Corporation
Notes to Consolidated Financial Statements
December 31, 1996
1. ORGANIZATION
On June 30, 1993, Matrix Capital Corporation (Company) was formed and exchanged
1,000,000 shares of its common stock for 100 percent of the common stock of
United Financial, Inc. (United Financial), Matrix Financial Services Corporation
(Matrix Financial) and another company with minimal assets or operations. The
merger was accounted for as a pooling of interests and, accordingly, the 1993
consolidated financial statements were restated to include the accounts and
operations of the companies prior to the merger.
On October 18, 1996, the Company completed its initial public offering by
selling 1,750,000 shares of common stock at a price of $10.00 per share. On
November 18, 1996, the underwriters exercised their option to purchase an
additional 262,500 shares of the Company's common stock (over-allotment) at the
initial public offering price of $10.00. The net proceeds received in the
offering were approximately $18.2 million.
On September 23, 1993 the Company acquired Dona Ana Savings Bank, FSB (changed
its name to Matrix Capital Bank, herein referred to as Matrix Bank), a federally
chartered savings and loan association. Upon the acquisition of Matrix Bank,
the Company became a unitary savings and loan holding company which, through its
subsidiaries, is engaged in a single industry segment, the financial services
industries.
The Company's mortgage banking business is conducted through Matrix Financial,
and was established with the primary objective of acquiring, originating and
servicing residential mortgage loan servicing rights. Servicing mortgage loans
involves the contractual right to receive a fee for processing and administering
mortgage loan payments. The Company acquires servicing rights in the secondary
market as well as through Matrix FinancialOs wholesale loan origination offices
in the Atlanta, Denver, and Phoenix metropolitan areas, and through Matrix Bank
with offices in Las Cruces, New Mexico and Sun City, Arizona.
In June 1996, Matrix Financial formed an operating subsidiary, Matrix Funding
Corp., which purchased 154 acres of land for $1.3 million in cash for the
purpose of developing residential and multi-family lots in Ft. Lupton, Colorado.
Matrix Bank serves its local community by providing a full range of personal and
business depository services, offering residential and consumer loans, and
providing, on a limited basis, commercial real estate loans. Matrix Bank's
participation in the mortgage banking business includes the purchase of bulk
residential loan portfolios, with the intent of reselling the majority of the
loans, and extends to acquisitions of servicing portfolios, which are in turn
subserviced by Matrix Financial.
F-7
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
1. ORGANIZATION (CONTINUED)
In May 1996, Matrix Bank formed an operating subsidiary, Sterling Finance Co.,
Inc. (Sterling Finance), which acquired substantially all the assets of an
origination and seller of subprime automobile retail installment sales contracts
for approximately $47,000 in cash. The assets acquired (fixed assets and
prepaid expenses) were purchased at their estimated fair value and no goodwill
was recorded. On December 31, 1996, Matrix Bank sold the fixed assets and the
name of Sterling Finance to a third party buyer and ceased its subprime auto
lending operations.
United Financial provides brokerage and consulting services to financial
institutions and financial services companies in the mortgage banking industry,
primarily related to the brokerage and analysis of residential mortgage loan
servicing rights, corporate and mortgage loan servicing portfolio valuations,
and, to a lesser extent, consultation and brokerage services in connection with
mergers and acquisitions of mortgage banking entities.
United Special Services, Inc. (USS), a wholly owned subsidiary of the Company
formed in June 1995, provides real estate management and disposition services to
financial services companies and financial institutions, including Matrix
Financial and Matrix Bank.
United Capital Markets (UCM), a wholly owned subsidiary of the Company formed in
December 1996, focuses on risk management services for institutional clients.
2. SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of the Company and its subsidiaries
conform to generally accepted accounting principles and to general practices
within the financial services industry.
The following is a description of the more significant policies which the
Company follows in preparing and presenting its consolidated financial
statements.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and the
accompanying notes. Actual results could differ from these estimates.
F-8
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
Loans Held for Sale
Loans originated or purchased with the intent for sale in the secondary market
are carried at the lower of cost, net of discounts or premiums, or estimated
market value in the aggregate. Market value is determined using forward sale
commitments to permanent investors or current market rates for loans of similar
quality and type. Net unrealized losses, if any, would be recognized in a
valuation allowance by charges to income. Discounts or premiums on loans held
for sale are not accreted or amortized into income on an interest method,
however discounts and premiums related to payments of loan principal are
recorded in interest income. The loans are primarily secured by one to four
family residential real estate located throughout the United States.
Gains and losses on loan sales are recognized at the time of sale. Gains and
losses are calculated based upon the total consideration received, after
provisions to cover estimated future servicing costs and recourse provisions.
Losses related to recourse provisions in excess of the amount originally
provided are accrued as a liability at the time such additional losses are
determined, and recorded as part of noninterest expense.
Loans Held for Investment
Loans held for investment are stated at unpaid principal balances (since it is
the Company's intention to hold the loans until maturity), less unearned
discounts and premiums, deferred loan fees, loans in process, and allowance for
loan losses. Premiums, discounts and net origination fees on loans are
amortized to interest income over the contractual life of the related loans
using the interest method.
Allowance for Loan Losses
In January 1995, the Company adopted Statement of Financial Accounting Standards
No. 114, Accounting by Creditors for Impairment of a Loan, amended in October
1994 by Statement No. 118, Accounting by Creditors for Impairment of a Loan -
Income Recognition and Disclosures, hereinafter collectively referred to as
Statement No. 114. Under Statement No. 114, a loan is considered impaired when,
based on current information and events, it is probable that a creditor will be
unable to collect all amounts due according to the contractual terms of the
loan. Statement No. 114 applies to all loans except large groups of smaller-
balance homogeneous loans, which are collectively evaluated, loans measured at
fair value or at the lower of cost or fair value, leases and debt securities.
The statement does not address the overall adequacy of the allowance for loan
losses.
F-9
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
Potential impaired loans of the Company, as defined by Statement No. 114,
include only commercial, real estate construction and commercial real estate
mortgage loans classified as nonperforming loans. Impairment allowances are
considered by the Company in determining the overall adequacy of the allowance
for loan losses. The adoption of Statement No. 114 resulted in no material
change in the allowance for loan losses. When a loan is identified as
"impaired," accrual of interest ceases. The Company had no impaired loans, as
defined by Statement No. 114, as of or for the years ended December 31, 1995 and
1996, respectively.
The Company evaluates its mortgage loans collectively due to their homogeneous
nature. The allowance for loan losses is calculated, in part, based on
historical loss experience. In addition, management takes into consideration
other factors such as any qualitative evaluations of individual classified
assets, geographic and portfolio concentrations, new products or markets,
evaluations of the changes in the historical loss experience component, and
projections of this component into the current and future periods based on
current knowledge and conditions. After an allowance has been established for
the loan portfolio, management establishes an unallocated portion of the
allowance for loan losses, which is attributable to factors that cannot be
associated with a specific loan or loan portfolio. These factors include
general economic conditions, recognition of specific regional geographic
concerns, and trends in portfolio growth. Loan losses are charged against the
allowance when the probability of collection is considered remote. In the
opinion of management, the allowance, when taken as a whole, is adequate to
absorb reasonably foreseeable losses in the current loan portfolio.
