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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Mark One
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1998
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No.: 0-22353
FLAGSTAR BANCORP, INC.
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(Exact name of registrant as specified in its charter)
MICHIGAN 38-3150651
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2600 TELEGRAPH ROAD, BLOOMFIELD HILLS, MICHIGAN 48302-0953
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (248) 338-7700
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Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: None.
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 ninety 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 registrants 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. [ ]
The registrants voting stock is traded on the NASDAQ Stock Market. The aggregate
market value of the voting stock held by non-affiliates of the registrant,
computed by reference to the last sale price ($25.813 per share) at which the
stock was sold on March 22, 1999 was approximately $169.3 million. For purposes
of this calculation, the term "affiliate" refers to all executive officers and
directors of the registrant and all stockholders beneficially owning more than
10% of the registrant's Common Stock.
As of March 19, 1999, 13,670,000 shares of the registrant's Common Stock, $0.01
par value, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:
1. Portions of the Annual Report to Shareholders for the year ended
December 31, 1998. (Parts I and II)
2. Portions of Proxy Statement for 1999 Annual Meeting of Shareholders.
(Part III)
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TABLE OF CONTENTS
PART I
Item 1. Business 3
Item 2. Properties 15
Item 3. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 15
PART II
Item 5. Market for the Company's Common Stock and Related
Stockholder Matters 15
Management's Report 16
Item 6. Selected Financial Data 17
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 18
Item 7a. Quantitative and Qualitative Disclosures about Market Risk 33
Item 8. Financial Statements 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 64
PART III
Item 10. Directors and Executive Officer of the Registrant 64
Item 11. Executive Compensation 64
Item 12. Security Ownership of Certain Beneficial Owners and
Management 64
Item 13. Certain Relationships and Related Transactions 64
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports 65
Signatures 66
When used in this Form 10-K or future filings by the Company with the Securities
and Exchange Commission, in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be", "will allow",
"intends to", "will likely result", "are expected to", "will continue", "is
anticipated", "estimate", "project", or similar expressions are intended to
identify "forward looking statement" within the meaning of the Private
Securities Litigation Reform Act of 1996.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from those
anticipated or projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
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PART I
ITEM 1. BUSINESS
GENERAL
Flagstar Bancorp, Inc. ("Flagstar" or the "Company"), is the holding company for
Flagstar Bank, FSB (the "Bank"), a federally chartered stock savings bank
founded in 1987. With $3.0 billion in assets at December 31, 1998, Flagstar is
the largest independent savings institution headquartered in Michigan.
Flagstar's primary business consists of attracting deposits from the general
public and originating or acquiring residential mortgage loans. Flagstar's
primary objective is to securitize and sell the mortgage loans while retaining
the mortgage servicing rights. The Company also invests in a significant amount
of loans in order to maximize the Company's leverage ability and to receive the
interest spread between earning assets and paying liabilities. The Company also
acquires funds on a wholesale basis from a variety of sources, services a
significant volume of loans for others, and to a lesser extent makes consumer
loans, commercial real estate loans, and non-real estate commercial loans.
The Bank is a member of the Federal Home Loan Bank System ("FHLB") and is
subject to regulation, examination and supervision by the Office of Thrift
Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The
Company's deposits are insured by the FDIC through the Savings Association
Insurance Fund ("SAIF").
The Company's executive office is located at 2600 Telegraph, Bloomfield Hills,
Michigan 48302, and its telephone number at such office is (248) 338-7700.
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LENDING ACTIVITIES
Flagstar is a consumer-oriented financial services organization. The Company's
principal business is obtaining funds in the form of deposits and borrowings and
investing those funds in various types of loans. The acquisition or origination
of single family mortgage loans is the Company's primary lending activity.
During 1998, Flagstar was the thirteenth largest originator in the United
States. In 1997 and 1996, the Company was also one of the twenty largest
mortgage originators in the United States. To a much lesser extent, the Company
makes consumer loans, commercial real estate loans, and commercial loans.
The Company currently conducts its retail lending operations from 28
full-service bank branches and 31 loan origination centers located in Michigan,
Florida and Ohio. The Company's largest concentration of offices is in southern
and western Michigan, where all of its branches and 27 of its loan centers are
located. The Company also has three loan centers in central Florida, and one
loan center in central Ohio. At December 31, 1998, the largest percentage of
loans held or serviced by the Company related to properties located in southern
and western Michigan. The Company also maintains 15 wholesale lending offices
which conduct business with correspondent mortgage lenders nationwide.
The Company offers all of its mortgage loan services throughout its market areas
from its full-service bank branches, retail loan origination offices, and
wholesale lending offices. Its loan officers are made available at each of the
bank branches and retail loan centers to process loan applications.
MORTGAGE LOANS
The origination or acquisition of residential mortgage loans constitutes the
most significant lending activity of the Company. The Company originated or
acquired $18.8 billion, $7.9 billion, and $6.8 billion of mortgage loans during
the years ended December 31, 1998, 1997, and 1996, respectively. Each loan
originated or acquired is for the purpose of acquiring or refinancing a one to
four family residence and is secured by a first mortgage on the property. The
Company offers traditional fixed-rate and adjustable-rate mortgage loans with
terms ranging from one year to 30 years. The majority of the Company's products
conform to the respective underwriting guidelines established by the Federal
Home Loan Mortgage Corporation ("FHLMC or Freddie Mac"), the Federal National
Mortgage Association ("FNMA or Fannie Mae"), and the Government National
Mortgage Association ("GNMA or Ginnie Mae"). The Company also offers other
residential mortgage loans which meet the Company's underwriting guidelines but
which may have other terms and conditions customized to meet the needs of the
borrower.
The Company, as a part of its overall mortgage banking strategy securitizes
mortgage loans through FHLMC, FNMA, or GNMA. Securitization is the process by
which mortgage loans owned by the Company are exchanged for marketable
securities that are guaranteed by either FHLMC, FNMA, or GNMA and are
collateralized by the same mortgage loans that were exchanged. The Company
generally sells its longer-term, fixed-rate loans while investing in the shorter
duration and adjustable rate product. The servicing related to the sold loans is
generally retained by the Company and later sold in bulk sales to secondary
market investors. The Company, for the most part, does not sell the servicing
rights to loans originated within its retail market area. See Notes 3, 4, and 7
of the Notes to Consolidated Financial Statements in Item 8. Financial
Statements and Supplementary Data, herein.
The Company's written underwriting guidelines employ a system of internal
controls designed to maintain the quality of the loan portfolio. All mortgage
loans are reviewed by an underwriter at the Company's national headquarters or
at one of the Company's wholesale lending centers. The Company also employs
contract underwriters to underwrite loans. Additionally, certain correspondents
of the Company have been issued delegated underwriting. If the loan amount
exceeds the maximum purchase limitation of FHLMC and FNMA, but is less than
$500,000, a senior Bank officer must also approve the loan. If the loan exceeds
$500,000, the Company's Chief Executive Officer or President must also approve
the loan.
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MORTGAGE LOANS (CONTINUED)
The Company requires that any loan with a loan-to-value ratio in excess of 80%
must carry mortgage insurance. A loan-to-value ratio is the ratio that the
original principal amount of a loan bears to the appraised value of the
mortgaged property or, in the case of a purchase money mortgage, the lower of
the appraised value of the property or the purchase price of the property
securing the loan. The Company requires a lower loan-to-value ratio for
non-owner-occupied loans. In addition, all home mortgage loans originated by the
Company are subject to requirements for title, fire, and hazard insurance. Real
estate taxes are generally collected and held in escrow for disbursement by the
Company. The Company is further protected against fire or casualty loss on home
mortgage loans by a blanket mortgage impairment insurance policy covering a lack
or inadequacy of the mortgagor's required insurance.
CONSUMER LOANS
At December 31, 1998, Flagstar's consumer loan portfolio totaled $28.2 million,
or 1.1% of its total loan portfolio. The largest component of the Company's
consumer loan portfolio was adjustable-rate equity line loans which totaled
approximately $19.3 million, representing 68.0% of the total consumer loan
portfolio. The remaining balance of consumer loans, or approximately $9.0
million, consisted of loans such as home improvement, fixed-rate home equity,
personal lines of credit, and automobile loans. Flagstar's underwriting
standards for a consumer loan include an analysis of the applicant's payment
history on other indebtedness and an assessment of the applicant's ability to
meet existing obligations as well as payments on the proposed loan. Equity line
loans and home improvement loans are secured by a second mortgage on the
borrower's home.
COMMERCIAL REAL ESTATE LOANS
At December 31, 1998, the Company's commercial real estate loan portfolio
totaled $80.9 million, or 3.2% of the Company's total loan portfolio.
The Company's commercial real estate loans generally range from $500,000 to
$10,000,000, and are typically fixed-rate loans for up to five-year terms or
adjustable-rate loans for up to ten-year terms, with payment schedules based on
amortization periods of up to 30 years. Applications for commercial real estate
loans are reviewed and approved by a committee consisting of senior management.
All loans on income-producing properties are evaluated by a qualified, certified
appraiser to ensure that the appraised value of the property to be mortgaged
satisfies the Company's loan-to-value ratio requirements of no higher than 80%.
The Company also generally requires a minimum debt-service ratio of 1.1 to 1. In
addition, the Company considers the experience of the prospective borrower with
similar properties, the creditworthiness and managerial ability of the borrower,
the enforceability and collectibility of any relevant guarantees and the quality
of the asset to be mortgaged. The Company officer processing the loan also
generally performs various feasibility and income absorption studies in
connection with the loan, and also reviews the independent appraisal obtained on
the property.
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NON-REAL ESTATE COMMERCIAL LOANS
The Company offers a variety of non-real estate commercial loans, including
demand, term, and line-of-credit loans. At December 31, 1998, the Company's
non-real estate commercial loan portfolio was $3.6 million, or 0.1% of its total
loan portfolio.
The Company's underwriting policy with respect to non-real estate commercial
loans is based primarily upon the financial stability of the borrower and the
borrower's business.
WAREHOUSE LENDING
These loans are granted for terms of one day to 30 days. Warehouse lines of
credit are used by mortgage lenders to fund the closing of a mortgage loan which
most often is acquired by the Company. At December 31, 1998, the aggregate
amount of warehouse lines of credit granted by the Company to other mortgage
lenders was $450.8 million of which $235.7 million was outstanding. Each
borrowing consummated under the warehouse lending division is fully
collateralized by a mortgage loan. These lines of credit are also personally
guaranteed by a qualified principal officer of the borrower. Each mortgage
lender which applies for a warehouse line of credit is approved under the
Company's commercial loan standards. The borrower must also be approved under
another set of standards to be approved to sell loans to Flagstar.
LOANS BY TYPE
The following table sets forth the Company's total loans at December 31, 1998,
categorized as having fixed interest rates or adjustable interest rates.
Fixed Adjustable
Rate Rate Total
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(In Thousands)
Mortgage loans available for sale $1,175,185 $ 656,346 $1,831,531
Mortgage loans held for investment 203,460 161,007 364,467
Commercial real estate 72,266 8,592 80,858
Construction 34,367 -- 34,367
Consumer 8,851 19,348 28,199
Non-real estate commercial 1,203 2,398 3,601
Warehouse lending -- 235,693 235,693
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Total $1,495,332 $1,083,384 $2,578,716
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LOAN REPAYMENT SCHEDULE
The following table sets forth the scheduled principal payments of Flagstar's
loan portfolio at December 31, 1998, assuming that principal repayments are made
in accordance with the contractual terms of the loans.
Within 1 Year 2 Years 3 Years 5 Years 10 years Over
1 year to 2 years To 3 years to 5 years to 10 years To 15 years 15 years Totals
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(In Thousands)
Mortgage loans available for
sale $ 145,383 $ 135,517 $ 126,332 $ 254,683 $ 500,805 $ 322,806 $ 346,005 $1,831,531
Mortgage loans held for
investment 30,464 28,276 26,261 69,064 98,847 56,938 54,617 364,467
Commercial real estate 7,044 6,520 6,035 11,173 50,086 -- -- 80,858
Construction 34,367 -- -- -- -- -- -- 34,367
Consumer 3,537 3,209 2,911 5,280 10,655 2,607 -- 28,199
Warehouse lending 235,693 -- -- -- -- -- -- 235,693
Non-real estate commercial 3,601 -- -- -- -- -- -- 3,601
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Total
$ 460,089 $ 173,522 $ 161,539 $ 340,200 $ 660,393 $ 382,351 $ 400,622 $2,578,716
=====================================================================================================
ASSET QUALITY
Flagstar has implemented comprehensive internal asset review systems to provide
for early detection of problem assets. The Company's asset classifications and
the adequacy of its allowances for losses are analyzed quarterly based on, among
other things, historical loss experience and current economic conditions.
Although this system will not eliminate future losses due to unanticipated
declines in the real estate market or economic downturns, it should provide for
timely identification of those losses. Refer to four schedules included
hereafter (Tables 10 and 13), on pages 30-32, which set forth certain
information about the Company's non performing assets.
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ASSET QUALITY (CONTINUED)
DELINQUENT LOANS. Residential property loans are considered by the Company to be
delinquent when any payment of principal and/or interest is past due. While it
is the goal of management to work out a satisfactory repayment schedule with a
delinquent borrower, the Company will undertake foreclosure proceedings if the
delinquency is not satisfactorily resolved. The Company's procedures regarding
delinquent loans are designed to assist borrowers in meeting their contractual
obligation. The Company customarily mails notices of past due payments to the
borrower approximately 15, 30 and 45 days after the due date, and late charges
are assessed in accordance with Company parameters. The Company's Collection
Department makes telephone and/or personal contact with borrowers after a 30-day
delinquency. In certain cases, the Company recommends that the borrower seek
credit counseling assistance and may grant forbearance if the Company determines
that the borrower is likely to correct loan delinquencies within a reasonable
period of time. The Company ceases the accrual of interest on loans which are
more than 90 days delinquent. Such interest is recognized as income when
collected.
REPOSSESSED ASSETS. Real property which the Company acquires as a result of
foreclosure proceedings is classified as "real estate owned" until it is sold or
otherwise disposed of. The Company's Foreclosure Committee decides whether to
rehabilitate the property or sell it "as is," and whether to list the property
with a broker, sell the property directly to a third party, or sell it at
auction. Generally, the Company is able to dispose of a substantial portion of
this type of real estate and other repossessed assets during each year, but the
Company invariably acquires additional real estate and other assets through
repossession in the ordinary course of its business. At December 31, 1998, the
Company held approximately $23.0 million of repossessed assets.
SOURCES OF FUNDS
Customer deposits, which totaled $1.9 billion at December 31, 1998, represent
the principal funding source for Flagstar's lending and investing activities. In
addition, the Company derives funds from operations, loan principal payments,
loan sales, advances from the FHLB, and customer escrow accounts.
DEPOSIT ACTIVITIES. Flagstar has developed a variety of deposit products ranging
in maturity from demand-type accounts to certificates with maturities of up to
ten years, including regular and statement passbook accounts, checking and NOW
accounts, and various money market accounts. Flagstar primarily relies upon its
network of branches, the quality and efficiency of its customer service and its
pricing policies to attract deposits.
The following table sets forth information relating to the Company's deposit
flows for each of the years indicated:
Year Ended December 31,
1998 1997 1996 1995 1994
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(In Thousands)
Total deposits at the beginning of the year $1,109,933 $ 624,485 $ 526,974 $ 307,624 $ 190,761
Interest credited 82,452 50,143 30,431 25,123 9,037
Deposits acquired in merger -- -- -- -- 197,181
Net deposit increase / (decrease) 730,985 435,305 67,080 194,227 (89,355)
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Total deposits at the end of the year $1,923,370 $1,109,933 $ 624,485 $ 526,974 $ 307,624
==============================================================
BORROWINGS. The FHLB provides credit for savings institutions and other member
financial institutions. As a member of the FHLB, Flagstar is required to own
stock in the FHLB. Flagstar is authorized to apply for advances from the FHLB
using its mortgage loans as collateral. The FHLB generally permits advances up
to 50% of the Company's "adjusted assets", which are defined as assets reduced
by outstanding advances. At December 31, 1998, advances to the Company by the
FHLB totaled $456.0 million, or 17.6% of adjusted assets. Of the $456.0 million
outstanding at year-end, $6.0 million, or 1.3% of the Company's total FHLB
advances, consisted of daily borrowings which may be "put" back or paid off at
the Company's option without penalty. Refer to Note 9 of the Notes to
Consolidated Financial Statements, in Item 8. Financial Statements and
Supplementary Data, herein for further discussion of the Company's FHLB
advances.
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SOURCES OF FUNDS (CONT'D)
LOAN PRINCIPAL PAYMENTS. Payments totaled $489.6 million during 1998,
representing an increase of $172.4 million, or 54.4%, compared to 1997. This
increase, was attributable to the increased asset base and the lower interest
rate environment experienced in 1998, which increased the amount of loan
refinancings or payoffs.
LOAN SALES. Sales of mortgage loans totaled $17.8 billion in 1998, compared to
$7.3 billion sold in 1997. The sales recorded during 1998 were higher than in
1997 primarily because of the increased loan origination volume. Only a portion
of loans originated were retained by the Company and held for investment.
CUSTOMER ESCROW ACCOUNTS. Escrow accounts on mortgage loans increased from $43.4
million at December 31, 1997 to $104.5 million at December 31, 1998. This
increase was caused by an increase in loans serviced for others at December 31,
1998 from $6.4 billion at December 31, 1997 to $11.5 billion.
SUBSIDIARY ACTIVITIES
The Company conducts business through a number of wholly-owned subsidiaries in
addition to the Bank. The additional subsidiaries of the Company include Douglas
Insurance Agency, Inc. ("DIA"), FSSB Real Estate Development Corporation
("REDC"), and Flagstar Investment Group, Inc. ("Investment"). Of the additional
subsidiaries, Only DIA and Investment are presently active. DIA acts as an agent
for life insurance and property and casualty insurance companies and Investment
offer a full-service brokerage service.
The Bank, the Company's primary subsidiary, is a federally chartered, stock
savings bank headquartered in Bloomfield Hills, Michigan. The Bank owns five
subsidiaries: FSSB Mortgage Corporation ("Mortgage"), Flagstar Capital
Corporation ("Capital"), Flagstar Credit Corporation ("Credit"), Mid-Michigan
Service Corporation ("Mid-Michigan") and SSB Funding Corporation ("Funding").