Loans are placed on nonaccrual status when full payment of principal or interest
is in doubt, or generally when they are past due ninety days as to either
principal or interest. Previously accrued but unpaid interest is reversed and
charged against interest income and future accruals are discontinued. Interest
payments received on nonaccrual loans are recorded as interest income unless
there is doubt as to the collectibility of the recorded investment. In those
cases, cash received is recorded as a reduction in principal.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation is computed using the straight line method over the estimated lives
of the assets, which range from three to seven years for office furniture,
equipment and software and 30 years for buildings.
F-10
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
Mortgage Servicing Rights (MSR)
On January 1, 1995, the Company adopted Statement No. 122, Accounting for
Mortgage Servicing Rights. Since Statement No. 122 prohibits retroactive
application, the historical accounting results for 1994 have not been restated,
and accordingly, the accounting results for 1995 and 1996 are not directly
comparable to the results for prior periods.
With the adoption of this statement, the Company recognizes originated mortgage
servicing rights (OMSRs) as an asset separate from the underlying originated
mortgage loan by allocating the total cost of originating a mortgage loan
between the loan and the servicing right based on their respective fair values.
Mortgage servicing rights are carried at the lower of cost (allocated cost for
OMSRs), less accumulated amortization, or fair value. Mortgage servicing rights
are amortized in proportion to and over the period of the estimated future net
servicing income.
The fair value of mortgage servicing rights is determined based on the
discounted future servicing income stratified based on one or more predominant
risk characteristics of the underlying loans. The Company stratifies its
mortgage servicing rights by product type and investor to reflect the
predominant risk characteristics. To determine the fair value of mortgage
servicing rights, the Company uses a valuation model that calculates the present
value of future cash flows to determine the fair value of the mortgage servicing
rights. In using this valuation method, the Company incorporates assumptions
that market participants would use in estimating future net servicing income
which includes estimates of the cost of servicing per loan, the discount rate,
float value, an inflation rate, ancillary income per loan, prepayment speeds and
default rates. As of December 31, 1996, no valuation allowance was required and
the fair value of the aggregate mortgage servicing rights was approximately
$29,900,000.
Gain on Sale of Servicing Rights
The Company complies with EITF Issue No. 95-5, Determination of What Constitutes
a Sale of Mortgage Loan Servicing Rights, such that the gain on sale of
servicing rights is recognized when substantially all the risks and rewards
inherent in owning the mortgage servicing rights have been transferred to the
buyer, and any protection provisions retained by the Company are minor and can
be reasonably estimated.
Drafts Payable
Drafts payable represent the in transit outstanding funding of a new loan by the
Company via a negotiable instrument, however, the instrument has not yet been
presented to the bank for payment. Presentation to the bank generally occurs
within one to three days.
F-11
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
Loan Administration Income
Loan administration income represents service fees and other income earned from
servicing loans for various investors. Loan administration income includes
service fees that are based on a contractual percentage of the outstanding
principal balance plus late fees and other ancillary charges. Income is
recognized when the related payments are received.
Brokerage Income
Brokerage income represents fees earned related to brokerage and consulting
services. Brokerage income is recognized when earned.
Loan Origination Income
Loan origination income for loans originated for sale, which includes all
mortgage origination fees, secondary marketing activity and servicing-released
premiums on mortgage loans sold, net of outside origination costs, is recognized
as income at the time the loan is sold.
Loan origination income for loans originated for investment, which includes
mortgage origination fees and certain direct costs associated with loan
originations, is deferred and amortized as a yield adjustment over the
contractual life of the related loan using the interest method, adjusted for
estimated prepayments.
Stock Based Compensation
The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to the fair value of the shares at the date of grant.
In October 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, which provides an alternative to APB Opinion No. 25, Accounting
for Stock Issued to Employees, in accounting for stock-based compensation issued
to employees. Statement No. 123 allows for a fair value based method of
accounting for employee stock options and similar equity instruments awarded
after December 31, 1995. The Company has elected to account for stock-based
compensation plans in accordance with APB Opinion No. 25 and to follow the pro
forma net income, pro forma earnings per share, and stock-based compensation
plan disclosure requirements set forth in Statement No. 123.
F-12
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
Foreclosed Real Estate
Real estate acquired through foreclosure, deed in lieu of foreclosure or in
judgment is carried at the lower of fair value, minus estimated costs to sell,
or the related loan balance at the date of foreclosure. Valuations are
periodically performed by management and an allowance for loss is established by
a charge to operations if the carrying value of a property exceeds its fair
value, minus estimated costs to sell. The net carrying value of foreclosed real
estate, which is classified in other assets, was $835,000 and $788,000 at
December 31, 1995 and 1996, respectively.
Acquired Real Estate
Costs directly attributable to the acquisition, development, and construction of
land development are capitalized. Such costs include preacquisition costs,
direct project costs, and holding costs. The investment in land development is
carried at the lower of cost, which includes capitalized costs, or net
realizable value. Net unrealized losses, if any, would be recognized in a
valuation allowance. As of December 31, 1996 there was no valuation allowance
necessary for the land development.
Income Taxes
The Company and its subsidiaries file consolidated federal and state income tax
returns. The subsidiaries are charged for the taxes applicable to their profits
calculated on the basis of filing separate income tax returns. Matrix Bank
qualifies as a savings and loan association for income tax purposes.
The Company follows Statement No. 109, Accounting for Income Taxes, which uses
the liability method in accounting for income taxes. Under this method,
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax basis of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
Fair Value of Financial Instruments
In 1995, the Company adopted Statement No. 107, Disclosures about Fair Value of
Financial Instruments, which requires disclosure of fair value information about
financial instruments, whether or not recognized in the balance sheet, where it
is practicable to estimate their value. In cases where quoted market prices are
not available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard,
F-13
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
the derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Statement No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company. For additional information refer to Note 14 -
Financial Instruments.
Cash and Cash Equivalents
Cash equivalents, for purposes of the statements of cash flows, consist of cash
and interest earning deposits with banks with original maturities when purchased
of three months or less.
Net Income Per Share
Net income per common and common equivalent share are computed based on the
weighted average number of common shares outstanding during each period and the
dilutive effect, if any, of stock options outstanding.
Impact of Recently Issued Accounting Standards
In June 1996, the FASB issued Statement No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities. This
statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities and is
effective for periods beginning after December 31, 1996. Transactions covered
by Statement No. 125 include securitizations, sales of partial interests in
financial assets, repurchase agreements, securities lending, pledges of
collateral, loan syndications and participations, sales of receivables with
recourse, servicing of mortgages and other loans, and in-substance defeasances.
The statement uses a "financial components" approach that focuses on control to
determine the proper accounting for financial asset transfers. Under that
approach, after financial assets are transferred, an entity would recognize on
the balance sheet all assets it controls and liabilities it has incurred. It
would remove from the balance sheet those assets it no longer controls and
liabilities it has satisfied.
If the entity has surrendered control over the transferred assets, the
transaction would be considered a sale. Control is considered surrendered only
if the assets are isolated from the transferor; the transferee has the right to
pledge or exchange the assets or is a qualifying special-purpose entity; and the
transferor does not maintain effective control over the assets through an
agreement to repurchase or redeem them. If those conditions do not exist, the
transfer would be accounted for as a secured borrowing.
F-14
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
The Company will adopt Statement No. 125 in the first quarter of 1997 and, based
on current circumstances, does not believe the effect of adoption will be
material to its consolidated financial statements.