Mortgage, Credit, Mid-Michigan, and Funding are currently inactive subsidiaries.
Capital is a publicly-owned real estate investment trust whose common stock is
owned solely by the Bank and which purchases mortgage loans from the Bank and
holds them for investment purposes. Mortgage Affiliated Services, a wholly-owned
subsidiary, provided appraisal and document preparation services, was merged
with the Bank during the 1st quarter of 1998.
REGULATION
GENERAL
The Bank is chartered as a federal savings bank under the Home Owners' Loan Act,
as amended (the "HOLA"), which is implemented by regulations adopted and
administered by the OTS. As a federal savings bank, the Bank is subject to
regulation, supervision and regular examination by the OTS. The OTS also has
extensive enforcement authority over all savings institutions and their holding
companies, including the Company and the Bank. Federal banking laws and
regulations control, among other things, the Bank's required reserves,
investments, loans, mergers and consolidations, payment of dividends and other
aspects of the Bank's operations. The deposits of the Bank are insured by the
SAIF administered by the FDIC to the maximum extent provided by law (up to
$100,000 for each depositor). In addition, the FDIC has certain regulatory and
examination authority over OTS-regulated savings institutions and may recommend
enforcement actions against savings institutions to the OTS. The supervision and
regulation of the Bank is intended primarily for the protection of the deposit
insurance fund and depositors rather than for the Company, the holder of the
Bank stock.
The following discussion is intended to be a summary of certain statutes, rules
and regulations affecting the Company and the Bank. A number of other statutes
and regulations have an impact on its operations. The following summary of
applicable statutes and regulations does not purport to be complete and is
qualified in its entirety by reference to such statutes and regulations.
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REGULATION (CONT'D)
REGULATION OF THE BANK
BUSINESS ACTIVITIES. The Bank derives its lending and investment powers from the
HOLA and the regulations of the OTS thereunder. Under these laws and
regulations, the Bank may invest in mortgage loans secured by residential and
commercial real estate, commercial and consumer loans, certain types of
commercial paper and debt securities, and certain other assets. The Bank may
also establish service corporations that may engage in activities not otherwise
permissible for the Bank, including certain real estate equity investments and
securities and insurance brokerage. These investment powers are subject to
various limitations.
BRANCHING. Subject to certain limitations, OTS regulations currently permit a
federally chartered savings institution like the Bank to establish branches in
any state of the United States, provided that the federal savings institution
qualifies as a "domestic building and loan association" under the Internal
Revenue Code. See "--Qualified Thrift Lender Test." The authority for a federal
savings institution to establish an interstate branch network would facilitate a
geographic diversification of the institution's activities.
REGULATORY CAPITAL. The OTS has adopted capital adequacy regulations that
require savings institutions such as the Bank to meet three minimum capital
standards: a "core" capital requirement of 3% of adjusted total assets, a
"tangible" capital requirement of 1.5% of adjusted total assets, and a "total
risk-based" capital requirement of 8% of total risk-weighted assets. In
addition, the OTS has adopted regulations imposing certain restrictions on
savings institutions that have a total risk-based capital ratio of less than 8%,
a ratio of Tier 1 capital to risk-weighted assets of less than 4% or a ratio of
Tier 1 capital to total assets of less than 4% (or 3% if the institution is
rated Composite 1 under the CAMEL examination rating system). See "--Prompt
Corrective Regulatory Action." As of December 31, 1998, the Bank satisfied the
three minimum capital standards of the OTS. See Note 13 of the Notes to
Consolidated Financial Statements, in Item 8. Financial Statements and
Supplementary Data, herein.
PROMPT CORRECTIVE REGULATORY ACTION. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), all financial institutions are
categorized as either "well-capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized," or "critically
undercapitalized". Federal Banking regulators are required to take prompt
corrective action in respect of depository institutions that do not meet certain
minimum capital requirements, including a leverage limit and a risk-based
capital requirement. All institutions, regardless of their capital levels, are
restricted from making any capital distribution or paying any management fees
that would cause the institution to become undercapitalized. As required by
FDICIA, Banking regulators, including the OTS, have issued regulations that
classify insured depository institutions by capital levels and provide that the
applicable agency will take various prompt corrective actions to resolve the
problems of any institution that fails to satisfy the capital standards.
As of December 31, 1998, the Bank was "well-capitalized" as defined by the
regulations. See Note 13 of the Notes to Consolidated Financial Statements, in
Item 8. Financial Statements and Supplementary Data, herein.
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REGULATION (CONT'D)
FEDERAL DEPOSIT INSURANCE. The Bank is required to pay assessments, based on a
percentage of its insured deposits, to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
insurance assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution. Institutions are
assigned by the FDIC to one of three capital groups--well-capitalized,
adequately capitalized, or undercapitalized--and, within each capital category,
to one of three supervisory subgroups.
In order to recapitalize the SAIF and to equalize the deposit insurance premiums
paid by SAIF-insured institutions and institutions with deposits insured by the
Bank Insurance Fund ("BIF"), Congress enacted the Deposit Insurance Funds Act of
1996 (the "1996 Act"), which authorized the FDIC to impose a one-time special
assessment on all institutions with SAIF-assessable deposits in the amount
necessary to recapitalize the SAIF to the statutorily designated reserve ratio
of 1.25% of insured deposits. Institutions were assessed at the rate of 65.7
basis points per $100 of each institution's SAIF-assessable deposits as of March
31, 1996. The 1996 Act provided that the amount of the special assessment was
deductible for federal income tax purposes for the taxable year in which the
special assessment was paid.
As a result of the recapitalization of the SAIF by the 1996 Act, the FDIC
reduced the insurance assessment rate for SAIF-assessable deposits for periods
beginning on October 1, 1996. For 1997, the FDIC set the effective insurance
assessment rates for SAIF-insured institutions, such as the Bank, at zero to 27
basis points. In addition, SAIF-insured institutions will be required, until
December 31, 1999, to pay assessments to the FDIC at an annual rate of between
6.0 and 6.5 basis points to help fund interest payments on certain bonds issued
by the Financing Corporation ("FICO"), an agency of the federal government
established to recapitalize the predecessor to the SAIF. During this period, BIF
member banks will be assessed for payment of the FICO obligations at one-fifth
the annual rate applicable to SAIF member institutions. After December 31, 1999,
BIF and SAIF members will be assessed at the same rate (currently estimated at
approximately 2.4 basis points) to service the FICO obligations.
The 1996 Act also provides that the FDIC may not assess regular insurance
assessments for the SAIF unless required to maintain or to achieve the
designated reserve ratio of 1.25%, except for such assessments on those
institutions that are not classified as "well-capitalized" or that have been
found to have "moderately severe" or "unsatisfactory" financial, operational or
compliance weaknesses. The Bank is classified as "well-capitalized" and has not
been found by the OTS to have such supervisory weaknesses.
QUALIFIED THRIFT LENDER TEST. The HOLA and OTS regulations require all savings
institutions to satisfy one of two Qualified Thrift Lender ("QTL") tests or to
suffer a number of sanctions, including restrictions on activities. To qualify
as a QTL, a savings institution must either (i) be deemed a "domestic building
and loan association" under the Internal Revenue Code (the "Code") by
maintaining at least 60% of its total assets in specified types of assets,
including cash, certain government securities, loans secured by and other assets
related to residential real property, educational loans, and investments in
premises of the institution or (ii) satisfy the HOLA's QTL test by maintaining
at least 65% of "portfolio assets" in certain "Qualified Thrift Investments."
A savings institution must maintain its status as a QTL on a monthly basis in at
least nine out of every 12 months. An initial failure to qualify as a QTL
results in a number of sanctions, including the imposition of certain operating
restrictions and a restriction on obtaining additional advances from its Federal
Home Loan Bank. If a savings institution does not requalify under the QTL test
within the three-year period after it fails the QTL test, it would be required
to terminate any activity not permissible for a national bank and repay as
promptly as possible any outstanding advances from its Federal Home Loan Bank.
In addition, the holding company of such a Bank would similarly be required to
register as a bank holding company with the Federal Reserve Board.
At December 31, 1998, the Bank qualified as a QTL.
10
11
REGULATION (CONT'D)
SAFETY AND SOUNDNESS STANDARDS. FDICIA, as amended by the Riegle Community
Development and Regulatory Improvement Act of 1994, requires the OTS, together
with the other federal bank regulatory agencies, to prescribe standards, by
regulation or guideline, relating to internal controls, information systems and
internal audit systems, loan documentation, credit underwriting, interest rate
risk exposure, asset growth, asset quality, earnings, stock valuation, and
compensation, fees and benefits and such other operational and managerial
standards as the agencies deem appropriate. The OTS and the federal bank
regulatory agencies have adopted a set of guidelines prescribing safety and
soundness standards pursuant to the statute. The safety and soundness guidelines
establish general standards relating to internal controls and information
systems, internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth, and compensation, fees and benefits. In
general, the guidelines require, among other things, appropriate systems and
practices to identify and manage the risks and exposures specified in the
guidelines. The guidelines prohibit excessive compensation as an unsafe and
unsound practice and describe compensation as excessive when the amounts paid
are unreasonable or disproportionate to the services performed by an executive
officer, employee, director or principal stockholder.
In addition, on July 10, 1995, the OTS and the federal bank regulatory agencies
proposed guidelines for asset quality and earnings standards. Under the proposed
standards, a savings institution would be required to maintain systems,
commensurate with its size and the nature and scope of its operations, to
identify problem assets and prevent deterioration in those assets as well as to
evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves. Management believes that the asset
quality and earnings standards, in the form proposed by banking agencies, would
not have a material effect on the operations of the Company.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations upon
capital distributions by all savings institutions, including the Bank.
Limitations are imposed on cash dividends, payments to repurchase or otherwise
acquire its shares, payments to stockholders of another institution in a
cash-out merger and other distributions charged against capital. A savings
institution must give notice to the OTS at least 30 days before declaration of a
proposed capital distribution to its holding company, and capital distributions
in excess of specified earnings or by certain institutions are subject to prior
approval by the OTS. A savings institution that has capital in excess of all
regulatory capital requirements before and after a proposed capital distribution
and that is not otherwise restricted in making capital distributions, may, after
prior notice but without the approval of the OTS, make capital distributions
during a calendar year equal to the greater of (a) 100% of its net income to
date during the calendar year plus the amount that would reduce by one-half its
"surplus capital ratio" (the excess capital over its fully phased-in capital
requirements) at the beginning of the calendar year, or (b) 75% of its net
income for the previous four quarters. Any additional capital distributions
would require prior OTS approval. The OTS has proposed regulations that would
simplify the existing procedures governing capital distributions by savings
institutions. See "--Prompt Corrective Regulatory Action."
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes are not available for
payment of dividends or other distributions to the Company without payment of
taxes at the then current tax rate by the Bank on the amount of earnings removed
from the reserves for such distributions.
CONSUMER CREDIT REGULATION. The Company's mortgage lending activities are
subject to the provisions of various federal and state statutes, including,
among others, the Truth in Lending Act, the Equal Credit Opportunity Act, the
Real Estate Settlement Procedures Act, the Fair Housing Act, and the regulations
promulgated thereunder. These statutes and regulations, among other provisions,
prohibit discrimination, prohibit unfair and deceptive trade practices, require
the disclosure of certain basic information to mortgage borrowers concerning
credit terms and settlement costs, and otherwise regulate terms and conditions
of credit and the procedures by which credit is offered and administered. Many
of the above regulatory requirements are designed to protect the interests of
consumers, while others protect the owners or insurers of mortgage loans.
Failure to comply with these requirements can lead to administrative enforcement
actions, class action lawsuits and demands for restitution or loan rescission.
11
12
REGULATION (CONT'D)
TRANSACTIONS WITH AFFILIATES. The Bank is subject to restrictions imposed by
Sections 23A and 23B of the Federal Reserve Act on extensions of credit to, and
certain other transactions with, its holding company and other affiliates, and
on investments in the stock or other securities thereof. Such restrictions
prevent Flagstar and such other affiliates from borrowing from the Bank unless
the loans are secured by specified collateral, and require such transactions to
have terms comparable to terms of arm's-length transactions with third persons.
Further, such secured loans and other transactions and investments by the Bank
are generally limited in amount as to Flagstar and as to any other affiliate to
10% of the Bank's capital and surplus and as to Flagstar and all other
affiliates to an aggregate of 20% of the Bank's capital and surplus.
LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS. The Bank's
ability to extend credit to its directors, executive officers, and 10%
stockholders, as well as to entities controlled by such persons, is governed by
the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and
Regulation O of the Federal Reserve Board thereunder. Among other things, these
provisions require that an institution's extensions of credit to insiders (a) be
made on terms that are substantially the same as, and follow credit underwriting
procedures that are not less stringent than, those prevailing for comparable
transactions with unaffiliated persons and that do not involve more than the
normal risk of repayment or present other unfavorable features and (b) not
exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the institution's capital. In addition, extensions of credit in excess
of certain limits must be approved by the institution's Board of Directors.
RESERVE REQUIREMENTS. Pursuant to regulations of the Federal Reserve Board, all
FDIC-insured depository institutions must maintain average daily reserves
against their transaction accounts. No reserves are required to be maintained on
the first $4.7 million of transaction accounts, and reserves equal to 3% must be
maintained on the next $47.8 million of transaction accounts, plus reserves
equal to 10% on the remainder. These percentages are subject to adjustment by
the Federal Reserve Board. Because required reserves must be maintained in the
form of vault cash or in a non-interest-bearing account at a Federal Reserve
Bank, the effect of the reserve requirement is to reduce the amount of the
institution's interest-earning assets. As of December 31, 1998, the Bank met its
reserve requirements.
LIQUIDITY REQUIREMENTS. The Bank is required by OTS regulation to maintain an
average daily balance of liquid assets (cash, certain time deposits, banker's
acceptances, highly rated corporate debt and commercial paper, qualifying
mortgage-related securities and mortgage loans, securities of certain mutual
funds, and specified United States government, state or federal agency
obligations) equal to the monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable short-term savings deposits
plus short-term borrowings. The average daily liquidity ratio of the Bank for
the month ended December 31, 1998 was 12.9%.
FEDERAL HOME LOAN BANK SYSTEM. The Federal Home Loan Bank System consists of 12
district Federal Home Loan Banks subject to supervision and regulation by the
Federal Housing Finance Board ("FHFB"). The Federal Home Loan Bank provide a
central credit facility primarily for member institutions. As a member of the
FHLB, the Bank is required to acquire and hold shares of capital stock in the
FHLB in an amount at least equal to 1% of the aggregate unpaid principal of its
home mortgage loans, home purchase contracts, and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the FHLB,
whichever is greater. The Bank was in compliance with this requirement, with an
investment in FHLB stock at December 31, 1998 of $57.8 million.
REGULATION OF THE COMPANY
The Company is a savings and loan holding company under the HOLA and, as such,
is subject to OTS regulation, supervision and examination. In addition, the OTS
has enforcement authority over the Company and its non-savings institution
subsidiaries and may restrict or prohibit activities that are determined to
represent a serious risk to the safety, soundness or stability of the Bank or
any other subsidiary savings institution.
Under the HOLA, a savings and loan holding company may not (i) acquire, with
certain exceptions, more than 5% of a non-subsidiary savings institution or a
non-subsidiary savings and loan holding company; or (ii) acquire or retain
control of a depository institution that is not insured by the FDIC.
12
13
REGULATION (CONT'D)
As a unitary savings and loan holding company, the Company generally is not
subject to any restriction as to the types of business activities in which it
may engage, provided that the Bank continues to satisfy the QTL test. See
"--Regulation and Supervision of the Bank--Qualified Thrift Lender Test." Upon
any non-supervisory acquisition by the Company of another savings institution
that is held as a separate subsidiary, the Company would become a multiple
savings and loan holding company and would be subject to limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under the Bank Holding Company Act, subject to the prior approval of
the OTS, and to other activities authorized by OTS regulation.
COMPETITION
Based on total assets at December 31, 1998, the Company is the largest
independent savings institution headquartered in Michigan. The Company faces
substantial competition in attracting deposits at its bank branches. Its most
direct competition for deposits has historically come from other savings
institutions, commercial banks and credit unions. Money market funds and
full-service securities brokerage firms also provide competition in this area.
The primary factors in competing for deposits are the rates offered, the quality
of service, the hours of service, and the location of branch offices.
The Company's competition for lending products comes principally from other
savings institutions, commercial banks, mortgage companies, and other lenders.
The primary factors in competing are the rates and fees charged, the efficiency
and speed of the service provided, and the quality of the services provided.
PERSONNEL
At December 31, 1998, the Company had 1,675 full-time equivalent employees. The
employees are not represented by a collective bargaining unit. The Company
provides its employees with a comprehensive program of benefits, some of which
are on a contributory basis, including comprehensive medical and dental plans,
life insurance, disability insurance, and a 401K savings and investment plan.
Flagstar's management considers its employee relations to be excellent.
13
14
EXECUTIVE OFFICERS
The executive officers of the Company and the Bank are as follows:
Name and Age Position(s) Held
- ------------------------------------------------------------------------------------------------
Thomas J. Hammond, 55 Chief Executive Officer of the Company and the Bank
Mark T. Hammond, 33 President of the Company and the Bank
Joan H. Anderson, 48 Executive Vice President of the Company and the Bank
Michael W. Carrie, 44 Executive Vice President and Chief Financial Officer of the
Company and the Bank
Kirstin Hammond, 33 Executive Vice President of the Bank
Robert O. Rondeau, Jr., 30 Executive Vice President of the Bank
THOMAS J. HAMMOND has served as Chief Executive Officer of the Company since its
formation in 1993 and the Bank since its formation in 1987. Mr. Hammond is the
founder of the Bank.
MARK T. HAMMOND has served as President of the Company since December 1996 and
of the Bank since September 1995. He has been employed by the Bank since 1987.
Mr. Hammond is the son of Thomas J. Hammond, the Chief Executive Officer.
JOAN H. ANDERSON has been an Executive Vice President of the Bank since 1988 and
of the Company since 1993. She has been employed by the Bank since 1987.