Reclassifications
Certain amounts in the prior year financial statements have been reclassified to
conform to the current year presentation.
3. LOANS RECEIVABLE
Loans Held for Investment
Loans held for investment consist of the following:
DECEMBER 31
1995 1996
---------------------
(In thousands)
Residential loans $ 9,349 $16,625
Multi-family and commercial real estate 7,544 8,734
Construction loans 577 1,319
Consumer loans and other 3,381 3,704
---------------------
20,851 30,382
Less:
Loans in process 499 254
Purchase discounts, net 414 239
Unearned discounts on consumer loans 14 9
Allowance for loan losses 227 270
Specific valuation allowance on purchased loans 122 50
---------------------
1,276 822
---------------------
$19,575 $29,560
=====================
Activity in the allowance for loan
losses is summarized as follows:
YEAR ENDED DECEMBER 31
1994 1995 1996
------------------------------
(In thousands)
Balance at beginning of year $ 196 $ 220 $ 227
Provision for loan losses 24 - 34
Charge-offs - (42) (6)
Recoveries - 49 15
------------------------------
Balance at end of year $ 220 $ 227 $ 270
==============================
F-15
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
3. LOANS RECEIVABLE (CONTINUED)
Nonaccrual loans in the loans held for investment portfolio totaled
approximately $440,000 and $335,000 or 2.1 percent and 1.1 percent of the total
loans held for investment portfolio at December 31, 1995 and 1996, respectively.
Matrix Bank at December 31, 1996 had commitments to extend credit on consumer
and construction loans of approximately $3,885,000.
Loans Held for Sale
Loans held for sale consist of the following as of December 31:
1995 1996
---------------------
(In thousands)
First mortgage loans $133,622 $185,080
Automobile installment contracts - 1,315
---------------------
133,622 186,395
Less:
Purchase discounts, net 5,816 2,825
Valuation allowance 716 769
---------------------
6,532 3,594
---------------------
$127,090 $182,801
=====================
Activity in the valuation allowance is
summarized as follows:
YEAR ENDED DECEMBER 31
1994 1995 1996
-------------------------------
(In thousands)
Balance at beginning of year $ 342 $ 508 $ 716
Provision for valuation allowance 192 401 109
Charge-offs (26) (198) (64)
Recoveries - 5 8
-------------------------------
Balance at end of year $ 508 $ 716 $ 769
===============================
F-16
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
3. LOANS RECEIVABLE (CONTINUED)
Nonaccrual loans related to the loans held for sale portfolio aggregated
approximately $5,098,000 and $3,568,000 at December 31, 1995 and 1996,
respectively. Approximately $1,123,000 and $722,000 at December 31, 1995 and
1996, respectively, of the nonaccrual loans relate to a 90 percent senior
participation interest acquired by the Company in a $22,000,000 passthrough
certificate, with an outstanding balance of $5,115,000 at December 31, 1996,
secured by single family residential real estate mortgages which are classified
as loans held for sale. Losses incurred related to loans underlying the
passthrough certificate are first charged to the subordinate participation
interest, which was approximately $1.8 million at December 31, 1996.
Interest income that would have been recorded for all nonaccrual loans was
approximately $140,000, $156,000, and $120,000 during the years ended December
31, 1994, 1995, and 1996, respectively.
During 1996, the Bank formed two mortgage backed securities with an unpaid
principal balance of approximately $21,000,000 from its loans held for sale
portfolio. During the year ended December 31, 1996, the Company recognized a
gross gain on the sale of mortgage backed securities of approximately $171,000
and the taxes related to this sale were approximately $68,000.
On December 31, 1996, Matrix Bank sold the fixed assets and the right to the
name of Sterling Finance to a third party buyer and ceased its subprime auto
lending operations. During the time that Matrix Bank owned Sterling Finance, it
purchased numerous automobile retail installment contracts and sold
approximately $18,500,000 of such contracts, subject to certain recourse
provisions. During 1996, Sterling Finance was required to repurchase
approximately $2,500,000 of automobile installment contracts and repossessed
automobiles pursuant to the recourse provisions. Included in loans held for sale
at December 31, 1996 is approximately $1,220,000, net of discount, of these
automobile installment contracts. Matrix Bank had a recourse liability recorded
of approximately $600,000 at December 31, 1996 for the potential loss exposure
related to these automobile installment contracts and repossessed automobiles.
Matrix Bank has received a signed letter from the purchaser of the automobile
retail installment contracts that no additional repurchases will be required,
except with respect to certain terms and conditions in the purchase and sale
agreement, which are primarily limited to fraudulent misrepresentations by the
borrowers under the contracts. No instances of significant fraudulent
misrepresentations have been identified to date and it is the opinion of the
Company's management that there are no material repurchase obligations remaining
under the purchase and sale agreement.
Additionally, in other assets is approximately $500,000 in repossessed
automobiles which represents the estimated fair value of the automobiles, less
estimated costs to sell.
F-17
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
4. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
DECEMBER 31
1994 1995 1996
----------------------
(In thousands)
Land $ 417 $ 532 $ 692
Buildings 3,068 3,761 4,257
Leasehold improvements 118 127 248
Office furniture and equipment 1,407 1,721 2,863
Other equipment 186 960 975
----------------------
5,196 7,101 9,035
Less: accumulated depreciation and
amortization 738 1,197 1,756
----------------------
$4,458 $5,904 $7,279
======================
Included in occupancy and equipment expense is depreciation and amortization
expense of premises and equipment of approximately $414,000, $467,000, and
$659,000 for the years ended December 31, 1994, 1995 and 1996, respectively.
5. MORTGAGE SERVICING RIGHTS
The activity in the MSRs is summarized as follows:
YEAR ENDED DECEMBER 31
1994 1995 1996
---------------------------------
(In thousands)
Balance at beginning of year $ 1,818 $ 6,183 $13,817
Purchases 5,550 9,203 17,142
Originated, net of OMSRs sold - 885 441
Amortization (1,185) (1,817) (2,432)
Transfer of MSR to FHLMC (Note 12) - - (110)
Sales - (637) (5,178)
---------------------------------
Balance at end of year $ 6,183 $13,817 $23,680
=================================
Accumulated amortization of mortgage servicing rights aggregated approximately
$9,495,000 and $11,347,000 at December 31, 1995 and 1996, respectively.
F-18
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
5. MORTGAGE SERVICING RIGHTS (CONTINUED)
The Company's servicing activity is diversified throughout 48 states with
concentrations at December 31, 1996 in California, New York and Texas of
approximately 27.2 percent, 8.6 percent and 16.4 percent, respectively, based on
aggregate outstanding unpaid principal balances of the mortgage loans serviced.
As of December 31, 1995 and 1996, the Company subserviced loans for others of
approximately $85,000,000 and $140,000,000, respectively.
The Company's servicing portfolio (excluding subserviced loans) comprised the
following:
DECEMBER 31,
1995 1996
--------------------------------------------------
PRINCIPAL
NUMBER BALANCE NUMBER PRINCIPAL BALANCE
OF LOANS OUTSTANDING OF LOANS OUTSTANDING
--------------------------------------------------
(Dollars In thousands)
FHLMC 9,453 $ 671,966 12,107 $ 666,218
FNMA 7,820 483,947 13,426 764,632
GNMA 271 12,883 9,379 278,700
Other VA, FHA, and conventional loans 7,414 427,589 12,870 795,486
------------------------------------------------
24,958 $1,596,385 47,782 $2,505,036
================================================
The Company's custodial escrow balances shown in the accompanying consolidated
balance sheets pertain to escrowed payments of taxes and insurance and the float
on principal and interest payments on loans serviced on behalf of others and
owned by the Company, aggregating approximately $26,769,000 and $27,381,000 at
December 31, 1995 and 1996, respectively. The Company also has custodial
accounts on deposit from other mortgage companies aggregating approximately
$242,000 and $10,500,000 at December 31, 1995 and 1996, respectively. The
Companies custodial accounts are maintained at Matrix Bank in noninterest
bearing accounts. The balance of the custodial accounts fluctuate from month to
month based on the pass-through of the principal and interest payments to the
ultimate investors and the timing of the taxes and insurance payments.
The mortgage servicing portfolio includes recourse servicing equal to
approximately 0.7 and 0.4 percent of the total owned at December 31, 1995 and
1996, respectively. A reserve for losses is recorded, as appropriate, for loans
serviced for others, in which the investor has recourse to the Company, which
had a balance of approximately $52,000, $49,000 and $61,000 at December 31, 1994
and 1995 and 1996, respectively. Additionally, in certain circumstances the
Company is required to make advances for escrow and foreclosure costs for loans
which it services. The Company experienced losses for unrecoverable advances of
approximately $34,000, $144,000, and $28,000 for the years ended December 31,
1994, 1995 and 1996, respectively.
F-19
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
6. DEPOSITS
Deposit account balances are summarized as follows:
DECEMBER 31
----------------------------------------------------------
1995 1996
----------------------------------------------------------
(Dollars In thousands)
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT PERCENT RATE AMOUNT PERCENT RATE
----------------------------------------------------------
Passbook accounts $ 2,358 4.82% 3.40% $ 2,757 3.06% 3.45%
NOW accounts 3,832 7.84 1.49 4,732 5.25 1.66
Money market accounts 6,167 12.62 4.38 9,455 10.48 4.43
------- ------ ---- ------- ------ ----
12,357 25.28 3.18 16,944 18.79 3.59
Certificate accounts 36,513 74.72 5.97 73,235 81.21 5.85
------- ------ ---- ------- ------ ----
48,870 100.00% 90,179 100.00%
====== ======
Purchase premium 7 -
------- -------
$48,877 $90,179
======= =======
Weighted-average interest rate 5.23% 5.36%
==== ====
Contractual maturities of certificate accounts as of December 31, 1996:
Under 12 12 to 36 36 to 60
months months months
------------------------------------------
(In thousands)
3.00-3.99% $ 104 $ - $ -
4.00-4.99% 807 - -
5.00-5.99% 43,211 5,663 318
6.00-6.99% 8,078 8,737 3,211
7.00-7.99% 2,409 258 395
8.00-10.50% - 41 3
------------------------------------------
$54,609 $ 14,699 $ 3,927
==========================================
F-20
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
6. DEPOSITS (CONTINUED)
Interest expense on deposits is summarized as follows:
YEAR ENDED DECEMBER 31
1994 1995 1996
-------------------------------
(In thousands)
Passbook accounts $ 72 $ 85 $ 82
NOW accounts 76 52 63
Money market 195 240 405
Certificates of deposit 1,138 1,807 3,210
-------------------------------
$1,481 $2,184 $3,760
===============================
The aggregate amount of deposit accounts with a balance greater than $100,000
was approximately $2,066,000 and $5,457,000 at December 31, 1995 and 1996
respectively.
F-21
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
7. BORROWED MONEY
Borrowed money is summarized as follows:
DECEMBER 31
1995 1996
----------------------
(In thousands)
Term Notes Payable
Note payable to a third-party financial
institution due in annual principal
installments of $286,101, plus
interest, through 2003, collateralized
by the common stock of Matrix Bank;
interest at prime plus 1.0 percent. $ 2,289 $2,003
Notes payable to a third-party
financial institution due in 28
consecutive quarterly installments,
secured by MSRs; interest at prime
plus 2.0 percent and fixed at 10
percent. 631 521
Note payable to a bank, secured by a
deed of trust on real estate, unpaid
principal balance plus interest due
June 1998; interest at prime plus 1.0
percent. 921 938
$13,500,000 servicing acquisition loan
agreement with a bank, secured by
MSRs, due at the earlier of the
maturity of the MSRs or amortized over
five to six years from the date of the
borrowing through June 2002; interest
at federal funds rate plus 2.75
percent (8.05 percent at December 31,
1996); $12,000,000 available at
December 31, 1996. 8,709 1,500
Senior subordinated notes, interest at
13 percent payable semiannually,
unsecured and maturing July 2002, with
mandatory redemptions of $727,500 on
each of July 15, 1999, 2000 and 2001. 2,910 2,910
Note payable to a third-party financial
institution due in monthly
installments through 2000, secured by
equipment; interest at the one year
treasury rate plus 2.4 percent. 786 731
Note payable to a bank, secured by a
deed of trust on real estate, interest
due monthly at prime plus 1 percent,
unpaid principal due July 21, 1998. - 845
Other, interest at prime plus 2.0 percent 201 -
----------------------
Total term notes 16,447 9,448
F-22
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
7. BORROWED MONEY (CONTINUED)
DECEMBER 31
1995 1996
----------------------
(In thousands)
Revolving Lines
$50,000,000 revolving warehouse loan
agreement (with a $2,500,000 working
capital sublimit) with banks, secured
by mortgage loans held for sale,
mortgage servicing rights, eligible
servicing advance receivables and
eligible delinquent mortgage
receivables; interest at federal funds
rate plus 1.0 to 2.25 percent (6.50
and 7.55 percent average rate at
December 31, 1996 for the warehouse
loan and working capital loan,
respectively); $18,496,000 available
overall and $2,500,000 available under
the working capital sublimit at
December 31, 1996. $46,833 $31,504
----------------------
46,833 31,504
Other
Financing agreement with a bank,
secured by Ft. Lupton Subordinated
Series 1996 A1 revenue anticipation
warrants, interest is at 5 percent and
is due based on the semi-annual bonds
payments, unpaid principal due at bond
maturity. - 800
Agreements with a bank and an
investment bank to sell mortgage loans
originated by the Company under
agreements to repurchase. The
agreement can be terminated upon 90
days written notice by either party;
interest at the higher of the prime
rate or note rate on the loans. Total
commitment amount of these agreements
is $20,000,000, with $20,000,000
available at December 31, 1996. 570 -
MSR financing (see below). 1,243 679
----------------------
1,813 1,479
----------------------
$65,093 $42,431
======================
F-23
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
7. BORROWED MONEY (CONTINUED)
On January 31, 1997, the Company renegotiated the revolving credit facilities
for its $50,000,000 warehouse loan agreement, including the working capital
element, and its $13,500,000 servicing acquisition loan agreement. With this
renegotiation, the aggregate amount of revolving warehouse lines of credit
facilities was increased to $60.0 million, the aggregate amount of the servicing
acquisition facility was increased to $30.0 million, and the aggregate amount of
the working capital facility was increased to $10.0 million. The $10.0 million
working capital facility became a separate component to the revolving credit
facilities, and is no longer a sublimit to the warehouse loan agreement. The new
credit facility agreement requires Matrix Financial to maintain, among other
things, (i) total shareholder's equity of at least $10.0 million plus 100
percent of capital contributed after January 1, 1997, plus 50 percent of
cumulative quarterly net income, (ii) adjusted net worth, as defined, of at
least $12.0 million, (iii) a servicing portfolio of at least $2.0 billion, (iv)
principal debt of term line borrowings of no more than the lesser of 70 percent
of the appraised value of the mortgage servicing portfolio or 1.25 percent of
the unpaid principal balance of the mortgage servicing portfolio, (v) a ratio of
total adjusted debt to adjusted tangible net worth of no more than eight to one,
and (vi) a ratio of cash flow to current maturities of long-term debt and any
capital leases of at least 1.3 to 1.0.