MICHAEL W. CARRIE has served as an Executive Vice President of the Company and
the Bank since 1995 and Chief Financial Officer of the Company and the Bank
since 1993.
KIRSTIN HAMMOND has served as an Executive Vice President of the Bank since 1998
and has been employed by the Bank since 1991. Mrs. Hammond is the wife of Mark
T. Hammond, the President, and the daughter-in-law of Thomas J. Hammond, the
Chief Executive Officer.
ROBERT O. RONDEAU, JR. has served as an Executive Vice President of the Bank
since 1998 and as an employee of the Bank since 1995. Mr. Rondeau is the
son-in-law of Thomas J. Hammond, the Chief Executive Officer.
14
15
ITEM 2. PROPERTIES
The Company operates from 28 full-service bank branches and 31 retail loan
origination offices in Michigan, Florida, and Ohio. The Company also maintains
fifteen wholesale loan production offices. Flagstar owns the buildings and land
for 10 of its offices, owns the building but leases the land for one of its
offices and leases the remaining 67 offices, with lease expiration dates ranging
from 1999 to 2012. At December 31, 1998, the total net book value of all of the
Company's offices was approximately $6.7 million.
The Company leases two adjacent buildings in Bloomfield Hills, Michigan, which
house its executive offices. Substantially all of its operational and support
functions for its mortgage lending activities are housed in this facility. The
Company houses its retail banking operation from its owned facility in Jackson,
Michigan.
The Company utilizes a highly sophisticated PC-based data processing system. At
December 31, 1998, the net book value of the Company's computer related
equipment (including both hardware and software) was approximately $8.7 million.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company and its subsidiaries are parties to various legal
proceedings incident to their business. At December 31, 1998, there were no
legal proceedings which management anticipates would have a material adverse
effect on the Company. See Note 12 of Notes to Consolidated Financial
Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No items were submitted during the fourth quarter of the year covered by this
report for inclusion to be voted on by security holders through a solicitation
of proxies or otherwise.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK
The Company's common stock is traded on the NASDAQ Stock Market. The trading
symbol is FLGS. At March 19, 1999, there were 13,670,000 shares of the Company's
common stock outstanding.
QUARTERLY STOCK PRICE/DIVIDEND INFORMATION
The following table summarizes the Company's common stock price and dividend
activity for:
Quarter Ended
12/31/98 9/30/98 6/30/98 3/31/98
High price during the period
$30.500 $29.000 $28.875 $27.000
Low price during the period
20.000 20.750 23.125 17.500
Closing price at the end of the period
26.125 23.125 24.375 26.500
Price/earnings ratio (1)
9.0X 9.5X 11.3X 7.6X
Dividends per common share declared during the period
$0.08 $0.07 $0.07 $0.06
(1) Based on most recent twelve-month diluted earnings per share and
end-of-period stock prices.
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16
MANAGEMENT'S REPORT
FINANCIAL STATEMENTS
The management of the Company and the Bank are responsible for the preparation,
integrity, and fair presentation of its published financial statements and all
other information presented in this Form 10-K. The financial statements have
been prepared in accordance with generally accepted accounting principles and,
as such, include amounts based on informed judgements and estimates made by
management.
INTERNAL CONTROL
Management is responsible for establishing and maintaining an effective internal
control structure over financial reporting presented in conformity with both
generally accepted accounting principles ("GAAP") and the regulatory reporting
completed for the Office of Thrift Supervision through the compilation of the
quarterly Thrift Financial Report ("TFR"). The structure contains monitoring
mechanisms, and actions are taken to correct any deficiencies which are
identified.
There are inherent limitations in the effectiveness of any structure of internal
controls, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the
effectiveness of an internal control structure may vary over time.
Management assessed the Company's internal control structure over financial
reporting presented in conformity with both GAAP and in the creation of the TFR
at of December 31, 1998. This assessment was based on criteria for effective
internal control over financial reporting described in "Internal
Control-Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
believes that the Company maintained an effective internal control structure
over the financial reporting presented for both GAAP and the TFR, as of December
31, 1998.
The Audit Committee of the Company's Board of Directors consists entirely of
outside directors who are independent of the Company's management. It includes
members with financial management expertise, has access to its own outside
counsel or other advisors it deems necessary to fulfill its responsibilities,
and does not include any large customers of the Company. The Audit Committee is
responsible for recommending to the Board of Directors the selection of
independent auditors. It meets periodically with management, the independent
auditors and the internal auditors to ensure that they are carrying out their
responsibilities. The Audit Committee is also responsible for performing an
oversight role by reviewing and monitoring the financial, accounting and
auditing procedures of the Company in addition to reviewing the Company's
financial reports. The independent auditors and the internal auditors have full
and free access to the Audit Committee, with or without the presence of
management, to discuss the adequacy of the internal control structure for
financial reporting and any other matters which they believe should be brought
to the attention of the Audit Committee.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for ensuring compliance with the federal laws and
regulations concerning loans to insiders and the federal and state laws and
regulations concerning dividend restrictions, which are the laws and regulations
relating to safety and soundness which have been designated by the Federal
Deposit Insurance Corporation.
Management assessed its compliance with the designated safety and soundness laws
and regulations and has maintained records of its determinations and assessments
as required by the Federal Deposit Insurance Corporation. Based on this
assessment, management believes that the Company has complied, in all material
respects, with the designated safety and soundness laws and regulations for the
year ended December 31, 1998.
THOMAS J. HAMMOND MARK T. HAMMOND MICHAEL W. CARRIE
Thomas J. Hammond Mark T. Hammond Michael W. Carrie
Chairman of the Board Vice Chairman Executive Vice President
and Chief Executive Officer and President and Chief Financial Officer
March 19, 1999
16
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ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
SUMMARY OF CONSOLIDATED STATEMENTS OF EARNINGS: At or For the Year Ended December 31,
1998 1997 1996 (1) 1995 1994
------------------------------------------------------------------
(In Thousands, Except Share Data)
Interest income $191,261 $122,752 $ 76,179 $ 71,304 $ 35,112
Interest expense 137,187 80,033 45,967 41,443 14,486
------------------------------------------------------------------
Net interest income 54,074 42,719 30,212 29,861 20,626
Provisions for losses 18,631 5,015 2,604 238 290
------------------------------------------------------------------
Net interest income after provisions for losses 35,443 37,704 27,608 29,623 20,336
Other income 118,413 59,836 58,534 36,988 42,732
Operating and administrative expenses 86,843 62,503 58,820 41,716 37,619
------------------------------------------------------------------
Earnings before federal income tax provision 67,013 35,037 27,322 24,895 25,449
Provision for federal income taxes 25,950 13,265 10,299 9,419 9,318
------------------------------------------------------------------
Net earnings $ 41,063 $ 21,772 $ 17,023 $ 15,476 $ 16,131
==================================================================
Basic earnings per share: $ 3.00 $ 1.70 $ 1.51 $ 1.37 $ 1.42
Diluted earnings per share: $ 2.90 $ 1.68 $ 1.51 $ 1.37 $ 1.42
Dividends per common share $ 0.28 $ 0.06 $ 0.09 $ 0.18 $ 0.04
Dividend payout ratio 9.32% 3.77% 5.87% 12.92% 2.48%
SUMMARY OF CONSOLIDATED STATEMENTS OF FINANCIAL
CONDITION:
Total assets $3,046,445 $1,901,084 $1,297,226 $1,045,094 $ 723,150
Loans receivable 2,558,716 1,655,259 1,110,836 923,933 633,409
Mortgage servicing rights 150,258 83,845 30,064 27,957 18,179
Deposits 1,923,370 1,109,933 624,485 526,974 307,624
FHLB advances 456,019 482,378 389,801 191,156 200,750
Stockholders' equity 163,852 126,617 78,468 62,445 49,419
OTHER FINANCIAL AND STATISTICAL DATA:
Tangible capital ratio 6.44% 5.40% 5.58% 5.19% 5.54%
Core capital ratio 6.54% 5.62% 6.01% 5.84% 6.63%
Total risk-based capital ratio 12.93% 11.74% 10.91% 10.12% 12.08%
Equity-to-assets ratio (at the end of the period) 5.38% 6.66% 6.05% 5.98% 6.83%
Equity-to-assets ratio (average for the period) 5.03% 6.22% 6.19% 5.54% 8.91%
Book value per share $ 11.98 $ 9.26 $ 6.97 $ 5.55 $ 4.37
Shares outstanding 13,670 13,670 11,250 11,250 11,309
Average shares outstanding 13,670 12,837 11,250 11,274 11,389
Mortgage loans originated or purchased $18,852,885 $ 7,873,099 $ 6,791,665 $ 5,195,605 $ 3,720,173
Mortgage loans sold $17,803,958 $ 7,222,394 $ 6,581,897 $ 4,760,806 $ 3,551,319
Mortgage loans serviced for others $11,472,211 $ 6,412,797 $ 4,801,581 $ 6,788,530 $ 5,691,421
Capitalized value of mortgage servicing rights 1.31% 1.31% 0.63% 0.41% 0.32%
Interest rate spread 1.85% 2.10% 2.13% 2.36% 3.37%
Net interest margin 2.14% 2.74% 3.07% 3.46% 4.63%
Return on average assets 1.45% 1.29% 1.53% 1.63% 3.19%
Return on average equity 28.77% 20.69% 24.68% 29.42% 35.78%
Efficiency ratio 49.6% 59.7% 64.8% 60.4% 58.3%
Charge off ratio 0.17% 0.20% 0.13% 0.00% 0.08%
Ratio of allowances to total loans 0.78% 0.33% 0.31% 0.23% 0.29%
Ratio of non performing assets to total assets 1.97% 3.29% 3.16% 1.25% 0.42%
Ratio of allowance to non performing loans 53.78% 12.41% 11.43% 19.67% 107.59%
Number of Bank branches 28 19 15 13 9
Number of retail loan origination centers 31 35 41 31 29
Number of correspondent offices 15 16 10 9 6
1. The 1996 earnings reflect the one time SAIF assessment of $3.4 million
($2.2 million after tax) paid in September 1996. Without this assessment,
earnings would have been $19.2 million and return on average equity, return
on average assets and the efficiency ratio would have been 27.87%, 1.73%,
and 61.0%, respectively.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PROFILE AND INTRODUCTION
In 1993, Flagstar Bancorp, Inc. ( "Flagstar" or the "Company" ), was formed in
order to become the holding company for Flagstar Bank, FSB, a federally
chartered stock savings bank founded in 1987. Flagstar completed an initial
public offering ("IPO") of common stock in May 1997. Since 1994, the Company has
worked to increase its retail banking franchise. Initiated by the acquisition of
Security Savings Bank, F.S.B., the Company has increased its bank branch
locations each year. This growth has been achieved by aggressively developing
the Company's core businesses. This consistent focus on retail and wholesale
mortgage lending, retail deposit gathering, and mortgage loan servicing has
allowed the Company to annually increase its net interest income and recurring
fee income. The Company's continued focus on information processing technology
has allowed Flagstar to maintain double digit annual growth while keeping
control over operating expenses. As a result, Flagstar has continued to be a
highly profitable company over the years, maintaining high returns for its
shareholders. With $3.0 billion in assets at December 31, 1998, Flagstar is the
largest independent savings institution headquartered in Michigan. Flagstar is
also the largest independent thrift mortgage originator in the United States
with $18.8 billion in mortgage originations.
RESULTS OF OPERATIONS
Flagstar's net income totaled $41.1 million ($2.90 per share - diluted) for the
year ended December 31, 1998, compared to $21.8 million ($1.68 per share -
diluted) in 1997 and $17.0 million ($1.51 per share - diluted) in 1996. The 1998
earnings constitute a 88.5% increase in profitability over 1997. The 1996
earnings reflect the after-tax cost of the one-time assessment, mandated by
federal law, of $2.2 million, or $.20 per share, for the recapitalization of the
SAIF of the FDIC. The increased level of earnings in each period was
attributable to a variety of factors but primarily from increases in average
earning assets, increased levels of mortgage loan production, along with the
continued growth in the retail banking operation.
NET INTEREST INCOME
The level of net interest income reported by the Company is impacted primarily
by the volume of average earning assets and the general level of interest rates.
During 1998, the Company earned $54.1 million in net interest income, which
represents an increase of 26.7% compared to the amount reported in 1997 and
represented 31.4% of the Company's total revenue in 1998. This increase is
primarily attributable to a $973.0 million increase in average earning assets.
During 1997, the Company earned $42.7 million in net interest income, which
represented an increase of 41.4% compared to the $30.2 million reported in 1996
and 41.7% of 1997 revenue. The 1997 increase was primarily attributable to a
$573.5 million increase in average earning assets.
The Company's net interest spread decreased to 1.85% during the year ended
December 31, 1998, compared to 2.10% during the prior year. The Company
typically originates long term mortgage loans and funds these mortgage loans
with short term liabilities. The Company then sells these mortgage loans upon
their conversion to a mortgage-backed security, usually within 90 days. The
yield earned on the Company's earning assets decreased by 0.32%, from 7.87%
during 1997 to 7.55% during 1998, while the cost of interest-bearing liabilities
decreased by 0.07%, from 5.77% during 1997 to 5.70% during 1998.
The Company's net interest margin decreased to 2.14% of average earning assets
during the year ended December 31, 1998, compared to 2.74% during the prior
year, due to the decreased spread mentioned and also because of the $45.7
million decrease in the amount that earning assets exceeded interest-bearing
liabilities.
In 1997, the yield earned on the Company's earning assets increased by 0.14%
from 7.73% during 1996 to 7.87%. While, the cost of interest-bearing liabilities
increased by 0.17%, from 5.60% during 1996 to 5.77% during 1997. These increases
caused the interest rate spread to decrease by 0.03%. The Company's net interest
margin also decreased from the 3.07% reported in 1996 to 2.74% during the year
ended December 31, 1997, due to the decrease in the interest rate spread offset
in part by an increase in the amount that earning assets exceeded
interest-bearing liabilities.
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Table 1 presents interest income from average earning assets, expressed in
dollars and yields, and interest expense on average interest-bearing
liabilities, expressed in dollars and rates. Interest income from earning assets
includes the amortization of net premiums and the amortization of net deferred
loan origination costs. Nonaccruing loans were included in the average loan
amounts outstanding.
TABLE 1
AVERAGE YIELDS EARNED AND RATES PAID
Years Ended December 31,
------------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------ ---------------------------------- ----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------------------------------------------------------------------------------------------------------
( In thousands )
INTEREST-EARNING ASSETS:
Loans receivable, net $ 2,478,955 $ 187,124 7.55% $ 1,526,873 $ 120,214 7.87% $ 964,257 $ 74,588 7.74%
FHLB stock 49,970 4,000 8.00 30,685 2,471 8.05 18,776 1,471 7.83
Other 2,851 137 4.81 1,238 67 5.41 2,230 120 5.38
------------------------ ----------------------- ---------------------
Total 2,531,776 $ 191,261 7.55% 1,558,796 $ 122,752 7.87% 985,263 $ 76,179 7.73%
Other assets 306,904 133,963 129,005
----------- ------------ -----------
Total assets $ 2,838,680 $ 1,692,759 $ 1,114,268
=========== ============ ===========
INTEREST-BEARING
LIABILITIES:
Deposits $ 1,452,325 $ 82,452 5.68% $ 878,064 $ 50,143 5.71% $ 552,391 $ 30,431 5.15%
FHLB advances 833,944 48,332 5.80 480,062 28,709 5.98 247,204 14,291 5.78
Other 119,250 6,403 5.37 28,671 1,181 4.12 21,227 1,245 5.87
------------------------ ----------------------- ---------------------
Total interest-bearing
liabilities 2,405,519 $ 137,187 5.70% 1,386,797 $ 80,033 5.77% 820,822 $ 45,967 5.60%
Other liabilities 290,442 200,721 224,484
Stockholders equity 142,720 105,241 68,962
----------- ------------ -----------
Total liabilities and
Stockholders equity $ 2,838,680 $ 1,692,759 $ 1,114,268
=========== ============ ===========
Net interest-earning assets $ 126,257 $ 171,999 $ 164,441
=========== ============ ===========
---------- ---------- --------
Net interest income $ 54,074 $ 42,719 $ 30,212
========== ========== ========
-------- ------- -----
Interest rate spread 1.85% 2.10% 2.13%
======== ======= =====
Net interest margin 2.14% 2.74% 3.07%
======== ======= =====
Ratio of average interest-
earning assets to
interest-bearing liabilities 105% 112% 120%
======== ======= =====
19
20
Table 2 presents the dollar amount of changes in interest income and interest
expense for the components of earning assets and interest-bearing liabilities
which are presented in Table 1. Table 2 distinguishes between the changes
related to average outstanding balances (changes in volume while holding the
initial rate constant) and the changes related to average interest rates
(changes in average rates while holding the initial balance constant).
TABLE 2
RATE/VOLUME ANALYSIS
Years Ended December 31,
-----------------------------------------------------------
1998 versus 1997 1997 versus 1996
Increase (Decrease) Increase (Decrease)
Due To: Due To:
Volume Rate Total Volume Rate Total
--------------------------- -----------------------------
EARNING ASSETS: (In Millions)
Loans receivable, net $ 74.9 $ (8.0) $ 66.9 $ 44.6 $ 1.1 $ 45.7
FHLB stock 1.5 0.0 1.5 1.0 - 1.0
Other 0.1 0.0 0.1 (.1) - (.1)
--------------------------- -----------------------------
Total $ 76.5 $ (8.0) $ 68.5 $ 45.5 $ 1.1 $ 46.6
INTEREST-BEARING LIABILITIES:
Deposits $ 32.8 $ (0.5) $ 32.3 $ 18.8 $ .9 $ 19.7
FHLB advances 21.2 (1.5) 19.7 13.9 .5 14.4
Other 3.6 1.5 5.1 .3 (.3) -
--------------------------- -----------------------------
Total $ 57.6 $ (0.5) $ 57.1 $ 33.0 $ 1.1 $ 34.1
=========================== =============================
Change in net interest income $ 18.9 $ (7.5) $ 11.4 $ 12.5 $ - $ 12.5
=========================== =============================
NON-INTEREST INCOME
Flagstar's non-interest income totaled $118.4 million for the year ended
December 31, 1998, compared to $59.8 million in 1997 and $58.5 million in 1996.