The terms of the senior subordinated notes limit cash dividends to an amount
equal to 50 percent of consolidated net income as long as the dividend does not
exceed 10 percent of consolidated shareholders' equity. The Company may redeem
the senior subordinated notes, in whole or in part, at any time after July 15,
1998 at a redemption price of 102 percent of par through July 14, 1999 and,
thereafter, at par, plus accrued and unpaid interest. The Company was obligated
to register under the Securities Act of 1933 the senior subordinated notes on or
before February 1, 1997. Since such registration statement was not effected by
February 1, 1997, the interest rate increased to 14 percent.
As of December 31, 1996 the maturities of term notes payable during the next
five years and thereafter are as follows:
(In thousands)
1997 $ 648
1998 2,500
1999 1,493
2000 1,499
2001 1,479
Thereafter 1,829
--------------
$9,448
==============
F-24
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
7. BORROWED MONEY (CONTINUED)
The Company must comply with certain financial and other covenants related to
the foregoing debt agreements including the maintenance of specific ratios, net
worth and other amounts as defined in the credit agreements. At December 31,
1996, the Company was in compliance with these covenants.
MSR Financing
In 1992 and 1994 the Company entered into two unrelated transactions with
portions of its owned servicing portfolio which were accounted for as financings
due to various terms of the agreements regarding continuing involvement. Amounts
due to the other parties under the financings had balances of approximately
$1,243,000 and $679,000 at December 31, 1995 and 1996, respectively. The MSRs
pledged as collateral for the loans relate to mortgage loans with unpaid
principal balances of approximately $125,000,000 and $74,000,000 at December 31,
1995 and 1996, respectively. One of these financing arrangements was completely
paid off in 1996. In the remaining financing arrangement, the Company retains a
portion of the servicing income associated with the pledged or related MSRs,
with the balance of the servicing income paid to the other parties as a
reduction of the debt and interest. The implicit interest rate of the financing
varies depending on the servicing income derived from the MSRs.
A portion of the payment made under this arrangement is recorded as interest
expense on the level yield method. The amounts due the other parties are payable
solely from the servicing income derived from the MSRs, and there is no implicit
or explicit guarantee as to repayment. The total amounts paid to the other
parties aggregated approximately $717,000, $620,000 and $785,000 during the
years ended December 31, 1994, 1995 and 1996, respectively.
8. FEDERAL HOME LOAN BANK OF DALLAS BORROWINGS
Federal Home Loan Bank of Dallas borrowings aggregated $19,000,000 and
$51,250,000 at December 31, 1995 and 1996, respectively. The advances bear
interest at rates which adjust daily and are based on the mortgage repo rate.
All advances are secured by first mortgage loans of Matrix Bank and all Federal
Home Loan Bank of Dallas stock.
Matrix Bank has a commitment from the Federal Home Loan Bank of Dallas for
advances of approximately $55,000,000 at December 31, 1996. Matrix Bank adopted
a collateral pledge agreement whereby it has agreed to keep on hand, at all
times, first mortgages free of all other pledges, liens, and encumbrances with
unpaid principal balances aggregating no less than 170 percent of the
outstanding secured advances from the Federal Home Loan Bank of Dallas. All
stock in the Federal Home Loan Bank of Dallas is pledged as additional
collateral for these advances.
F-25
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
9. INCOME TAXES
The income tax provision consists of the following:
YEAR ENDED DECEMBER 31
1994 1995 1996
-------------------------
(In thousands)
Current
Federal $1,350 $1,630 $1,720
State 210 418 440
Deferred
Federal 236 169 (42)
State 50 43 (12)
-------------------------
$1,846 $2,260 $2,106
=========================
A reconciliation of the provision for income taxes with the expected income
taxes based on the statutory federal income tax rate follows:
YEAR ENDED DECEMBER 31
1994 1995 1996
-------------------------
(In thousands)
Expected income tax provision $1,530 $1,979 $1,829
State income taxes 270 293 282
Other 46 (12) (5)
-------------------------
$1,846 $2,260 $2,106
=========================
F-26
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
9. INCOME TAXES (CONTINUED))
Deferred tax assets and liabilities result from the tax effects of temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes shown below.
DECEMBER 31
1995 1996
---------------------
(In thousands)
Deferred tax assets:
Allowance for losses $ 190 $ 551
Discounts and premiums 177 108
Amortization of servicing rights 160 -
Other 51 82
---------------------
Total deferred tax assets 578 741
Deferred tax liabilities:
Gain on sale of loans (275) (279)
Amortization of servicing rights - (106)
Depreciation (241) (302)
Other (62) -
----------------------
Total deferred tax liabilities (578) (687)
----------------------
Net deferred tax asset $ - $ 54
======================
10. REGULATORY
The Company is a unitary thrift holding company and, as such, is subject to the
regulation, examination and supervision of the Office of Thrift Supervision
(OTS).
Matrix Bank is also subject to various regulatory capital requirements
administered by the OTS. Failure to meet minimum capital requirements can
initiate certain mandatory, and possibly additional discretionary actions,
actions by regulators that, if undertaken, could have a direct material effect
on Matrix Bank's financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, Matrix Bank must meet
specific capital guidelines that involve quantitative measures of the Matrix
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. Matrix Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
F-27
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
10. REGULATORY (CONTINUED)
Quantitative measures established by regulation to ensure capital adequacy
require Matrix Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to total
assets (as defined). Management believes, as of December 31, 1996, that Matrix
Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification from the OTS categorized
Matrix Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized Matrix Bank must
maintain minimum total risk-based, Tier I risk based and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------- ----------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- --------- -----------
(In thousands)
As of December 31, 1996
Total Capital (to Risk
Weighted Assets) $12,406 11.1% $8,979 8.0% $11,224 10.0%
Tier I Capital (to Risk
Weighted Assets) 11,367 10.1 4,489 4.0 6,734 6.0
Tier I Capital (to Average
Assets) 11,367 7.8 5,803 4.0 7,254 5.0
As of December 31, 1995
Total Capital (to Risk
Weighted Assets) 8,321 13.3% 4,997 8.0% 6,246 10.0%
Tier I Capital (to Risk
Weighted Assets) 7,540 12.1 2,499 4.0 3,748 6.0
Tier I Capital (to Average
Assets) 7,540 7.2 4,195 4.0 5,243 5.0
The various federal banking statutes to which Matrix Bank is subject also
include other limitations regarding the nature of the transactions in which it
can engage or assets it may hold or liabilities it may incur.
Matrix Bank is required to maintain balances with the Federal Reserve Bank of
Dallas in a noninterest earning account based on a percentage of deposit
liabilities. Such balances averaged $888,0000 and $659,000 in 1995 and 1996,
respectively.