The 1998 results constitute a 98.0% increase over 1997 and the 1997 results
reflect a 2.2% increase over 1996. The increased level of revenue in each period
was attributable to a variety of factors but primarily resulted from an increase
each year in the Company's revenues on loan sales which offset the Company's
decrease in recorded revenues from the sales of mortgage servicing rights and
loan administration fees.
LOAN ADMINISTRATION
The Company's loan servicing operation produced negative fee income from loans
serviced for others of $2.5 million for the year ended December 31, 1998,
compared to positive net fees of $6.1 million recorded in 1997 and $11.9 million
recorded in 1996. The volatility in this revenue source was the result of the
changes in the levels of prepayment induced amortization recorded on the
mortgage servicing rights portfolio ( "MSR" ) and the changes in the average
volume of loans serviced during the respective periods.
During 1998, the volume of loans serviced for others averaged $9.4 billion, a
95.8% increase over the 1997 average servicing portfolio of $4.8 billion, and a
38.2% increase over the average servicing portfolio of $6.8 billion during 1996.
During 1998, the Company recorded $29.9 million, or 32 basis points (0.32%) in
fee revenue versus $16.6 million recorded in 1997, and $23.2 million recorded in
1996. The fee revenue recorded in 1998 was offset by $32.4 million of MSR
amortization. The Company recorded $10.5 million and $11.3 million of MSR
amortization during 1997 and 1996, respectively.
NET GAIN ON LOAN SALES
Net gains on the loan sales totaled $110.7 million, $21.8 million and $4.5
million for the years ended December 31, 1998, 1997 and 1996, respectively. The
amount of net gain recorded in any one period is directly affected by the amount
of loans sold and the profit spread achieved.
During 1998, the volume of loans sold totaled $17.8 billion, a 147.2% increase
over 1997 loan sales of $7.2 billion, and a 9.1% increase over 1996 loan sales
of $6.6 billion. During 1998 the Company received an average 0.62% in gain
versus 0.30% recorded in 1997, and 0.07% recorded in 1996. This increase in
gains spread is primarily attributable to the favorable pricing received by the
Company because of the large volumes of loans delivered to the secondary market.
20
21
NON-INTEREST INCOME (CONT'D)
NET GAIN ON MORTGAGE SERVICING RIGHTS
For 1998, the net gain on the sale of MSR totaled $3.8 million. The 1998 gain
was a $23.3 million decrease from the $27.1 million recorded in 1997, and a
$31.3 million decrease from $35.1 million recorded in 1996. The gain on sale of
mortgage servicing rights recorded is directly affected by the amount of loan
servicing rights sold and the profit spread achieved.
During 1998, the volume of MSR sold totaled $10.9 billion, a 153.5% increase
over 1997 MSR sales of $4.3 billion, and a 47.3% increase over 1996 MSR sales of
$7.4 billion. During 1998, the Company sold newly originated MSR which had a
book value which more closely approximated the current market value of the MSR
sold. In 1997 and 1996, the Company sold some newly originated MSR but also sold
seasoned MSR which had a book value substantially lower than the sales price of
the MSR. Any MSR that was created from a mortgage loan originated through the
Company's retail production channel prior to May 1995 did not have a carrying
value on the books and records of the Company. The majority of these non-valued
MSR's were sold in 1996 and 1997.
OTHER FEES AND CHARGES
Other fees and charges, which include certain loan fees, deposit-related fees,
and escrow waiver fees totaled $6.4 million, $4.8 million, and $7.0 million in
1998, 1997, and1996, respectively. In each period the total fees recorded were
affected by the production volume of loans originated that were not classified
as single family residential mortgage loans.
NON-INTEREST EXPENSE
Operating expenses, before the capitalization of direct costs of loan closings,
totaled $151.6 million, $99.9 million, and $92.2 million for the years ended
December 31, 1998, 1997, and 1996, respectively. Included in the operating
expenses for the year ended December 31, 1996, is the payment of the $3.4
million pre-tax FDIC special assessment discussed previously herein. Gross
operating and administrative expenses excluding this non recurring charge
totaled $88.8 million for 1996. The 51.7% increase in overhead expense items in
1998 versus 1997 and the 8.4% increase in expenses between 1997 versus 1996 were
due to general increases in the price levels for goods and services, higher
mortgage loan origination volume, and the growth of the retail banking
operation.
During 1998, Flagstar opened 9 bank branches, bringing the branch network total
to 28. As the Company shifts its funding sources to more retail in nature and
increases the size of the branch network, management expects that the operating
expenses associated with the branch network will continue to increase while the
cost of funds will begin to decrease.
The Company's gross compensation and benefits expense, before the capitalization
of direct costs of loan closings, totaled $55.2 million, $42.1 million, and
$40.5 million for the years ended December 31, 1998, 1997, and 1996,
respectively. The 31.1% increase in 1998 is primarily attributable to the
employees hired to accommodate the Company's record mortgage loan production,
normal salary increases, and the staff hired at the new bank branches. Total
Company staffing increased by 491, or 41.5%, full-time equivalents at December
31, 1998, versus December 31, 1997.
Commission expense, which is a variable cost associated with mortgage loan
production, totaled $28.5 million, $14.2 million, and $12.4 million during the
years ended December 31, 1998, 1997, and 1996, respectively. Commission expense
totaled .15%, .18%, and .18% of total mortgage production in 1998, 1997, and
1996, respectively.
Occupancy and equipment expense totaled $16.0 million, $12.8 million, and $12.1
million during the years ended December 31, 1998, 1997, and 1996, respectively.
The continued increase in this expense category is reflective of the staffing
increases, the expansion undertaken in the Company branch network, along with
the Company's continuing investment in computer technology.
Advertising expense, which totaled $2.3 million during the year ended December
31, 1998, increased $.7 million, or 43.8%, over the $1.6 million of expense
incurred during the prior year. Advertising expense totaled $.9 million in 1996.
The continued increase in this expense category is reflective of the expansion
undertaken in the Company branch network.
21
22
NON-INTEREST EXPENSE (CONT'D)
The Company's FDIC premiums increased by $0.3 million, to $0.8 million during
1998 compared to $.5 million in 1997, and $1.0 million during 1996. In each
successive year, Flagstar has paid higher insurance premiums due to its
increased deposit base. As previously discussed, during 1996 the Company was
required by federal law to pay a one-time, industry wide deposit premium
assessment, the Company's portion of which totaled $3.4 million. This assessment
was used to fully recapitalize the SAIF. Payment of this special assessment
reduced the Company's annual FDIC insurance premium rate from 23 basis points of
insured deposit liabilities to 6.5 basis points, or by approximately 72%,
prospectively.
Other expense is a collection of non-specific expenses incurred during the
respective years. Other expense totaled $47.5 million, $27.3 million, and $20.5
million during the years ended December 31, 1998, 1997, and 1996, respectively.
The continued increase in this expense category is reflective of the increased
levels of mortgage production, the expansion undertaken in the Company bank
branch network, the increased costs associated with the enlarged real estate
owned portfolio, the increased amount of loans pending foreclosure, and the
increased amount of loans in a delinquency status.
TABLE 3
NON-INTEREST EXPENSES
Years Ended December 31,
1998 1997 1996
-----------------------------------------
(In thousands)
Compensation and benefits $ 55,170 $ 42,132 $ 40,524
Commissions 28,459 14,231 12,367
Occupancy and equipment 15,964 12,810 12,125
Advertising 2,303 1,637 943
Core deposit amortization 1,290 1,290 1,290
Federal insurance premium 837 477 4,435
Other 47,530 27,305 20,474
-----------------------------------------
Total 151,553 99,882 92,158
Less: capitalized direct costs of loan closings (64,710) (37,379) (33,338)
-----------------------------------------
Total, net $ 86,843 $ 62,503 $ 58,820
=========================================
Efficiency ratio(1) 49.6% 59.7% 64.8%
(1) Total operating and administrative expenses (excluding the amortization of
the core deposit premium) divided by the sum of net interest income and non
interest income.
In accordance with generally accepted accounting principles, certain loan
origination costs are capitalized and added as an adjustment of the basis of the
individual loans originated. These cost are amortized as an adjustment of the
loan yield over the life of the loan or expensed when the loan is sold.
Accordingly, during 1998 Flagstar deferred $64.7 million of loan origination
costs, while during 1997 and 1996 such deferred expenses totaled $37.4 million
and $33.3 million, respectively. On a per loan basis, the cost deferral totaled
$431, $541, and $503 during 1998, 1997, and 1996, respectively. The decrease in
the cost per loan recorded in 1998 reflects the efficiencies created when
volumes increase substantially. The 1998 and 1997 numbers are also affected by
inflationary increases and the increased costs associated with the Company's
shift to correspondent funding versus wholesale funding which was the
predominant lending channel in 1996.
FEDERAL INCOME TAXES
For the year ended December 31, 1998, the Company's provision for federal income
taxes as a percentage of pretax earnings was 38.7%, compared to 37.9% in 1997
and 37.7% in 1996. For all periods presented in the Consolidated Statements of
Earnings, the provision for federal income taxes varies from statutory rates
primarily because of the non-deductibility of the core deposit amortization and
other non-deductible corporate expenses. Refer to Note 10 of the Notes to the
Consolidated Financial Statements, in Item 8. Financial Statements and
Supplementary Data, herein for further discussion of the Company's federal
income taxes.
22
23
FINANCIAL CONDITION
The Company's assets totaled $3.0 billion at December 31, 1998, reflecting an
increase of $1.1 billion over December 31, 1997. Loans receivable, net increased
$903.4 million, reflecting the increased amount of recent residential mortgage
loan production held on the Company's books that is pending sale. During 1998,
mortgage loan originations totaled a record $18.8 billion, compared to $7.9
billion in 1997 and $6.8 billion in 1996. Table 4, 5, 6 and 7 set forth the
Company's loan portfolio and the activity within the different loan categories,
for the past five years.
TABLE 4
LOAN PORTFOLIO SCHEDULE
At December 31,
DESCRIPTION: 1998 1997 1996 1995 1994
-------------------------------------------------------------------------------
(In Thousands)
Mortgage loans available for sale $ 1,831,531 $ 1,197,152 $ 840,767 $ 620,455 $ 205,480
Loans held for investment:
Mortgage loans 364,467 282,224 120,924 178,246 354,554
Consumer loans 28,199 34,004 33,608 39,331 19,271
Commercial loans 3,601 2,710 4,435 4,542 3,728
Construction loans 34,367 35,373 59,270 48,933 25,499
Warehouse Lending 235,693 77,545 41,767 4,024 3,818
Commercial real estate loans 80,858 31,751 13,565 30,504 22,930
-------------------------------------------------------------------------------
Total loans held for investment 747,185 463,607 273,569 305,580 429,800
Allowance for losses (20,000) (5,500) (3,500) (2,102) (1,871)
-------------------------------------------------------------------------------
Total loans receivable (net) $ 2,558,716 $ 1,655,259 $ 1,110,836 $ 923,933 $ 633,409
===============================================================================
TABLE 5
LOANS AVAILABLE FOR SALE ACTIVITY SCHEDULE
Year Ended December 31,
DESCRIPTION: 1998 1997 1996 1995 1994
-----------------------------------------------------------------------
(In Thousands)
Beginning mortgage loans available for sale $ 1,197,152 $ 840,767 $ 620,455 $ 205,480 $ 389,073
Mortgage loans originated, net 19,041,414 7,950,098 6,850,277 5,251,510 3,752,650
Mortgage loans repurchased 32,337 58,516 54,788 4,477 2,683
Mortgage loans transferred from held for investment -- -- -- 185,111 --
Mortgage loans sold servicing retained, net 17,081,172 6,559,893 5,651,216 4,239,777 3,421,784
Mortgage loans sold servicing released, net 891,907 736,235 948,352 540,421 248,218
Mortgage loan amortization / prepayments 319,060 273,969 74,683 244,144 161,225
Mortgage loans transferred to held for investment, net 147,233 82,132 10,502 1,781 107,699
-----------------------------------------------------------------------
Ending mortgage loans available for sale $ 1,831,531 $ 1,197,152 $ 840,767 $ 620,455 $ 205,480
=======================================================================
23
24
FINANCIAL CONDITION (CONT'D)
TABLE 6
LOANS HELD FOR INVESTMENT ACTIVITY SCHEDULE
Year Ended December 31,
DESCRIPTION: 1998 1997 1996 1995 1994
------------------------------------------------------------
(In Thousands)
Beginning loans held for investment $463,607 $273,569 $305,580 $429,800 $ 26,906
Loans originated 176,816 127,576 129,436 162,137 236,700
Increase in lines of credit 148,880 38,859 - - -
Loans transferred from available for sale 147,233 82,132 10,502 1,781 107,699
Loans acquired in merger - - - - 140,302
Loan amortization / prepayments 170,534 43,239 161,372 101,246 79,002
Loans transferred to available for sale - - - 185,111 -
Loans transferred to repossessed assets 18,817 15,290 10,577 1,781 2,805
------------------------------------------------------------
Ending loans held for investment $747,185 $463,607 $273,569 $305,580 $429,800
============================================================
TABLE 7
LOANS SERVICED FOR OTHERS ACTIVITY SCHEDULE
Year Ended December 31,
DESCRIPTION: 1998 1997 1996 1995 1994
---------------------------------------------------------------------------
(In Thousands)
Beginning loans serviced for others $ 6,412,797 $ 4,801,581 $ 6,788,530 $ 5,691,421 $ 6,198,311
Loans servicing originated 16,912,051 6,530,243 5,633,545 4,220,385 3,303,101
Loans servicing acquired in merger - - - - 44,340
Loan servicing amortization / prepayments 1,807,014 1,283,336 1,146,564 851,188 1,277,049
Loans servicing sales 10,045,623 3,635,691 6,473,930 2,272,088 2,577,282
---------------------------------------------------------------------------
Ending loans serviced for others $11,472,211 $ 6,412,797 $ 4,801,581 $ 6,788,530 $ 5,691,421
===========================================================================
LOANS RECEIVABLE. Mortgage loans available for sale and mortgage loans held for
investment increased, in the aggregate, $716.6 million from $1.5 billion at
December 31, 1997 to $2.2 billion at December 31, 1998. Mortgage loans available
for sale increased $634.4 million, or 53.0%, to $1.8 billion at December 31,
1998, from $1.2 billion at December 31, 1997. Loans held for investment
increased $283.6 million, or 61.2%, from $463.6 million at December 31, 1997 to
$747.2 million at December 31, 1998. In each case management retained more loans
to maximize the earnings power available because of the leverage available to
the Company.
ALLOWANCE FOR LOSSES. The allowance for losses totaled $20.0 million at December
31, 1998, an increase of $14.5 million, or 263.6%, from $5.5 million at December
31, 1997. The allowance for losses as a percentage of non-performing loans was
53.78% and 12.41% at December 31, 1998 and 1997, respectively. The Company's
non-performing loans totaled $37.2 million and $44.3 million at December 31,
1998 and 1997, respectively, and, as a percentage of total loans, were 1.45% and
2.67% at December 31, 1998 and 1997, respectively.
The increase in the allowance for losses in 1998 compared to 1997 was based upon
management's assessment of relevant factors, including the types and amounts of
non-performing loans, the continued increase in the amount of historical charge
offs and anticipated loss experience on such types of loans, and the current and
projected economic conditions. Additionally, the allowance was increased to
compensate for the substantial increase in the amount of total loans outstanding
and the amount of loans which have been sold to the secondary market. The
Company is liable for certain representations and warranties made in regards to
the sold loans. See Asset Quality on page 30 and Tables 10 through 13 for
additional information on the Company's provision for losses, loan loss
allowance, and non performing loans.
24
25
FINANCIAL CONDITION (CONT'D)
FHLB STOCK. Holdings of FHLB stock increased from $40.0 million at December 31,
1997 to $57.8 million at December 31, 1998 since the Company's FHLB advances
increased to fund the increased mortgage loan portfolio. As a member of the
FHLB, the Company is required to hold shares of FHLB stock in an amount at least
equal to 1% of the aggregate unpaid principal balance of its mortgage loans,
home purchase contracts and similar obligations at the beginning of each year,
or 1/20th of its FHLB advances, whichever is greater. See "Regulation--Federal
Home Loan Bank System."
PREMISES AND EQUIPMENT. Premises and equipment, net of accumulated depreciation,
totaled $31.1 million at December 31, 1998, an increase of $2.0 million, or
6.9%, from $29.1 million at December 31, 1997. This increase reflects the
Company's investment in technology, along with the expansion of the Bank
branches, and the increased national presence in the mortgage acquisition area.
MORTGAGE SERVICING RIGHTS. Mortgage servicing rights totaled $150.3 million at
December 31, 1998, an increase of $66.5 million, from $83.8 million at December
31, 1997. For the year ended December 31, 1998, $16.9 billion of loans
underlying mortgage servicing rights were originated and purchased, and $11.8
billion were reduced through sales, prepayments, and amortization resulting in a
net increase in mortgage loans serviced for others of $5.1 billion from $6.4
billion to $11.5 billion at December 31, 1998.
OTHER ASSETS. Other assets increased $88.8 million, or 249.4%, to $124.4 million
at December 31, 1998, from $35.6 million at December 31, 1997. The majority of
this increase was attributable to the receipt of receivables recorded in
conjunction with three sales of MSR which totaled $4.7 billion on December 31,
1998. Upon the sale of MSR, the Company receives a down payment from the
purchaser equivalent to approximately 20% of the total purchase price and
records a receivable account for the balance of the purchase price due. This
recorded receivable is typically cleared within a six month time frame.
LIABILITIES. The Company's total liabilities increased $1.1 billion, or 61.1%,
to $2.9 billion at December 31, 1998, from $1.8 billion at December 31, 1997.
This increase was attributable to an increase in nearly every liability
category.
DEPOSITS. Deposit accounts increased $813.4 million, or 73.3%, to $1.9 billion
at December 31, 1998, from $1.1 billion at December 31, 1997. This increase
reflects the Company's deposit growth strategy through its retail branch network
and its pricing strategy. The number of bank branches increased from 19 at
December 31, 1997 to 28 at December 31, 1998. The Company's aggressive pricing
strategy attracts one-year certificates of deposit and brokered funds. The
Company relies upon both its retail customer base and nationwide advertising of
its deposit rates to attract deposits. At December 31, 1998, the Company's
certificates of deposit totaled $1.6 billion, with an average balance of $56,037
and a weighted average cost of 5.75%. Of such amount, approximately $1.1 billion
were brokered deposits with a weighted average cost of 5.66%.
FHLB ADVANCES. FHLB advances decreased $26.4 million, or 5.5%, to $456.0 million
at December 31, 1998, from $482.4 million at December 31, 1997. The Company
relies upon such advances as a source of funding for the origination or purchase
of loans for sale in the secondary market. The outstanding balance of FHLB
advances fluctuates from time to time depending upon the Company's current
inventory of loans available for sale and the availability of lower cost funding
from its retail deposit base and its escrow accounts.
UNDISBURSED PAYMENTS. Undisbursed payments on loans serviced for others
increased $138.6 million, or 302%, to $184.5 million at December 31, 1998, from
$45.9 million at December 31, 1997. The month-end average amount of these funds
was $97.6 million and $40.6 million during 1998 and 1997, respectively. These
amounts represent payments received from borrowers for interest, principal and
related loan charges, which have not been remitted to loan investors. These
balances fluctuate with the size of the servicing portfolio and increase during
a time of high payoff or refinance volume. Loans serviced for others at December
31, 1998 equaled $11.5 billion versus $6.4 billion at December 31, 1997.
25
26
FINANCIAL CONDITION (CONT'D)
ESCROW ACCOUNTS. The amount of funds in escrow accounts increased $61.1 million,
or 140.8%, to $104.5 million at December 31, 1998, from $43.4 million at
December 31, 1997. The average of the month end balances in these accounts was
$81.3 million and $58.5 million during 1998 and 1997, respectively. These
accounts are maintained on behalf of mortgage customers and include funds
earmarked for real estate taxes, homeowner's insurance, and other insurance
product liabilities. These balances fluctuate with the size of the servicing for
others portfolio and also depend upon the scheduled payment dates for the
related expenses. Loans serviced for others at December 31, 1998 equaled $11.5
billion versus $6.4 billion at December 31, 1997.
LIABILITY FOR CHECKS ISSUED. The liability for checks issued increased $19.7
million, or 42.9%, to $65.6 million at December 31, 1998, from $45.9 million at
December 31, 1997. This liability reflects the outstanding amount of checks the
Company has written in conjunction with acquiring mortgage loans. This account
grows or contracts in conjunction with the amount of loans that are in the
Company's mortgage pipeline.
FEDERAL INCOME TAXES PAYABLE. Federal income taxes payable increased $28.5
million, or 137.0%, to $49.3 million at December 31, 1998, from $20.8 million at
December 31, 1997. See Note 10 of Notes to the Consolidated Financial
Statements.
OTHER LIABILITIES. Other liabilities increased $67.0 million, or 426.8%, to
$82.7 million at December 31, 1998, from $15.7 million at December 31, 1997.
This increase was primarily attributable to the issuance of $57.5 million of
preferred stock by Flagstar Capital Corporation, a subsidiary of the Bank.
26
27
SEGMENT REPORTING
RETAIL BANKING OPERATIONS
The Company provides a full range of Banking services to consumers and small
businesses in southern and western Michigan. The Company operates a network of
28 Bank branches. Throughout 1998, the Company has focused on expanding its
branch network in these markets in order to increase its access to retail
deposit funding sources. This provides cross-marketing opportunities of consumer
banking services to the Company's mortgage customers in Michigan.
MORTGAGE BANKING OPERATIONS
Flagstar's mortgage banking activity consists of the origination of mortgage
loans or the purchase of mortgage loans from the originating lender. Flagstar
conducts the wholesale portion of its mortgage banking operation through a
network of correspondent lenders consisting of banks, thrifts, mortgage
companies, and mortgage brokers. This mortgage banking network conducts mortgage
lending operations nationwide. These mortgage loans, the majority of which are
subsequently sold in the secondary mortgage market, conform to the underwriting
standards of FHLMC or FNMA.
The following tables present certain financial information concerning the
results of operations of Flagstar's retail banking and mortgage banking
operation. See Note 16 of Notes to the Consolidated Financial Statements.
TABLE 8A
RETAIL BANKING OPERATIONS
At or for the year ended December 31,
1998 1997 1996 (1)
----------------------------------------
(In thousands)
Revenues $ 35,144 $ 30,202 $ 13,791
Earnings before taxes 19,994 19,341 3,305
Identifiable assets 969,485 564,551 387,201
1. Included in the 1996 earnings before taxes is a one-time assessment to
recapitalize the SAIF. The Company's pre-tax portion of which totaled $3.4
million.
TABLE 8B
MORTGAGE BANKING OPERATIONS
At or for the year ended December 31,
1998 1997 1996
----------------------------------------
(In thousands)
Revenues $ 137,343 $ 72,353 $ 74,955
Earnings before taxes 47,019 15,696 24,017
Identifiable assets 2,260,045 1,463,288 1,112,676
27
28
ASSET AND LIABILITY MANAGEMENT
Flagstar considers that its primary business objective is to provide
shareholders the highest return possible on their investment while maintaining a
certain risk posture. This objective includes the management of credit risk and
interest rate risk.
Interest rate risk generally refers to the potential volatility in net interest
income resulting from changes in interest rates. Flagstar's interest rate risk
management focuses on interest rate sensitivity through the use of simulation
models, in an attempt to measure and project the potential effects of various
market interest-rate scenarios on the Company's balance sheet. Unlike most
savings institutions, Flagstar will record higher levels of net interest income
in a rising interest rate environment and will experience declining net interest
income during periods of falling interest rates. This happens because the
Company's assets reprice or are sold faster than the majority of the Company's
funding sources will reset.
Any difference between the amount of assets and liabilities repricing or
maturing within one year is referred to as the "one-year repricing gap." A
positive one-year repricing gap indicates that more assets reprice than
liabilities. Conversely, a negative one-year repricing gap indicates that more
liabilities reprice than assets. The Company's one-year repricing gap stood at a
positive $1.4 billion, or 47.4% of total assets at December 31, 1998.(See Table
9 -- Asset/Liability Repricing Schedule, December 31, 1998).
While gap analysis is the most commonly used indicator of interest rate risk in
the savings and loan industry, there is no single interest rate risk measurement
system that takes into consideration all of the factors which influence the net
interest margin. Other significant factors which impact reported net interest
margins include changes in the shape of the U.S. Treasury yield curve, the
volume and composition of loan originations and repayment rates on loans.
Table 9 sets forth the repricing of the Company's earning assets and
interest-bearing liabilities at December 31, 1998, based on the interest rate
scenario at that date. The principal amounts of each asset and liability are
shown in the period in which they are anticipated to mature or reprice. Based on
available published statistics, average prepayment rates with respect to
mortgage loans have been estimated at 18.64%. The decay rate used for passbook
savings accounts was 15%.
TABLE 9
ASSET/LIABILITY REPRICING SCHEDULE
Maturing/Repricing In: FMV
1999 2000 2001 2002 2003 Thereafter Total Rate Total
----------------------------------------------------------------------------------------------------
EARNING ASSETS: (In Millions)
Mortgage loans available for
sale $ 709 $ 151 $ 123 $ 103 $ 100 $ 646 $ 1,832 7.41% $ 1,855
Loans held for investment 501 17 15 14 22 158 727 7.77 731
Other earning assets 58 -- -- -- -- -- 58 8.00 58
----------------------------------------------------------------------------------- -------
Total $ 1,268 $ 168 $ 138 $ 117 $ 122 $ 804 $ 2,617 7.52% $ 2,644
INTEREST-BEARING LIABILITIES:
Deposits $ 995 $ 348 $ 218 275 $ 19 $ 68 $ 1,923 5.53% $ 1,937
FHLB advances 156 200 -- -- 100 -- 456 5.64 457
----------------------------------------------------------------------------------- -------
Total $ 1,151 $ 548 $ 218 $ 275 $ 119 68 $ 2,379 5.55% $ 2,394
OFF-BALANCE SHEET:
Commitment to sell loans $ 1,805 ($ 33) ($ 35) ($ 37) ($ 40) ($ 1,660) (16)
Commitment to originate loans (478) 9 10 10 11 438 14
------------------------------------------------------------------------
Total $ 1,327 ($ 24) ($ 25) ($ 27) ($ 29) ($ 1,222)
------
Interest rate spread 1.97%
======
Excess (Deficiency) of
Earning assets over (to)
-----------------------------------------------------------------------------------
Interest-bearing liabilities $ 1,444 ($ 404) ($ 105) ($ 185) ($ 26) ($ 486) $ 238 (1)
===================================================================================
(1) The excess of earning assets over paying liabilities has the effect of
increasing the indicated spread by .50%.
28
29
ASSET QUALITY
The Company has consistently maintained a conservative posture with respect to
credit risk. Mortgage lending, the Company's primary lending focus, has
historically resulted in minimal charge-offs. At December 31, 1998,
approximately 97.8% of the Company's earning assets consisted of mortgage loans.
The credit quality of the Company's commercial, consumer, and commercial real
estate loan portfolio, which in the aggregate comprise only 13.3% of total
earning assets (13.6% of total loans) at December 31, 1998, remains good. During
the past two years, the Company has begun emphasizing commercial real estate
lending. Management plans to increase the size of this loan portfolio.
Management expects to achieve this growth with adherence to sound underwriting
and credit standards.
Management believes, the Company's level of non performing assets, which totaled
$60.2 million at December 31, 1998, continues to represent an acceptable level
of credit risk for Flagstar. The Company, in accordance with applicable
disclosure requirements, defines an asset as non performing if it meets any of
the following criteria: 1) a loan more than 90 days past due; 2) real estate
acquired in a settlement of a loan; or 3) a restructured loan whose terms have
been modified due to the borrower's inability to pay as contractually specified
("troubled debt restructurings"). Loans are generally placed into non accrual
status when they become 90 days delinquent. Gross interest income of
approximately $3.9 million, $4.8 million and $2.7 million would have been
recorded in 1998, 1997, and 1996, respectively, on non accrual loans if the
loans had performed in accordance with their original terms.
TABLE 10
NON PERFORMING ASSETS
December 31,
1998 1997 1996 1995 1994
----------------------------------------------------------------------
(In Thousands)
Non accrual loans $ 37,190 $ 44,329 $ 30,621 $ 10,686 $ 1,739
Real estate and other repossessed assets 22,966 18,262 10,363 2,359 1,271
----------------------------------------------------------------------
Total non performing assets 60,156 62,591 40,984 13,045 3,010
Less allowance for losses (20,000) (5,500) (3,500) (2,102) (1,871)
----------------------------------------------------------------------
Total non performing assets (net of allowances) $ 40,156 $ 57,091 $ 37,484 $ 10,943 $ 1,139
======================================================================
Ratio of non performing assets to total assets 1.97% 3.29% 3.16% 1.25% 0.42%
Ratio of non performing loans to total loans 1.44% 2.67% 2.75% 1.15% 0.27%
Ratio of allowances to non performing loans 53.78% 12.41% 11.43% 19.67% 107.59%
Ratio of allowances to total loans 0.78% 0.33% 0.31% 0.23% 0.29%
Ratio of net charge-offs to average loans 0.17% 0.20% 0.13% 0.00% 0.08%
The Company's 1998 year-end ratio of non performing assets to total assets was
1.97%. The adequacy of the allowance for losses is evaluated regularly and is
based upon judgements concerning the amount of risk inherent in the Company's
portfolio. At December 31, 1998, $36.2 million, or 97.3% of total non performing
loans were secured by residential real estate.
During 1998, the Company recorded a provision for losses of $14.5 million, this
increased the allowance for losses to $20.0 million. Management recorded this
additional allowance in order to compensate for the $908.0 million, or 54.3%
increase in loans receivable and the substantial increase in the amount of loans
that the Company has sold to the secondary market. Generally, for loans sold to
the secondary market, the Company is responsible for certain representations and
warranties regarding the adherence to underwriting and loan program guidelines.
At December 31, 1998, the Company had sold $39.9 billion in loans to the
secondary market over the previous 60 months. This volume of loan sales is $11.7
billion, or 41.5%, larger than the $28.2 billion sold in the sixty months
preceding December 31, 1997. Although all of the loans were sold on a non
recourse basis, the Company repurchased $32.3 million, $58.5 million, and $54.8
million in mortgage loans from secondary market investors during 1998, 1997, and
1996, respectively. These loans were required to be repurchased
29
30
ASSET QUALITY (CONT'D)
because of their delinquent status and/or their non compliance with the
underwriting and loan program guidelines that they were initially sold under.
The predominance of the charge-offs recorded by the Company ($4.1 million, $3.0
million, and $1.2 million in 1998, 1997, and 1996, respectively) were primarily
attributed to loans originated within the prior sixty month period, repurchased
from secondary market investors, foreclosed on, and disposed of at a loss.
Management is of the opinion that the allowance for losses at December 31, 1998
is adequate to meet potential losses in the portfolio. It must be understood,
however, that these allowances are dependent upon estimates and appraisals and
the possibility exists that changes in these assumptions might be required
because of changing economic conditions. See Tables 10 through 13 for additional
information on the Company's loan loss allowance and non performing loans. Also
refer to Notes 1 and 4 of Notes to Consolidated Financial Statements in Item 8.
Financial Statements and Supplementary Data, herein for further discussion of
the Company's policies regarding provisions for losses and allowances for
uncollected interest.
TABLE 11
NON-ACCRUAL LOANS AT DECEMBER 31, 1998
NON PERFORMING AS A % OF AS A % OF
LOAN PORTFOLIO LOAN LOAN PORTFOLIO NON PERFORMING
BALANCE BALANCE BALANCE LOANS
-------------------- --------------------- --------------------- ----------------------
(In Thousands)
One- to four-family $ 2,195,998 $ 36,376 1.66% 97.81%
Commercial 3,601 28 0.78 0.08
Construction 34,367 672 1.96 1.81
Consumer 28,199 114 0.40 0.30
Warehouse lending 235,693 -- -- --
Commercial real estate 80,858 -- -- --
---------------------------------------------------------------------------------------
Total loans 2,578,716 37,190 1.44% 100.00%
Less allowances for losses (20,000) (20,000)
------------------------------------------
Total loans (net of allowances) $ 2,558,716 $ 17,190
==========================================
30
31
TABLE 12
ALLOCATION OF THE ALLOWANCE FOR LOSSES
At December 31,
1998 1997 1996 1995 1994
---------------------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
of Loans Of Loans of Loans Of Loans of Loans
in Each In Each in Each In Each in Each
Category Category Category Category Category
to Total To Total to Total To Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
---------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Mortgage loans :
Available for sale $ 5,000 71.1% $ 1,500 72.1% $ 1,000 75.4% $ 248 67.0% $ 289 32.3%
Held for investment 3,000 14.1% 700 17.0% 200 10.9% 78 19.2% 531 55.8%
Construction 1,000 1.3% 300 2.1% 400 5.3% 367 5.3% 191 4.0%
Consumer 1,000 1.1% 300 2.0% 300 3.0% 393 4.3% 193 3.0%
Commercial 500 0.2% 100 0.2% 50 0.4% 22 0.5% 19 0.6%
Commercial real estate 3,500 3.1% 700 1.9% 100 1.2% 305 3.3% 234 3.7%
Warehouse lending 1,500 9.1% 100 4.7% 150 3.8% 21 0.4% 19 0.6%
Unallocated 4,500 -- % 1,800 -- % 1,300 -- % 668 -- % 395 -- %
---------------------------------------------------------------------------------------------------------
Total $ 20,000 100.0% $ 5,500 100.0% $ 3,500 100.0% $ 2,102 100.0% $ 1,871 100.0%
=========================================================================================================
TABLE 13
ACTIVITY WITHIN THE ALLOWANCE FOR LOSSES
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------
(In thousands)
Balance at the beginning of the period $ 5,500 $ 3,500 $ 2,102 $ 1,871 $ 901
Provision for losses 18,631 5,015 2,604 238 290
Allowances of acquired institution -- -- -- -- 1,001
Charge-offs, net of recoveries (4,131) (3,015) (1,206) (7) (321)
--------------------------------------------------------------------------------
Balance at the end of the period $ 20,000 $ 5,500 $ 3,500 $ 2,102 $ 1,871
================================================================================
31
32
LIQUIDITY AND CAPITAL RESOURCES
The standard measure of liquidity in the thrift industry is the ratio of cash
and eligible investments, as defined by regulation, to the sum of net
withdrawable savings and borrowings due within one year. The OTS has established
the current minimum liquidity requirement at 4%. The Company, as a component of
its overall asset and liability management strategy, maintains qualifying liquid
assets at levels which exceed regulatory requirements. For the month ending
December 31, 1998, the Company's liquidity ratio was 12.9%.
The Company's primary sources of funds are customer deposits, loan repayments
and sales, advances from the FHLB, and cash generated from operations, and
customer escrow accounts. While these sources are expected to continue to be
available to provide funds in the future, the mix and availability of funds will
depend upon future economic and market conditions. Flagstar does not foresee any
difficulty in meeting its liquidity requirements.
Loan principal repayments totaled $489.6 million during 1998, representing an
increase of $172.4 million, or 54.4%, compared to 1997. This increase, was
attributable to an increased asset base and a lower interest rate environment in
1998 which increased the amount of loan refinancings or payoffs.
Sales of mortgage loans totaled $17.8 billion in principal balance during 1998,
compared to $7.2 billion in 1997. The sales recorded during 1998 were higher
than in 1997 due to the increased loan origination volume. Only a portion of
loans originated are retained by the Company and held for investment.
Customer deposits increased $813.4 million, or 73.3%, and totaled $1.9 billion
at December 31, 1998. The increase is directly attributable to the Company's
aggressive approach to increasing retail deposits. During 1998, the Company
decreased its borrowings from the FHLB by $26.4 million, or 5.5%. The Company
utilizes FHLB advances to assist in funding mortgage loan production.
In May 1997, the Company completed an initial public offering of its common
stock. The net proceeds received by the Company totaled $27.3 million.
In November 1997, the Company paid an initial quarterly cash dividend on its
common stock of $0.06 per share. On February 13, 1998, May 15, 1998, August 14,
1998, and November 16, 1998, the Company's Board of Directors paid a quarterly
cash dividend of $0.06, $0.07, $0.07, and $0.08 per share, respectively.