F-28
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
10. REGULATORY (CONTINUED)
Matrix Bank is required by Federal regulations to maintain a minimum level of
liquid assets of five percent. Matrix Bank exceeded the Federal requirement at
December 31, 1995 and 1996, respectively.
Matrix Financial is subject to examination by various regulatory agencies
involved in the mortgage banking industry. Each regulatory agency requires the
maintenance of a certain amount of net worth, the most restrictive of which
required $1,224,000 at December 31, 1995 and $1,709,000 at December 31, 1996.
11. SHAREHOLDERS' EQUITY
Common Stock
The authorized common stock of the Company consists of 50,000,000 shares with a
par value of $.0001 per share. There were 3,888,939 and 5,901,439 shares of
common stock outstanding at December 31, 1995 and 1996, respectively. Holders
of common stock are entitled to receive dividends when, and if, declared by the
board of directors. Each share of common stock entitles the holders thereof to
one vote, and cumulative voting is not permitted.
Preferred Stock
The authorized preferred stock of the Company consists of 5,000,000 shares with
a par value of $.0001 per share. The board of directors is authorized, without
further action of the shareholders of the Company, to issue from time to time
shares of preferred stock in one or more series and with such relative rights,
powers, preferences, and limitations as the board of directors may determine at
the time of issuance. Such shares may be convertible into common stock and may
be superior to the common stock in the payment of dividends, liquidation, voting
and other rights, preferences and privileges.
Stock Option Plan
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and related Interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
Accounting for Stock-Based Compensation, requires use of option valuation models
that were not developed for use in valuing employee stock options. Under APB
25, because the exercise price of the Company's employee stock options equals
the market price of the underlying stock on the date of grant, no compensation
expense is recognized.
F-29
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
11. SHAREHOLDERS' EQUITY (CONTINUED)
In September 1996, the board of directors and shareholders adopted the 1996
Stock Option Plan, which amended and restated the Company's stock option plan
adopted in 1995. The Company's 1996 Stock Option Plan has authorized the grant
of options to substantially all of the Company's full-time employees and
directors for up to 525,000 shares of the Company's common stock. All options
granted have ten year terms and vest based on the determination by the Company's
compensation committee.
The 1996 Stock Option Plan authorized the granting of incentive stock options
("Incentive Options") and nonqualified stock options ("Nonqualified Options") to
purchase common stock to eligible persons. The 1996 Stock Option Plan is
currently administered by the compensation committee (administrator) of the
board of directors. The 1996 Stock Option Plan provides for adjustments to the
number of shares and to the exercise price of outstanding options in the event
of a declaration of stock dividend or any recapitalization resulting in a stock
split-up, combination or exchange of shares of common stock.
No Incentive Option may be granted with an exercise price per share less than
the fair market value of the common stock at the date of grant. The
Nonqualified Options may be granted with any exercise price determined by the
administrator of the 1996 Stock Option Plan. The expiration date of an option
is determined by the administrator at the time of the grant, but in no event may
an option be exercisable after the expiration of ten years from the date of
grant of the option.
The 1996 Stock Option Plan further provides that in most instances an option
must be exercised by the optionee within 30 days after the termination of the
consulting contract between such consultant and the Company or termination of
the optionee's employment with the Company, as the case may be, if and to the
extent such option was exercisable on the date of such termination.
Pro forma information regarding net income and earnings per share is required by
Statement 123, which also requires that the information be determined as if the
Company had accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1995
and 1996, respectively: risk-free interest rates of 5.4 percent and 6.0
percent; a dividend yield of zero percent; volatility factors of the expected
market price of the Company's common stock of .39 and .39; and a weighted-
average expected life of the option of four years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
F-30
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
11. SHAREHOLDERS' EQUITY (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for earnings per share
information):
YEAR ENDED DECEMBER 31
1995 1996
---------------------
Pro forma net income $3,446 $3,237
Pro forma earnings per share:
Primary 0.88 0.75
Fully diluted 0.88 0.75
Because Statement 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1997.
A summary of the Company's stock option activity, and related information for
the years ended December 31 follows:
1995 1996
---------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE XERCISE
OPTIONS PRICE OPTIONS PRICE
----------------------------------------
Outstanding, beginning of year - $ - 79,500 $ 5.13
Granted 79,500 5.13 129,600 10.00
Exercised - - - -
Forfeited - - - -
------ -------
Outstanding, end of year 79,500 $ 5.13 209,100 $ 8.15
====== =======
Exercisable at end of year 39,750 $ 5.13 87,000 $ 5.55
Weighted average fair value of options
granted during the year $ 2.19 $ 4.06
Exercise prices for options outstanding as of December 31, 1996 ranged from
$5.13 to $10.00. The weighted average remaining contractual life of those
options is 9.1 years.
Restricted Net Assets
As a result of the regulatory requirements and debt covenants, substantially all
of the net assets of the Company are restricted at December 31, 1995 and 1996.
F-31
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
11. SHAREHOLDERS' EQUITY (CONTINUED)
Warrants
The Company issued warrants exercisable for an aggregate of 75,000 shares of its
common stock to its primary underwriters upon the closing of the Company's
initial public offering. The warrants are exercisable from time to time during
the four years after the one year anniversary of their date of grant, and are
not transferable during the first year after their grant. The exercise price for
the shares of common stock underlying such warrants is $12 per share. The shares
of common stock underlying such warrants are entitled to certain demand and
incidental registration rights.
12. COMMITMENTS, CONTINGENCIES AND RELATED PARTY TRANSACTIONS
Employee Stock Purchase Plan
In September 1996, the board of directors and shareholders adopted the Matrix
Capital Corporation Employee Stock Purchase Plan ("Purchase Plan") and reserved
125,000 shares of common stock ("ESPP Shares") for issuance thereunder. The
Purchase Plan became effective upon consummation of the initial public offering.
The price at which ESPP shares are sold under the Purchase Plan is 85 percent of
the lower of the fair market value per share of common stock on the enrollment
or the purchase date.
Leases
The Company leases office space and certain equipment under noncancelable
operating leases. Annual amounts due under the office and equipment leases as of
December 31, 1996 are approximately as follows:
(In thousands)
1997 $370
1998 267
1999 54
2000 21
2001 1
-------------
$713
=============
Total rent expense aggregated approximately $481,000, $437,000 and $349,000, for
the years ended December 31, 1994, 1995 and 1996, respectively.
F-32
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
12. COMMITMENTS, CONTINGENCIES AND RELATED PARTY TRANSACTIONS (CONTINUED)
Loan Commitments and Hedging
In the ordinary course of business, the Company makes commitments to originate
residential mortgage loans (Pipeline) and holds originated loans until delivery
to an investor. Inherent in this business is a risk associated with changes in
interest rates and the resulting change in the market value of the Pipeline and
funded loans. The Company mitigates this risk through the use of mandatory and
nonmandatory forward commitments to sell loans. At December 31, 1995, the
Company had $93,133,000 in Pipeline and funded loans offset with mandatory
forward commitments of $64,743,000 and nonmandatory forward commitments of
$15,267,000. At December 31, 1996, the Company had $62,578,000 in Pipeline and
funded loans offset with mandatory forward commitments of $49,150,000 and
nonmandatory forward commitments of $8,144,000. The inherent value of the
forward commitments is considered in the determination of the lower of cost or
market for the Pipeline and funded loans. The Company does not hold any other
derivatives at December 31, 1995 or 1996.