Stockholders' equity increased $37.3 million to $163.9 million at December 31,
1998, an increase of 29.5%. This level of stockholders' equity represented 5.38%
of total assets at December 31, 1998.
At December 31, 1998, the Company had outstanding rate-lock commitments to lend
$620.8 million in mortgage loans, along with outstanding commitments to make
other types of loans totaling $16.9 million. Because such commitments may expire
without being drawn upon, they do not necessarily represent future cash
commitments. Also, as of December 31, 1998, the Company had outstanding
commitments to sell $1.8 billion of mortgage loans. These commitments will be
funded within 90 days. Total commercial and consumer unused collateralized lines
of credit totaled $248.4 million at December 31, 1998. Such commitments include
$450.8 million in warehouse lines of credit to various mortgage companies, of
which $235.7 million was drawn upon as of December 31, 1998.
32
33
ACCOUNTING AND REPORTING DEVELOPMENTS
RECENTLY ISSUED ACCOUNTING STANDARDS. In June 1997, the FASB issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"), which requires that an entity recognize all derivatives as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. The statement is effective January 1, 2000 for the
Company; however, management has not quantified the impact of this pronouncement
on the Company's financial position.
The FASB has issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise" ("SFAS 134"). The statement requires that an entity engaged
in mortgage banking activities classify any resulting mortgage-backed securities
or other retained interests based on its ability and intent to sell or hold
these investments. The statement is effective for 1999 for the Company; however,
management does not expect this pronouncement to have a significant impact on
the Company's financial position.
IMPACT OF INFLATION AND CHANGING PRICES. The Consolidated Financial Statements
and Notes thereto 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 the changes in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of the
Company's operations. Unlike most industrial companies, nearly all the assets
and liabilities of the Company are monetary in nature. As a result, interest
rates have a greater impact on the Company's performance than do the effects of
general levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services.
YEAR 2000 PROBLEM. The Company is aware of the current concerns throughout the
business community of reliance upon computer software programs that do not
properly recognize the year 2000 in date formats, often referred to as the "Year
2000 Problem." The Year 2000 Problem is the result of software being written
using two digits rather than four digits to define the applicable year (i.e.,
"98" rather than "1998"). A failure by a business to properly identify and
correct a Year 2000 Problem in its operations could result in system failures or
miscalculations. In turn, this could result in disruptions of operations,
including among other things a temporary inability to process transactions, send
invoices or otherwise engage in routine business transactions on a day-to-day
basis.
Operations of the Company depend upon the successful operation on a daily basis
of its computer software programs. The Company generally relies upon software
purchased from third party vendors rather than internally generated software. In
its analysis of the software, and based upon its ongoing discussions with these
vendors, management believes that most of its software already reflects changes
necessary to avoid the Year 2000 Problem. The Company expects to update during
1999 any remaining software that could be affected by the Year 2000 Problem to
eliminate remaining concerns. This update is not expected to have any adverse
material financial impact on the Company. If either our computer systems or
those of our vendors fail to function properly because of the Year 2000 problem,
the results of our operations may materially suffer.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information set for the under Item 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" - Asset/Liability Management"
is incorporated herein.
33
34
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants 35
Consolidated Statements of Financial Condition as of December 31, 1998 and 1997 36
Consolidated Statements of Earnings for the Years Ended December 31, 1998, 1997 and 1996 37
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1998, 1997, and 1996 38
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997, and 1996 39
Notes to the Consolidated Financial Statements 40
34
35
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Flagstar Bancorp, Inc.
We have audited the accompanying consolidated statements of financial condition
of Flagstar Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of earnings, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
a 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 financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Flagstar Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the results of their consolidated operations and their consolidated cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
Grant Thornton LLP
Detroit, Michigan
February 12, 1999
35
36
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS)
- --------------------------------------------------------------------------------
AT DECEMBER 31,
ASSETS 1998 1997
-----------------------------
Cash and cash equivalents $ 75,799 $ 21,928
Loans receivable
Mortgage loans available for sale 1,831,531 1,197,152
Loans held for investment 747,185 463,607
Less: allowance for losses (20,000) (5,500)
----------- -----------
Loans receivable, net 2,558,716 1,655,259
Federal Home Loan Bank stock 57,837 40,025
Other investments 500 538
----------- -----------
Total earning assets 2,617,053 1,695,822
Accrued interest receivable 24,812 16,492
Repossessed assets 22,966 18,262
Premises and equipment 31,124 29,131
Mortgage servicing rights 150,258 83,845
Other assets 124,433 35,604
----------- -----------
Total assets $ 3,046,445 $ 1,901,084
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposit accounts $ 1,923,370 $ 1,109,933
Federal Home Loan Bank advances 456,019 482,378
----------- -----------
Total interest bearing liabilities 2,379,389 1,592,311
Accrued interest payable 16,659 10,555
Undisbursed payments on
Loans serviced for others 184,498 45,852
Escrow accounts 104,455 43,368
Liability for checks issued 65,634 45,896
Federal income taxes payable 49,265 20,808
Other liabilities 82,693 15,677
----------- -----------
Total liabilities 2,882,593 1,774,467
Commitments and Contingencies (Notes 4, 6, 7, 12 and 16) -- --
STOCKHOLDERS' EQUITY
Common stock - $.01 par value, 40,000,000 shares
Authorized, 13,670,000 shares issued at
December 31, 1998 and December 31, 1997 137 137
Additional paid in capital 29,988 29,988
Retained earnings 133,727 96,492
----------- -----------
Total stockholders' equity 163,852 126,617
----------- -----------
Total liabilities and stockholders' equity $ 3,046,445 $ 1,901,084
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
36
37
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
----------------------------------------
INTEREST INCOME
Loans $ 187,124 $ 120,214 $ 74,588
Other 4,137 2,538 1,591
--------- --------- ---------
Total 191,261 122,752 76,179
INTEREST EXPENSE
Deposits 82,452 50,143 30,431
FHLB advances 48,332 28,709 14,291
Other 6,403 1,181 1,245
--------- --------- ---------
Total 137,187 80,033 45,967
--------- --------- ---------
Net interest income 54,074 42,719 30,212
Provision for losses 18,631 5,015 2,604
--------- --------- ---------
Net interest income after provision for losses 35,443 37,704 27,608
NON-INTEREST INCOME
Loan administration (2,532) 6,127 11,859
Net gain on loan sales 110,682 21,775 4,511
Net gain on sales of mortgage servicing rights 3,820 27,095 35,129
Other fees and charges 6,443 4,839 7,035
--------- --------- ---------
Total 118,413 59,836 58,534
NON-INTEREST EXPENSE
Compensation and benefits 32,508 25,930 25,553
Occupancy and equipment 15,964 12,810 12,126
General and administrative 38,371 23,763 21,141
--------- --------- ---------
Total 86,843 62,503 58,820
--------- --------- ---------
Earnings before federal income taxes 67,013 35,037 27,322
Provision for federal income taxes 25,950 13,265 10,299
--------- --------- ---------
NET EARNINGS $ 41,063 $ 21,772 $ 17,023
========= ========= =========
EARNINGS PER SHARE - BASIC $ 3.00 $ 1.70 $ 1.51
========= ========= =========
EARNINGS PER SHARE - DILUTED $ 2.90 $ 1.68 $ 1.51
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
37
38
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
ADDITIONAL TOTAL
COMMON PAID IN RETAINED STOCKHOLDERS'
STOCK CAPITAL EARNINGS EQUITY
--------- --------- --------- ---------
Balance at January 1, 1996 $ 112 $ 2,816 $ 59,517 $ 62,445
Net earnings - - 17,023 17,023
Dividend paid ($0.09 per share) - - (1,000) (1,000)
--------- --------- --------- ---------
Balance at December 31, 1996 112 2,816 75,540 78,468
Net earnings - - 21,772 21,772
Initial public offering of common shares 25 27,172 - 27,197
Dividend paid ($ 0.06 per share) - - (820) (820)
--------- --------- --------- ---------
Balance at December 31, 1997 137 29,988 96,492 126,617
Net earnings - - 41,063 41,063
Dividend paid ($ 0.28 per share) - - (3,828) (3,828)
--------- --------- --------- ---------
Balance at December 31, 1998 $ 137 $ 29,988 $ 133,727 $ 163,852
========= ========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
38
39
FLAGSTAR BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
- --------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
--------------------------------------------------
OPERATING ACTIVITIES
Net earnings $ 41,063 $ 21,772 $ 17,023
Adjustments to reconcile net earnings to net cash used in operating activities
Provision for losses 18,631 5,015 2,604
Depreciation and amortization 39,897 17,161 17,287
Net gain on the sale of assets (868) (1,100) (187)
Net gain on loan sales (110,682) (21,775) (4,511)
Gain on sales of mortgage servicing rights (3,820) (27,095) (35,129)
Proceeds from sales of loans available for sale 18,033,222 7,225,460 6,604,080
Originations and repurchases of loans available for sale, net of
principal repayments (18,579,866) (7,578,375) (6,830,382)
Increase in accrued interest receivable (8,320) (9,866) (2,319)
(Increase) decrease in other assets (90,149) 16,250 (34,369)
Increase in accrued interest payable 6,104 7,843 497
Increase (decrease) in liability for checks issued 19,738 6,083 (46,037)
Increase (decrease) in federal taxes payable 16,481 (18,553) 8,666
Provision (benefit) for deferred federal income taxes 11,977 16,813 (773)
Increase (decrease) in other liabilities 67,015 (1,268) 4,020
------------ ------------ ------------
Net cash used in operating activities (539,577) (341,635) (299,530)
INVESTING ACTIVITIES
Maturity of other investments 38 349 431
Purchase of other investments - - (500)
Originations of loans held for investment, net of principal repayments (283,578) (190,040) 31,936
Purchase of Federal Home Loan Bank stock (17,812) (20,300) (1,925)
Proceeds from the disposition of repossessed assets 14,994 8,205 1,813
Acquisitions of premises and equipment (8,189) (16,306) (7,596)
Proceeds from the disposition of premises and equipment 20 2,733 -
Proceeds from the disposition real estate held for investment - 735 -
Increase in mortgage servicing rights (245,204) (92,441) (63,499)
Proceeds from the sale of mortgage servicing rights 150,197 55,273 85,203
------------ ------------ ------------
Net cash (used in) provided by investing activities (389,534) (251,792) 45,863
FINANCING ACTIVITIES
Net increase in deposit accounts 813,437 485,448 97,511
Net (decrease) increase in Federal Home Loan Bank advances (26,359) 92,577 198,645
Net receipt (disbursement) of payments of loans serviced for others 138,645 (15,593) 1,433
Net receipt (disbursement) of escrow payments 61,087 (17,641) (27,854)
Proceeds from the initial public offering - 27,197 -
Dividends paid to stockholders (3,828) (820) (1,000)
------------ ------------ ------------
Net cash provided by financing activities 982,982 571,168 268,735
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 53,871 (22,259) 15,068
Beginning cash and cash equivalents 21,928 44,187 29,119
------------ ------------ ------------
Ending cash and cash equivalents $ 75,799 $ 21,928 $ 44,187
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Loans receivable transferred to repossessed assets $ 18,817 $ 15,290 $ 10,577
============ ============ ============
Total interest payments made on deposits and other borrowings $ 131,083 $ 72,189 $ 45,470
============ ============ ============
Federal income taxes paid $ - $ 15,000 $ 2,300
============ ============ ============
Loans available for sale transferred to loans held for investment $ 147,233 $ 63,827 $ -
============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
39
40
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1 - NATURE OF BUSINESS
Flagstar Bancorp, Inc. ("Flagstar" or the "Company"), is the holding company for
Flagstar Bank, FSB (the "Bank"), a federally chartered stock savings bank
founded in 1987. Flagstar's primary business consists of attracting deposits
from the general public and originating or acquiring residential mortgage loans.
The Company also acquires funds on a wholesale basis from a variety of sources,
services a significant volume of loans for others, and to a lesser extent makes
consumer loans, commercial real estate loans, and non-real estate commercial
loans.
The Bank is a member of the Federal Home Loan Bank System ("FHLB") and is
subject to regulation, examination and supervision by the Office of Thrift
Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC"). The
Bank's deposits are insured by the FDIC through the Savings Association
Insurance Fund ("SAIF").
In January 1996, the Bank changed its name from First Security Savings Bank, FSB
to Flagstar Bank, FSB.
NOTE 2 - CORPORATE STRUCTURE
The Company conducts business through a number of wholly-owned subsidiaries in
addition to the Bank. The additional subsidiaries of the Company include Douglas
Insurance Agency, Inc. ("DIA"), FSSB Real Estate Development Corporation
("REDC"), and Flagstar Investment Group, Inc. ("Investment"). Of the additional
subsidiaries, DIA and Investment are presently active. DIA acts as an agent for
life insurance and property and casualty insurance companies and Investment
offers a full-service brokerage service.
The Bank, the Company's primary subsidiary, is a federally chartered, stock
savings bank headquartered in Bloomfield Hills, Michigan. The Bank owns five
subsidiaries: FSSB Mortgage Corporation ("Mortgage"), Flagstar Capital
Corporation ("Capital"), Flagstar Credit Corporation ("Credit"), Mid-Michigan
Service Corporation ("Mid-Michigan") and SSB Funding Corporation ("Funding").
Mortgage, Credit, Mid-Michigan, and Funding are currently inactive subsidiaries.
Capital purchases mortgage loans from the Bank and holds them for investment
purposes. Mortgage Affiliated Services, a wholly-owned subsidiary, provided
appraisal and document preparation services, was merged with the Bank during the
first quarter of 1998.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following summarizes the significant accounting policies of the Company
applied in the preparation of the accompanying consolidated financial
statements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company. All
significant intercompany balances and transactions have been eliminated.
40
41
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STATEMENT OF CASH FLOWS
For purposes of the statements of cash flows, the Company considers its
investment in overnight deposits to be cash equivalents.
LOANS RECEIVABLE
The Company originates loans which are designated to be held for investment or
sale during the origination process. Mortgage loans available for sale are
carried at the lower of aggregate cost or estimated market value. Management
periodically reviews the portfolio and makes necessary adjustments for market
value. Net unrealized losses are recognized in a valuation allowance which is
charged to earnings. Gains or losses recognized upon the sale of loans are
determined using the specific identification method. Mortgage loans held for
investment are carried at amortized cost. The Company has both the intent and
the ability to hold all mortgage loans held for investment for the foreseeable
future.
ALLOWANCE FOR LOSSES
The allowance is maintained at a level adequate to absorb losses inherent in the
loan portfolio. Management determines the adequacy of the allowance by applying
projected loss ratios to the risk ratings of loans both individually and by
category. The projected loss ratios incorporate such factors as recent loss
experience, current economic conditions, the risk characteristics of the various
categories and concentrations of loans, transfer risk and other pertinent
factors.
Loans which are deemed uncollectible are charged off and deducted from the
allowance. The provision for losses and recoveries on loans previously charged
off are added to the allowance. In addition, a specific provision is made for
expected loan losses to reduce the recorded balances of loans receivable to
their estimated net realizable value. Such specific provision is based on
management's estimate of net realizable value considering the current and
anticipated operating or sales environment. These estimates of collateral value
are particularly susceptible to market changes that could result in adjustments
to the results of earnings in the future. Recovery of the carrying value of such
loans or such loan or the underlying collateral is dependent to a great extent
on economic, operating and other conditions that may beyond the Company's
control. The Company considers its residential mortgage loan portfolio to
represent a pool of smaller balance homogeneous loans. Commercial, commercial
real estate, construction and consumer loan portfolios are specifically reviewed
for impairment.
The Company considers a loan impaired when it is probable, in the opinion of
management, that interest and principal may not be collected according to the
contractual terms of the loan agreement. Consistent with this definition, the
Company considers all non-accrual loans (with exception of residential
mortgages) to be impaired. Impaired loans which have risk characteristics that
are unique to an individual borrower, are evaluated on a loan-by-loan basis.
However, impaired loans that have risk characteristics in common with other
impaired loans, (such as loan type, geographical location, or other
characteristics that would cause the ability of the borrowers to meet
contractual obligations to be similarly affected by changes in economic or other
conditions), are aggregated and historical statistics, such as average recovery
period and average amount recovered, along with a composite effective interest
rate are used as a means of measuring those impaired loans. Loan impairment is
measured by estimating the expected future cash flows and discounting them at
the respective effective interest rate or by valuing the underlying collateral.
41
42
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOAN ORIGINATION FEES, COMMITMENT FEES AND RELATED COSTS
Loan fees received are accounted for in accordance with SAFS No. 91, "Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases". Mortgage loan fees and certain direct
origination costs are capitalized. On loans available for sale, the net fee or
cost is recognized at the time the loan is sold. For mortgage loans held for
investment, the deferred amount is accounted for as an adjustment to interest
income using a method that approximates the interest method.
REPOSSESSED ASSETS
Repossessed assets include one-to-four family residential property, commercial
property, and one-to-four family homes under construction. At the date of
foreclosure, real estate properties acquired in settlement of loans are recorded
at the lower of cost or net realizable value. Valuations are periodically
performed by management, and a charge to earnings is made if the carrying value
of a property exceeds its estimated fair value. Costs of holding repossessed
assets, principally taxes and legal fees, are expensed as incurred.
FEDERAL INCOME TAXES
The Company accounts for income taxes on the asset and liability method.
Deferred tax assets and liabilities are recorded based on the difference between
the tax bases of assets and liabilities and their carrying amounts for financial
reporting purposes. Current taxes are measured by applying the provisions of
enacted tax laws to taxable income to determine the amount of taxes receivable
or payable.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation. Land is
carried at historical cost. Depreciation is calculated on the straight-line
method over the estimated useful lives of the assets as follows:
Office buildings - 31 years
Computer hardware and software - 3 to 5 years
Furniture, fixtures and equipment - 5 to 7 years
Automobiles - 3 years
42
43
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MORTGAGE SERVICING RIGHTS
Mortgage servicing rights ("MSR") represent the cost of acquiring the right to
service mortgage loans. These costs are initially capitalized and subsequently
amortized in proportion to, and over the period of, the estimated net loan
servicing income.
The value of the mortgage servicing rights are periodically evaluated in
relation to the estimated discounted net future servicing revenues. The
portfolio is aggregated into stratifications based on loan term and type, and
note rate. Estimates of remaining loan lives and prepayment rates are
incorporated into this analysis. Changes in these estimates could materially
change the estimated fair value. Valuation adjustments are recorded when the
fair value of the servicing asset is less than the amortized book value on a
stratum basis. Any valuation adjustment is recorded as an offset to the asset
and a charge to current earnings.
LOAN SALES
The Company sells its available for sale mortgage loans to secondary market
investors on a non-recourse basis. At the time of the sale, the Company makes
certain representations and warranties to the investors. Should an investor
determine that a breach of such representations or warranties occurred, the
Company may be required to repurchase loans from the investor. Such
representations and warranties generally relate to the fact that the loans have
been underwritten in accordance with the investor's guidelines and that the
loans conform to the laws of the state of origination. Gain or loss on the sale
of such loans is recognized upon consummation of the sale.
PREFERRED STOCK OF SUBSIDIARY
In February and March of 1998, Flagstar Capital Corporation offered to the
public and sold 2,300,000 shares of its 8.50%, noncumulative, Series A Preferred
Shares, $25 par value per share, providing gross proceeds totaling $57.5
million. The Series A Preferred Shares are traded on the Nasdaq Stock Market,
under the symbol "FLGSP". Capital used the net proceeds raised from the offering
of the Series A Preferred Shares to acquire mortgage loans from the Bank.
Capital is a real estate investment trust for federal income tax purposes. The
net proceeds received by Capital qualify as regulatory capital, with certain
limitations as defined by regulation. The Series A Preferred Shares are recorded
on the books of the Company as a minority interest and are included in other
liabilities. Dividends paid on the Series A Preferred Shares are deductible for
tax purposes and included in interest expense - other.
The Series A Preferred Shares are generally not redeemable until February 24,
2003. On or after that date, the Series A Preferred Shares are redeemable in
whole or in part by the Company for cash. The Series A Preferred Shares are not
subject to sinking fund or mandatory redemption and are not convertible into any
securities of the Company.
43
44
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK BASED COMPENSATION
The FASB issued SFAS No. 123, "Accounting for Stock Based Compensation," for
transactions entered into during 1996 and thereafter. The statement establishes
a fair market value method of accounting for employee stock options and similar
instruments such as warrants, and encourages all companies to adopt that method
of accounting for all employee stock option plans. However, the statement allows
companies to continue measuring compensation costs for such plans using
accounting guidance in place prior to SFAS No. 123. Companies that elect to
remain with the former method of accounting must make pro forma disclosures of
net earnings and earnings per share as if the fair value method provided for in
SFAS No.123 had been adopted. The Company has not adopted the fair value
provisions of SFAS No. 123 but has disclosed the pro forma effects in accordance
with the pronouncement.
EARNINGS PER SHARE
Basic earnings per share excludes dilution and is computed by dividing earnings
available to common shareholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised and converted into common stock or resulted in the issuance of
common stock that could then share in the earnings of the Company. The Company
adopted SFAS No. 128 at December 31, 1997.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The financial condition of a financial services company, and to some extent, its
operating performance, is dependent to a significant degree upon estimates and
appraisals of value, evaluations of creditworthiness and assumptions about
future events and economic conditions. Recent history has demonstrated that
these estimates, appraisals, evaluations and assumptions are subject to rapid
change, and that such changes can materially affect the reported financial
condition of a financial services company and its financial performance, and may
result in restrictions on an institution's ability to continue to operate in its
customary manner.
RECLASSIFICATIONS
Certain amounts within the accompanying consolidated financial statements and
the related notes have been reclassified to conform to the 1998 presentation.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The statement is
effective January 1, 2000 for the Company; however, management has not
quantified the impact of this pronouncement on the Company's financial position.
The FASB has issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise" ("SFAS 134"), The statement requires that an entity engaged
in mortgage banking activities classify any resulting mortgage-backed securities
or other retained interests based on its ability and intent to sell or hold
these investments. The statement is effective for 1999 for the Company; however,
management does not expect this pronouncement to have a significant impact on
the Company's financial position.
44
45
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 4 - LOANS RECEIVABLE
The loan portfolio is summarized as follows (in thousands):
DECEMBER 31,
1998 1997
-----------------------------
Available for sale - mortgage loans $ 1,831,531 $ 1,197,152
Held for investment
Mortgage loans 364,467 282,224
Commercial real estate loans 80,858 31,751
Commercial loans 3,601 2,710
Construction loans 34,367 35,373
Warehouse lending 235,693 77,545
Consumer loans 28,199 34,004
-----------------------------
Total 747,185 463,607
-----------------------------
Total loans 2,578,716 1,660,759
Less allowance for losses (20,000) (5,500)
-----------------------------
Total $ 2,558,716 $ 1,655,259
=============================
Activity in the allowance for losses is summarized as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
--------------------------------------
Balance, beginning of period $ 5,500 $ 3,500 $ 2,102
Provision charged to earnings 18,631 5,015 2,604
Charge-offs, net of recoveries (4,131) (3,015) (1,206)
--------------------------------------
Balance, end of period $ 20,000 $ 5,500 $ 3,500
======================================
The Company has no commitments to make additional advances on restructured or
other non performing loans. Loans on which interest accruals have been
discontinued totaled approximately $37.2 million at December 31, 1998 and $44.3
million at December 31, 1997. Interest that would have been accrued on such
loans totaled approximately $3.9 million, $4.8 million, and $2.7 million during
1998, 1997, and 1996, respectively.
At December 31, 1998 the recorded investment in impaired loans, pursuant to SFAS
No. 114, totaled $1.0 million and the average outstanding balance for the year
ended December 31, 1998 was $1.6 million. No allowance for losses was required
on these loans because the measured values of the loans exceeded the recorded
investments in the loans. Interest income recognized on impaired loans during
the year ended December 31, 1998, was not significant. At December 31, 1997, the
recorded investment in impaired loans totaled $3.6 million and the average
outstanding balance for the year ended December 31, 1997 was $3.5 million.
45
46
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 5 - REPOSSESSED ASSETS
Repossessed assets include the following (in thousands):
DECEMBER 31,
1998 1997
--------------------
One-to-four family $22,786 $18,082
Commercial properties 180 180
--------------------
Repossessed assets, net $22,966 $18,262
====================
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment balances are as follows (in thousands):
DECEMBER 31,
1998 1997
-----------------------
Land $ 9,125 $ 9,119
Office buildings 7,398 7,090
Computer hardware and software 20,733 16,827
Furniture, fixtures and equipment 15,493 11,813
Automobiles 527 434
-----------------------
Total 53,276 45,283
Less accumulated depreciation (22,152) (16,152)
-----------------------
Premises and equipment, net $ 31,124 $ 29,131
=======================
Depreciation expense amounted to approximately $6.2 million, $5.2 million, and
$4.6 million for the years ended December 31, 1998, 1997 and 1996, respectively.
The Company conducts a portion of its business from leased facilities. Lease
rental expense totaled approximately $4.8 million, $3.9 million and $4.1 million
for the years ended December 31, 1998, 1997 and 1996, respectively. The
following outlines the Company's minimum contractual lease obligations as of
December 31, 1998 (in thousands):
1999 $ 4,967
2000 3,632
2001 1,293
2002 926
2003 452
Thereafter 813
------------
Total $ 12,083
============
46
47
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 7 - MORTGAGE SERVICING RIGHTS
Not included in the accompanying consolidated financial statements are mortgage
loans serviced for others. The unpaid principal balances of these loans at
December 31, 1998 are summarized as follows (in thousands):
DECEMBER 31,
MORTGAGE LOANS SERVICED FOR: 1998 1997
----------------------------
FHLMC and FNMA $11,084,838 $ 6,081,885
MSHDA 56,897 57,695
GNMA 932 4,970
Other investors 329,544 268,247
----------------------------
Total $11,472,211 $ 6,412,797
============================
Custodial accounts maintained in connection with the above mortgage servicing
rights were approximately $253.6 million and $81.2 million at December 31, 1998
and 1997, respectively. These amounts include payments for principal, interest,
taxes, and insurance collected on behalf of the individual investor.
The following is an analysis of the changes in mortgage servicing rights (in
thousands):
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
------------------------------------------
Balance, beginning of period $ 83,845 $ 30,064 $ 27,957
Capitalization 245,204 92,441 63,499
Sales (146,377) (28,178) (50,075)
Amortization (32,414) (10,482) (11,317)
------------------------------------------
Balance, end of period $ 150,258 $ 83,845 $ 30,064
==========================================
At December 31, 1998, 1997, and 1996, the estimated fair value of the mortgage
loan servicing portfolio was $151.2, $92.4, and $54.0 million, respectively.
47
48
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 8 - DEPOSIT ACCOUNTS
The deposit accounts are as follows (in thousands):
DECEMBER 31,
1998 1997
-------------------------------
Demand, NOW and money market accounts $ 97,043 $ 63,662
Passbook savings 181,975 79,951
Certificates of deposit 1,644,352 966,320
-------------------------------
Total deposit accounts $ 1,923,370 $ 1,109,933
===============================
Non interest-bearing deposits included in the demand, NOW and money market
accounts balances at December 31, 1998 and 1997 were approximately $15.7 million
and $28.9 million, respectively.
The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 was approximately $997.9 million and $621.8 million at December 31,
1998 and 1997, respectively.
The following indicates the scheduled maturities of the Company's certificates
of deposit as of December 31, 1998:
DECEMBER 31,
1998
------------
Three months or less $ 266,172
Over three through six months 181,753
Over six through twelve months 421,331
One to two years 325,444
Thereafter 449,652
------------
Total $1,644,352
============
Interest expense on deposit accounts is summarized as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
--------------------------------------------
Demand, NOW and money market accounts $ 1,692 $ 1,346 $ 2,499
Passbook savings 5,933 3,193 428
Certificates of deposit 74,827 45,604 27,504
--------------------------------------------
Total $82,452 $50,143 $30,431
============================================
48
49
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 9 - FHLB ADVANCES
The following indicates certain information related to the FHLB advances (in
thousands):
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
--------------------------------------------
Maximum outstanding at any month end $1,136,750 $ 718,878 $ 389,801
Average balance 833,944 480,062 247,204
Average interest rate 5.80% 5.98% 5.78%
The Company has the authority and approval from the FHLB to utilize a total of
$1.3 billion in collateralized borrowings. Advances at December 31, 1998 totaled
$456.0 million and carried a weighted rate of 5.64%. Advances totaling $150.0
million, $200.0 million, and $100.0 million mature during 1999, 2000, and 2003,
respectively. The remaining $6.0 million were daily adjustable rate advances.
Pursuant to collateral agreements with the FHLB, advances are collateralized by
non-delinquent single-family residential mortgage loans.
NOTE 10 - FEDERAL INCOME TAXES
Components of the provision for federal income taxes consists of the following
(in thousands):
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
------------------------------------------------
Current provision/(benefit) $ 13,973 ($ 3,548) $ 11,072
Deferred provision/(benefit) 11,977 16,813 (773)
------------------------------------------------
$ 25,950 $ 13,265 $ 10,299
================================================
The Company's effective tax rates differ from the statutory federal tax rates.
The following is a summary of such differences (in thousands):
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
-------------------------------------------
Provision at statutory federal income tax rate $ 23,455 $ 12,263 $ 9,563
Increase (decrease) resulting from:
Amortization of deposit premium 452 450 450
Other, net 2,043 552 286
-------------------------------------------
Provision at effective federal income tax rate $ 25,950 $ 13,265 $ 10,299
===========================================
49
50
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
The details of the net tax liability are as follows (in thousands):
DECEMBER 31,
1998 1997
-----------------------
DEFERRED TAX ASSETS:
Mark-to-market adjustments on earning assets $ 1,050 $ 1,050
Interest not accrued 1,380 1,589
Book bad debt reserves 10,533 -
Other 1,733 455
-----------------------
Total 14,696 3,094
DEFERRED TAX LIABILITIES:
Deferred fees (436) (1,033)
Tax bad debt reserves (1,361) -
Mortgage loan servicing rights (52,590) (29,029)
Purchase accounting valuation adjustments (164) (252)
Premises and equipment (376) (1,034)
-----------------------
Total (54,927) (31,348)
-----------------------
Net deferred tax liability (40,231) (28,254)
Currently (payable)/receivable (9,034) 7,446
-----------------------
Net tax liability ($49,265) ($20,808)
=======================
Flagstar files a consolidated federal income tax return on a calendar year
basis. Through its tax year ended December 31, 1995, the Company has determined
its deduction for bad debts based on the reserve method in lieu of the specific
charge-off method. Under the reserve method, the Company has established and
maintained a reserve for bad debts against which actual loan losses are charged.
As a qualifying thrift institution, the Company has calculated its addition to
its bad debt reserve under either, (1) the "percentage of taxable income" method
or (2) the "experience" method. The Company used the percentage of taxable
income method in determining its bad debt reserve addition for its 1995 tax
year.
During August 1996, the President signed the Small Business Job Protection
Act of 1996 ("the Jobs Act") which contains certain provisions that require all
savings banks and thrifts to account for bad debts for income tax reporting
purposes in the same manner as banks. The effect on a large thrift such as the
Company is that it must change its tax method of accounting for determining its
allowable bad debt deduction from the reserve method to the specific charge-off
method. Consequently, the bad debt deduction based on a percentage of taxable
income or the experience method is no longer allowed for years beginning after
December 31, 1995.
50
51
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 10 - FEDERAL INCOME TAXES (CONTINUED)
The bad debt reserves maintained for tax purposes and accumulated after 1987 are
subject to recapture as part of the change. Base year reserves (generally
pre-1987 bad debt reserves) will not be recaptured unless the Company, or a
successor institution, liquidates, redeems shares or pays a dividend in excess
of earnings and profits. The recapture will generally be taken into account
ratably over six years beginning with the 1996 tax year. The Company may defer
the recapture up to an additional two years if it meets certain residential
lending requirements during tax years beginning before January 1, 1998.
Income taxes have been provided for the temporary difference between the
allowance for losses and the increase in the bad debt reserve maintained for tax
purposes since the 1987 base year. The cumulative amount of this difference at
December 31, 1995 was approximately $3.5 million for the Company. As a result of
the Jobs Act, the cumulative difference of $3.5 million will be recaptured.
Management believes that the Company has met the conditions to defer the
recapture of the reserve during 1996 and 1997. The Jobs Act had no effect on the
base year reserves of the Company. Consequently, the Company has not provided
deferred taxes of approximately $1.4 million on the balance of its tax bad debt
reserves as of the 1987 base year.
NOTE 11- EMPLOYEE BENEFITS
The Company maintains a 401(k) plan for its employees. Under the plan, eligible
employees may contribute up to 6% of their compensation up to a maximum of
$10,000 annually. The Company currently provides a matching contribution up to
3% of an employee's annual compensation up to a maximum of $5,000. The Company's
contributions vest at a rate such that an employee is fully vested after seven
years of service. The Company's contributions to the plan for the years ended
December 31, 1998, 1997 and 1996 were approximately $866,000, $590,000, and
$594,000, respectively. The Company may also make discretionary contributions to
the plan; however, none have been made.
NOTE 12 - CONTINGENCIES
The Company is involved in certain lawsuits incidental to its operations.
Management, after review with its legal counsel, is of the opinion that
settlement of such litigation will not have a material effect on the Company's
financial condition.
A substantial part of the Company's business has involved the origination,
purchase, and sale of mortgage loans. During the past several years, numerous
individual claims and purported consumer class action claims were commenced
against a number of financial institutions, their subsidiaries and other
mortgage lending institutions generally seeking civil statutory and actual
damages and rescission under the federal Truth in Lending Act (the "TILL"), as
well as remedies for alleged violations of various state unfair trade practices
laws restitution or unjust enrichment in connection with certain mortgage loan
transactions.
The Company has a substantial mortgage loan servicing portfolio and maintains
escrow accounts in connection with this servicing. During the past several
years, numerous individual claims and purported consumer class action claims
were commenced against a number of financial institutions, their subsidiaries
and other mortgage lending institutions generally seeking declaratory relief
that certain of the lenders' escrow account servicing practices violate the Real
Estate Settlement Practices Act and breach the lenders' contracts with
borrowers. Such claims also generally seek actual damages and attorney's fees.
51
52
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 12 - CONTINGENCIES (CONTINUED)
In addition to the foregoing, mortgage lending institutions have been subjected
to an increasing number of other types of individual claims and purported
consumer class action claims that relate to various aspects of the origination,
pricing, closing, servicing, and collection of mortgage loans and that allege
inadequate disclosure, breach of contract, or violation of state laws. Claims
have involved, among other things, interest rates and fees charged in connection
with loans, interest rate adjustments on adjustable-rate loans, timely release
of liens upon payoffs, the disclosure and imposition of various fees and charge,
and the placing of collateral protection insurance.
While the Company has had various claims similar to those discussed above
asserted against it, management does not expect these claims to have a material
adverse effect on the Company's financial condition, results of operations, or
liquidity.
NOTE 13 - REGULATORY MATTERS
The Financial Institutions Reform Recovery and Enforcement Act of 1989
("FIRREA"), which instituted major reforms in the operation and supervision of
the savings and loan industry, contains provisions for capital standards. These
standards require savings institutions to have a minimum regulatory tangible
capital (as defined in the regulation) equal to 1.50% of adjusted total assets
and a minimum 3.00% core capital (as defined) of adjusted total assets.
Additionally, savings institutions are required to meet a total risk-based
capital requirement of 8.00%.
The Company is also subject to the provisions of the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"). FDICIA includes significant
changes to the legal and regulatory environment for insured depository
institutions, including reductions in insurance coverage for certain kinds of
deposits, increased supervision by the Federal regulatory agencies, increased
reporting requirements for insured institutions, and new regulations concerning
reporting on internal controls, accounting and operations.
FDICIA's prompt corrective action regulations define specific capital categories
based on an institutions' capital ratios. The capital categories, in declining
order, are "well" capitalized, "adequately capitalized", "undercapitalized",
"significantly undercapitalized", and "critically undercapitalized."