Land Development Commitment
In June 1996, the Company purchased 154 acres of land for $1.3 million in cash
for the purpose of developing residential and multi-family lots in Ft. Lupton,
Colorado. As part of the acquisition, the Company entered into a Residential
Facilities Development Agreement (Development Agreement) with the City of Ft.
Lupton. The Development Agreement is a residential and planned unit development
agreement providing for the orderly planning, engineering and development of a
golf course and surrounding residential community. The City of Ft. Lupton is
responsible for the development of the golf course and the Company is
responsible for the development of the surrounding residential lots.
The Development Agreement sets forth a mandatory obligation on the part of the
Company to pay the City of Ft. Lupton pledged enhancement assessments of
$600,000. These pledged enhancement assessments require the Company to pay the
city a $2,000 fee each time the Company sells a developed residential lot. The
Company is obligated to pay a minimum of $60,000 in assessment fees per year
beginning in 1998 through 2007.
The Company also entered into a development management agreement with a local
developer to complete the development of the land. The terms of the agreement
specify that the Company is to earn a preferred rate of return on its investment
and, once the initial amount of its investment has been returned, the remaining
profits are split equally. The development management agreement obligates the
Company to provide up to an additional $500,000 of funds for development. The
Company has no other financial obligations to the developer beyond the $500,000.
As of December 31, 1996, the Company has included in its basis in the
development $38,000 in capitalized interest costs. At December 31, 1996, the
total basis of the land development is $1,431,000 and is classified in other
assets in the accompanying consolidated balance sheets.
F-33
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
12. COMMITMENTS, CONTINGENCIES AND RELATED PARTY TRANSACTIONS (CONTINUED)
Financing Agreement
In 1996, the Company purchased $800,000 of City of Fort Lupton Subordinated
Series 1996 A1 revenue anticipation warrants, with interest at 9.75 percent and
due December 15, 2015. The warrants are classified as other receivables in the
accompanying consolidated balance sheets. The Company entered into an agreement
with a bank to sell the warrants, subject to certain repurchase obligations
resulting from the bank's annual remarketing of the bonds, with interest at five
percent. The Company entered into a letter of credit agreement of $825,000 to
guarantee its repurchase obligation.
Contingencies
Matrix Bank has received demands from an investor for repurchase of loans
related to a servicing portfolio purchased by Matrix Bank from an unrelated
third-party mortgage banker (Seller). The repurchase demand is pursuant to a
claim of breach of covenants and warranties by the Seller related to
documentation deficiencies in connection with the origination and sale of the
loans. In January 1996, Matrix Bank commenced suit against the Seller to
recover, among other things, the purchase price paid for certain residential
mortgage loans. In connection with the lawsuit and the servicing portfolio at
issue, Matrix Bank has full representations and warranties from the Seller.
Since the representations and warranties have not been honored by the Seller,
Matrix Bank included a cause of action in the lawsuit seeking to compel the
Seller to repurchase the portfolio. During 1996, the servicing relating to FHLMC
was transferred to FHLMC for no consideration. Matrix Bank accrued a liability
of approximately $500,000 at December 31, 1995 and $420,000 at December 31, 1996
for the potential loss exposure related to the pending repurchase requests
which, in the opinion of management, is adequate for estimated future losses.
The Company is a defendant in two lawsuits filed in 1996 that seek class action
status, which allege that the Company breached the terms of plaintiffs'
promissory notes and mortgages by imposing certain changes at the time the
plaintiffs prepaid their mortgage loans. The Company has entered into an
agreement, which is subject to court approval, to settle one lawsuit and dismiss
the other lawsuit. A settlement order of dismissal was entered into for the
dismissed lawsuit on November 13, 1996.
In January 1997, a preliminary approval of the settlement was granted by the
Court. Notice to class members was mailed in January 1997 and published in
February 1997. The settlement agreement requires the Company to establish a
settlement fund of $640,000 which covers the costs of notice and class
administration, attorneys' fees, and recovery to class members. As of December
31, 1996, the Company accrued a liability of approximately $600,000 related to
the settlement. In the opinion of management, the accrued liability at December
31, 1996 is adequate as the actual payments made from the settlement fund is
dependent on the response rate from the plaintiff class members. The final
approval hearing for the settlement is scheduled for April 1997.
F-34
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
12. COMMITMENTS, CONTINGENCIES AND RELATED PARTY TRANSACTIONS (CONTINUED)
The Company and its subsidiaries are parties to various other litigation
matters, in most cases involving ordinary and routine claims incidental to the
business of the Company. The ultimate legal and financial liability of the
Company, if any, with respect to such pending litigation cannot be estimated
with certainty, but the Company believes, based on its examination of such
matters, that such ultimate liability will not have a material adverse effect on
the consolidated financial position, results of operations or cash flows of the
Company.
Related Party Transactions
The Company has a note receivable from an affiliate of $750,000 at December 31,
1995 and 1996, which bears interest at 13 percent and is due October 1, 2000.
The note is secured by a secondary lien on the assets of the affiliate. The
Company leases office space to the affiliate for approximately $8,500 per month.
The lease expires in September 1997, but the Company anticipates that it will be
renewed.
At December 31, 1995 and December 31, 1996, the Company had an unsecured loan
receivable from a shareholder of approximately $80,000, which bears interest at
the prime rate and is due December 31, 1997.
13. DEFINED CONTRIBUTION PLAN
The Company has a 401(k) defined contribution plan (Plan) covering all employees
who have elected to participate in the Plan. Each participant may make pretax
contributions to the Plan up to 15 percent of such participant's earnings with a
maximum of $9,500 in 1996. The Company makes a matching contribution of 25
percent of the participant's total contribution. Matching contributions made by
the Company vest over six years. The cost of the plan approximated $46,000,
$61,000 and $83,000 during the years ended December 31, 1994, 1995 and 1996,
respectively.
14. FINANCIAL INSTRUMENTS
Off-Balance Sheet Risk and Concentration of Commitments
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of its business. These instruments are commitments to
originate or purchase first mortgage loans and forward loan sale commitments
(see Note 12) and involve credit and interest rate risk in excess of the amount
recognized in the consolidated balance sheet.
Commitments to originate or purchase mortgage loans amounted to approximately
$18,900,000 at DecemberE31, 1996. Additionally, the Company has a $400,000
commitment to lend funds on a secured basis. The Company plans to fund the
commitments in its normal commitment period. The Company evaluates each
customer's creditworthiness on a case-by-case basis.
F-35
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
14. FINANCIAL INSTRUMENTS (CONTINUED)
The Company's credit risks comprised the outstanding loans held for sale and
loans held for investment as shown in the consolidated balance sheets, and loans
sold with recourse aggregating approximately $354,000 and $16,214,000 at
December 31, 1995 and 1996, respectively. The loans are located throughout the
United States and are collateralized primarily by a first mortgage on the
property.
Fair Value of Financial Instruments
The carrying amounts and estimated fair value of financial instruments are as
follows:
DECEMBER 31
1995 1996
------------------ ------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------------------------------------
(In thousands)
Financial assets:
Cash $ 1,381 $ 1,381 $ 2,319 $ 2,319
Interest earnings deposits 5,586 5,586 9,499 9,499
Loans held for sale, net 127,090 130,638 182,801 183,741
Loans held for investment, net 19,575 19,829 29,560 29,824
Federal Home Loan Bank of Dallas stock 1,954 1,954 2,871 2,871
Financial liabilities:
Deposits 48,877 49,283 90,179 90,401
Custodial escrow balances 27,011 27,011 37,881 37,881
Drafts payable 8,817 8,817 5,961 5,961
Payable for purchase of MSRs 1,312 1,312 8,044 8,044
Federal Home Loan Bank of Dallas
borrowings 19,000 19,000 51,250 51,250
Borrowed money 65,093 65,093 42,431 42,431
The following methods and assumptions were used by the Company in estimating the
fair value of the financial instruments:
The carrying amounts reported in the balance sheet for cash, interest earnings
deposits, Federal Home Loan Bank of Dallas stock, drafts payable, payable for
purchase of MSRs, Federal Home Loan Bank of Dallas borrowings, and borrowed
money approximate those assets and liabilities' fair values.
F-36
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
14. FINANCIAL INSTRUMENTS (CONTINUED)
The fair values of loans are based on quoted market prices where available or
outstanding commitments from investors. If quoted market prices are not
available, fair values are based on quoted market prices of similar loans sold
in securitization transactions, adjusted for differences in loan
characteristics. The fair value of forward sale commitments are included in the
determination of the fair value of loans held for sale.
The fair value disclosed for demand deposits (e.g., interest and noninterest
checking, savings, and money market accounts) are, by definition, equal to the
amount payable on demand at the reporting date (i.e., their carrying amounts).
Fair values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected periodic maturities
on time deposits. The component commonly referred to as deposit base intangible,
was not estimated at December 31, 1995 and 1996 and is not considered in the
fair value amount. The fair value disclosed for custodial escrow balances
liabilities (noninterest checking) is, by definition, equal to the amount
payable on demand at the reporting date (i.e., their carrying amounts).
F-37
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
15. PARENT COMPANY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Matrix Capital Corporation (Parent Company)
is as follows:
December 31
1994 1995 1996
--------------------------
CONDENSED BALANCE SHEETS (In thousands)
Assets:
Cash $ 180 $ 11 $ 45
Other receivables - 804 872
Premises and equipment, net 1,154 1,371 1,405
Other assets 303 515 507
Investment in and advances to
subsidiaries 8,924 13,853 34,731
--------------------------
Total assets $10,561 $16,554 $37,560
==========================
Liabilities and shareholders' equity:
Borrowed money (a) $ 4,052 $ 6,751 $ 6,372
Other liabilities 833 465 386
--------------------------
Total liabilities 4,885 7,216 6,758
Shareholders' equity:
Common stock - - 1
Additional paid in capital 2,525 2,626 20,816
Retained earnings 3,151 6,712 9,985
--------------------------
Total shareholders' equity 5,676 9,338 30,802
--------------------------
Total liabilities and shareholders'
equity $10,561 $16,554 $37,560
==========================
(a) The Parent's debt consists of a note payable to a third party financial
institution secured by common stock at Matrix Bank, note payable to a bank
secured by a deed of trust on real estate, senior subordinated notes and a
note payable to a third party financial institution secured by MSRs. The
Parent also guarantees the revolving warehouse and servicing acquisition
loan agreements. See Note 7 for additional information regarding the debt.
F-38
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
15. PARENT COMPANY CONDENSED FINANCIAL INFORMATION (CONTINUED)
As of December 31, 1995, the maturities of term notes payable during the next
five years and thereafter are as follows:
(In thousands)
1997 $ 439
1998 1,291
1999 1,123
2000 1,123
2001 1,096
Thereafter 1,300
------
$6,372
======
Year Ended December 31
1994 1995 1996
----------------------------------
(In thousands)
CONDENSED STATEMENTS OF INCOME
Income:
Interest income on loans $ - $ 44 $ 142
Other 472 374 130
----------------------------------
Total income 472 418 272
Expenses:
Compensation and employee benefits 767 1,042 1,344
Occupancy and equipment 18 92 299
Interest on borrowed money 170 592 805
Professional fees 82 112 138
Other general and administrative 81 704 328
----------------------------------
Total expenses 1,118 2,542 2,914
----------------------------------
Loss before income taxes and equity in
income of subsidiaries (646) (2,124) (2,642)
Income taxes (b) - - -
----------------------------------
Loss before equity in income of
subsidiaries (646) (2,124) (2,642)
Equity in income of subsidiaries 3,292 5,685 5,915
----------------------------------
Net income $2,646 $ 3,561 $ 3,273
==================================
(b) The Company's tax sharing agreement with its subsidiaries provides that the
subsidiaries will pay the Parent an amount equal to its individual current
income tax provision calculated on the basis of the subsidiary filing a
separate return. In the event a subsidiary incurs a net operating loss in
future periods, the subsidiary will be paid an amount equal to the current
income tax refund the subsidiary would be due as a result of carryback of
such loss, calculated on the basis of the subsidiary filing a separate
return. Accordingly, the parent's condensed statements of income do not
include any income tax benefit for the current losses.
F-39
Matrix Capital Corporation
Notes to Consolidated Financial Statements (continued)
15. PARENT COMPANY CONDENSED FINANCIAL INFORMATION (CONTINUED)
Year Ended December 31
1994 1995 1996
---------------------------------
(In thousands)
CONDENSED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Net income $ 2,646 $ 3,561 $ 3,273
Adjustments to reconcile net income to
net cash provided (used) by operating
activities:
Equity in income of subsidiaries (3,292) (5,685) (5,915)
Dividend from subsidiaries 1,368 2,207 1,642
Depreciation and amortization 5 34 127
Increase (decrease) in other liabilities 410 (368) (78)
Increase in other receivables and other (202) (1,016) (133)
assets
Noncash compensation expense - 101 -
---------------------------------
Net cash provided (used) by operating 935 (1,166) (1,084)
activities
Investing activities:
Purchases of premises and equipment (1,159) (251) (88)
Investment in and advances to (1,904) (1,451) (16,606)
subsidiaries ---------------------------------
Net cash used by investing activities (3,063) (1,702) (16,694)
Financing activities:
Repayments of notes payable (185) (1,133) (438)
Proceeds from notes payable 2,487 922 59
Proceeds from senior subordinated notes - 2,910 -
Proceeds from the sale of common stock - - 18,191
---------------------------------
Net cash provided by financing
activities 2,302 2,699 17,812
---------------------------------
Increase (decrease) in cash and cash 174 (169) 34
equivalents
Cash and cash equivalents at beginning
of year 6 180 11
---------------------------------
Cash and cash equivalents at end of year $ 180 $ 11 $ 45
=================================
16. SUBSEQUENT EVENT
On February 5, 1997, the Company acquired The Vintage Group Inc. ("Vintage")
with the issuance of 779,592 shares of the Company's common stock. The
transaction will be accounted for as a pooling of interests. Vintage's
subsidiaries, Sterling Trust Company ("Sterling Trust") and Vintage Financial
Services Corporation ("VFSC") are located in Waco, and Arlington, Texas,
respectively. Sterling Trust is a nonbank trust company specializing in self-
directed qualified retirement plans, individual retirement accounts, custodial,
and directed trust accounts. As of December 31, 1996, Sterling Trust had in
excess of 23,000 accounts with assets under administration of over $1.1 billion.
VFSC, whose name has been changed to First Matrix Investment Services Corp., is
a NASD broker/dealer that provides services to individuals and deferred
contribution plans.
F-40