Institutions categorized as "undercapitalized" or worse are subject to certain
restrictions, including the requirement to file a capital plan with OTS, and
increased supervisory monitoring, among other things. Other restrictions may be
imposed on the institution either by the OTS or by the FDIC, including
requirements to raise additional capital, sell assets, or sell the entire
institution.
The following chart delineates the categories as defined in the FDICIA
legislation:
TIER 1 TOTAL
RISK- RISKED-
CORE BASED BASED
CAPITAL CAPITAL CAPITAL
--------------------------------------------------------------
"Well capitalized" 5.0% 6.0% 10.0%
"Adequately capitalized" 4.0% 4.0% 8.0%
"Undercapitalized" Less than 4.0% Less than 4.0% Less than 8.0%
"Significantly undercapitalized" Less than 3.0% Less than 3.0% Less than 6.0%
52
53
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 13 - REGULATORY MATTERS (CONTINUED)
At December 31, 1998, Company's consolidated Core, Tier 1 risk-based, and Total
risk-based capital ratios were 6.54%, 11.83% and 12.93%, respectively. These
ratios place the Company in the "well capitalized" category.
The following is a calculation of Company's consolidated regulatory capital (in
thousands) at December 31, 1998:
TIER 1 TOTAL
RISK- RISK-
GAAP TANGIBLE CORE BASED BASED
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
-------------------------------------------------------------------------
GAAP CAPITAL, AS REPORTED $ 163,668 $ 163,668 $163,668 $ 163,668 $163,668
NON ALLOWABLE ASSETS:
Core deposit premium (3,225)
Mortgage servicing value (15,026) (15,026) (15,026) (15,026)
Other assets (305)
ADDITIONAL CAPITAL ITEMS:
Minority interest in subsidiary 49,548 49,548 49,548 49,548
General valuation allowance 20,000
----------------------------------------------------------
Regulatory capital 194,965 198,190 198,190 217,885
Minimum capital requirement % 1.50% 3.00% 4.00% 8.00%
Minimum capital requirement $ 45,423 90,942 67,031 134,838
----------------------------------------------------------
Regulatory capital - excess $ 149,542 $107,248 $ 131,159 $ 83,047
==========================================================
At December 31, 1997, Company's consolidated Core, Tier 1 risk-based, and Total
risk-based capital ratios were 5.62%, 11.22% and 11.74%, respectively. Those
ratios placed the Company in the "well capitalized" category.
The following is a calculation of Company's consolidated regulatory capital (in
thousands) at December 31, 1997:
TIER 1 TOTAL
RISK- RISK-
GAAP TANGIBLE CORE BASED BASED
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
-----------------------------------------------------------------------
GAAP CAPITAL, AS REPORTED $126,410 $126,410 $126,410 $126,410 $126,410
Nonallowable assets:
Core deposit premium (4,515)
Mortgage servicing value (20,640) (20,640) (20,640) (20,640)
Other assets (310)
ADDITIONAL CAPITAL ITEMS:
General valuation allowance 5,500
--------------------------------------------------------
Regulatory capital 101,255 105,770 105,770 110,960
Minimum capital requirement % 1.50% 3.00% 4.00% 8.00%
Minimum capital requirement $ 28,138 56,412 37,700 75,594
--------------------------------------------------------
Regulatory capital - excess $ 73,117 $ 49,358 $ 68,070 $ 35,366
========================================================
53
54
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 13 - REGULATORY MATTERS (CONTINUED)
The OTS risk-based capital regulation also includes an interest rate risk (IRR)
component that requires savings institutions with greater than normal IRR, when
determining compliance with the risk-based capital requirements, to maintain
additional total capital. The OTS has, however, indefinitely deferred
enforcement of its IRR requirements. Under the regulation, a savings
institution's IRR is measured in terms of the sensitivity of its "net portfolio
value" to changes in interest rates. A savings institution is considered to have
a "normal" level of IRR exposure if the decline in its net portfolio value after
an immediate 200 basis point increase or decrease in market interest rates is
less than 2% of the current estimated economic value of its assets. If the OTS
determines in the future to enforce the regulation's IRR requirements, a savings
institution with a greater than normal IRR would be required to deduct from
total capital, for purposes of calculating its risk-based capital requirement,
an amount equal to one half the difference between the institution's measured
IRR and 2%, multiplied by the economic value of the institution's total assets.
Management does not believe that this regulation, when enforced, will have a
material impact on Bank.
The United States Congress passed legislation that resulted in an assessment on
all Savings Association Insurance Fund ("SAIF") insured deposits in order to
recapitalize the SAIF Fund. This one-time assessment amounted to approximately
66 basis points on SAIF assessable deposits held as of March 31, 1995. The
assessment was paid in November 1996 and amounted to $3.4 million for Bank. Such
amount was charged to earnings in 1996.
NOTE 14 - CONCENTRATIONS OF CREDIT
Properties collateralizing loans receivable are geographically disbursed
throughout the United States. As of December 31, 1998, approximately 22.4% of
these properties are located in Michigan (measured by principal balance), and
another 52.8% are located in the states of California, Colorado, Ohio,
Washington, New York, Florida, Texas, Illinois, Oregon, and Utah. No other state
contains more than 2% of the properties collateralizing these loans.
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 issued by the Financial Accounting Standards Board, "Disclosures
about Fair Value of Financial Instruments", requires the disclosure of fair
value information about financial instruments, whether or not recognized in the
statement of financial condition, where it is practicable to estimate that
value. In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques. Because
assumptions used in these valuation techniques are inherently subjective in
nature, the estimated fair values cannot always be substantiated by comparison
to independent market quotes and, in many cases, the estimated fair values could
not necessarily be realized in an immediate sale or settlement of the
instrument.
The fair value estimates presented herein are based on relevant information
available to management as of December 31, 1998 and 1997. Management is not
aware of any factors that would significantly affect these estimated fair value
amounts. As these reporting requirements exclude certain financial instruments
and all non-financial instruments, the aggregate fair value amounts presented
herein do not represent management's estimate of the underlying value of the
Company. Additionally, such amounts exclude intangible asset values such as the
value of core deposit intangibles.
The following methods and assumptions were used by the Company to estimate the
fair value of each class of financial instruments and certain non-financial
instruments for which it is practicable to estimate that value:
Cash and cash equivalents: The carrying amount of cash and cash equivalents
approximates fair value.
54
55
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Loans receivable: This portfolio consists of mortgage loans available for sale
and investment, collateralized commercial lines of credit, commercial real
estate loans, builder development project loans, consumer credit obligations,
and single family home construction loans. Mortgage loans available for sale and
investment are valued using fair values attributable to similar mortgage loans.
The fair value of the other loans are valued based on the fair value of
obligations with similar credit characteristics.
Other investments: The carrying amount of other investments approximates fair
value.
FHLB stock: No secondary market exists for FHLB stock. The stock is bought and
sold at par by the FHLB. The recorded value, therefore, is the fair value. The
amount of stock required to be purchased is based on total assets and is
determined annually.
Deposit Accounts: The fair value of demand deposits and savings accounts
approximates the carrying amount. The fair value of fixed-maturity certificates
of deposit is estimated using the rates currently offered for deposits with
similar remaining maturities.
FHLB Advances: Rates currently available to the Company for debt with similar
terms and remaining maturities are used to estimate the fair value of the
existing debt.
Mortgage Servicing Rights: See Note 3 for a description of the method used to
value the mortgage servicing rights.
Financial instruments with off-balance-sheet risk: The fair value of financial
futures contracts, forward delivery contracts and fixed rate commitments to
extend credit are based on current market prices.
The following tables set forth the fair value of the Company's financial
instruments:
DECEMBER 31,
1998 1997
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------------------------------------------------------------
FINANCIAL INSTRUMENTS:
ASSETS:
Cash and cash equivalents $ 75,799 $ 75,799 $ 21,928 $ 21,928
Mortgage loans available for sale 1,831,531 1,854,928 1,197,152 1,212,364
Loans held for investment 727,185 730,516 458,107 459,759
Other investments 500 500 538 538
FHLB stock 57,837 57,837 40,025 40,025
LIABILITIES:
Deposits:
Demand deposits and savings accounts (279,018) (279,018) (143,613) (143,613)
Certificates of deposit (1,644,352) (1,657,744) (966,320) (969,111)
FHLB advances (456,019) (456,973) (482,378) (481,723)
OFF-BALANCE SHEET ITEMS:
Forward delivery contracts - (16,074) - (8,028)
Commitments to extend credit - 13,896 - 5,159
NON-FINANCIAL INSTRUMENTS:
Unrealized gains on mortgage
servicing rights ( see Note 7) - 984 - 8,516
55
56
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The Company enters into certain financial instruments with off-balance-sheet
risk in the ordinary course of business to reduce its exposure to changes in
interest rates. The Company utilizes only traditional financial instruments for
this purpose and does not enter into instruments such as leveraged derivatives
or structured notes. The financial instruments used for hedging interest rate
risk include financial futures contracts and forward delivery contracts. A hedge
is an attempt to reduce risk by creating a relationship whereby any losses on
the hedged asset or liability are expected to be counterbalanced in whole or
part by gains on the hedging financial instrument. Thus, market risk resulting
from a particular off-balance-sheet instrument is normally offset by other on or
off-balance-sheet transactions. The Company seeks to manage credit risk by
limiting the total amount of arrangements outstanding, both by counterparty and
in the aggregate, by monitoring the size and maturity structure of the financial
instruments, by assessing the creditworthiness of the counterparty, and by
applying uniform credit standards for all activities with credit risk.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
Notional principal amounts indicated in the following table represent the extent
of the Company's involvement in particular classes of financial instruments and
generally exceed the expected future cash requirements relating to the
instruments.
DECEMBER 31,
1998 1997
--------------------------
(IN MILLIONS)
Forward delivery contracts $ 1,837 $ 853
Commitments to extend credit 882 624
All of the Company's financial instruments with off-balance sheet risk expire
within one year.
Financial Futures Contracts: There were no Treasury futures contracts
outstanding at December 31, 1998 or 1997. Gains or losses on futures
transactions are recorded on the specific identification method in response to
adjustments in the fair market value of the instruments. During, 1998 there were
no Treasury future contracts implemented and therefore no gain or loss recorded
in 1998. During 1997 and 1996, the Company recorded losses on financial futures
amounting to approximately, $128,000 and $90,000, respectively.
Forward Delivery Contracts: Forward delivery contracts are entered into to sell
mortgage loans:
FORWARD DELIVERY CONTRACTS
DECEMBER 31,
1998 1997
---------------------
(IN MILLIONS)
MORTGAGE LOAN TYPE:
Fixed $ 1,837 $ 836
Balloon - 10
Variable - 7
---------------------
Total $ 1,837 $ 853
=====================
Substantially all forward delivery contracts are entered into with the FHLMC,
FNMA or GNMA.
56
57
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (CONTINUED)
Commitments to Extend Credit: The Company's exposure to credit loss for
commitments to extend credit is represented by the contractual amount of those
agreements. The Company uses the same credit policies in making funding
commitments as it does for on-balance-sheet instruments. These commitments
generally have fixed expiration dates or other termination clauses. Because
commitments may expire without being drawn upon, the total contract amounts do
not necessarily represent future cash requirements.
DECEMBER 31,
1998 1997
--------------
(IN MILLIONS)
Single family mortgage $621 $499
Other 261 125
--------------
Total $882 $624
==============
Fixed $649 $515
Variable 233 109
--------------
Total $882 $624
==============
NOTE 16 - SEGMENT INFORMATION
The Company operations can be segmented into mortgage banking and retail
banking. Following is a presentation of financial information by business for
the period indicated.
FOR THE YEAR ENDED DECEMBER 31, 1998
---------------------------------------------------------------
RETAIL MORTGAGE
BANKING BANKING
OPERATION OPERATION ELIMINATIONS COMBINED
---------------------------------------------------------------
(IN THOUSANDS)
Revenues $ 35,144 $ 137,343 $ - $ 172,487
Earnings before income taxes 19,994 47,019 - 67,013
Depreciation and amortization 2,258 37,639 - 39,897
Capital expenditures 2,922 5,267 - 8,189
Identifiable assets 969,485 2,260,045 (183,085) 3,046,445
Intersegment income (expense) 6,940 (6,940) - -
FOR THE YEAR ENDED DECEMBER 31, 1997
--------------------------------------------------------------
RETAIL MORTGAGE
BANKING BANKING
OPERATION OPERATION ELIMINATIONS COMBINED
-------------- -------------- ----------------- --------------
(IN THOUSANDS)
Revenues $ 30,202 $ 72,353 $ - $ 102,555
Earnings before income taxes 19,341 15,696 - 35,037
Depreciation and amortization 2,021 15,140 - 17,161
Capital expenditures 409 15,897 - 16,306
Identifiable assets 564,551 1,463,288 (126,755) 1,901,084
Intersegment income (expense) 8,873 (8,873) - -
57
58
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 16 - SEGMENT INFORMATION (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1996
--------------------------------------------------------------
RETAIL MORTGAGE
BANKING BANKING
OPERATION OPERATION ELIMINATIONS COMBINED
-------------- -------------- ----------------- --------------
(IN THOUSANDS)
Revenues $ 13,791 $ 74,955 $ - $ 88,746
Earnings before income taxes 3,305 24,017 - 27,322
Depreciation and amortization 1,589 15,698 - 17,287
Capital expenditures 312 7,284 - 7,596
Identifiable assets 387,201 1,112,676 (202,651) 1,297,226
Intersegment income (expense) 14,186 (14,186) - -
Revenues are comprised of net interest income (before the provision for credit
losses) and non-interest income. Non-interest expenses are fully allocated to
each segment. The intersegment income (expense) consists of interest expense
incurred or charged by the mortgage banking segment on intersegment borrowing.
NOTE 17 - EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator of the basic
and diluted earnings per share calculation for the year ended December 31, 1998
(in thousands):
EARNINGS SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------------- -------------------- -----------------
Basic earnings $ 41,063 13,670 $ 3.00
Effect of options - 505 -
----------------- -------------------- -----------------
Diluted earnings $ 41,063 14,175 $ 2.90
================= ==================== =================
The following is a reconciliation of the numerator and denominator of the basic
and diluted earnings per share calculation for the year ended December 31, 1997
(in thousands):
EARNINGS SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------------- -------------------- -----------------
Basic earnings $ 21,772 12,837 $ 1.70
Effect of options - 103 -
----------------- -------------------- -----------------
Diluted earnings $ 21,772 12,940 $ 1.68
================= ==================== =================
The weighted average shares outstanding for computing earnings per share in 1996
was 11,250,000. Because there were no options outstanding in 1996, basic and
diluted earnings per share were identical.
58
59
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 18 - INITIAL PUBLIC OFFERING
STOCK OFFERING
The Company completed an initial public offering in May 1997 of 5,500,000 shares
of common stock; including 2,800,000 shares being sold by the shareholders of
Flagstar. That sale resulted in proceeds to the Company of $27.2 million.
NOTE 19 - STOCK OPTION AND PURCHASE PLANS, AND OTHER COMPENSATION PLANS
In 1997, Flagstar's Board of Directors adopted resolutions to implement various
stock option and purchase plans and deferred and incentive compensation plans
effective upon the completion of the common stock offering.
STOCK OPTION PLAN
The purpose of the Stock Option Plan ("Option Plan") is to provide an additional
incentive to directors and employees by facilitating their purchase of Common
Stock. The Option Plan has a term of 10 years from the date of its approval in
April 1997, after which no awards may be made. Additional shares totaling
197,542 are reserved for future issuance by the Company.
The Option Plan is accounted for in accordance with the provisions of APB No.
25, "Accounting for Stock Issued to Employees" and the Company has adopted the
disclosure requirements of SFAS No. 123.
No compensation has been recognized for the plan. Had compensation costs for the
plan been determined based on the fair value of the options at the grant date
consistent with the method of SFAS No. 123, the Company's earnings per share for
the year ended December 31, 1998 and 1997 would have been as follows (in
thousands, except per share data):
1998 1997
---------------------------
Net Earnings
As reported $41,063 $21,772
Pro forma $37,391 $19,299
Basic earnings per share
As reported $3.00 $1.70
Pro forma $2.74 $1.50
Diluted earnings per share
As reported $2.90 $1.68
Pro forma $2.64 $1.49
The fair value of each option grant is estimated using the Black-Scholes
options-pricing model with the following weighted average assumptions used for
grants in 1998 and 1997, respectively: dividend yield of 2%; expected volatility
of 31.44% and 39.00%; risk free rate of 5.60% and 7.00%; and expected lives of
3.0 years and 6.0 years.
59
60
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 19 - STOCK OPTION AND PURCHASE PLANS, AND OTHER COMPENSATION PLANS
(CONTINUED)
The following table summarizes the activity which occurred in the years ended
December 31, 1998 and 1997:
Weighted Average Number of
Grant Price Options
---------------------------------------------
Options outstanding at January 31, 1997 $ - -
Granted 13.00 1,108,300
Canceled 13.00 10,500
---------------------------------------------
Options outstanding at December 31, 1997 13.00 1,097,800
Granted 21.36 92,658
Canceled 13.00 21,000
---------------------------------------------
Options outstanding at December 31, 1998 $ 13.66 1,169,458
=============================================
The following information pertains to the stock options issued pursuant to the
1997 Stock Option Plan but not exercised at December 31, 1998:
Number of Options Weighted Average Weighted Average Weighted Number
Grant Price Outstanding at Remaining Contractual Grant Exercisable at
Range December 31, 1998 Life (years) Price December 31, 1998
$ 13.00 1,076,800 5.34 $ 13.00 -
$ 19.50 - 21.50 78,658 5.34 20.16 -
$ 28.13 14,000 5.34 28.13 -
-------------------------- ----------------------------------------------
1,169,458 $ 13.66 -
========================== ==============================================
STOCK PURCHASE PLAN
Under the Employee Stock Purchase Plan ("Purchase Plan"), eligible participants,
upon providing evidence of a purchase of Flagstar's common shares from any third
party on the open market, receive a payment from Flagstar equal to 15% of the
share price. The Purchase Plan includes limitations on the maximum reimbursement
to a participant during a year. The Purchase Plan has not been designed to
comply with the requirements of the Internal Revenue Code with respect to
employee stock purchase plans.
INCENTIVE COMPENSATION PLAN
The Incentive Compensation Plan ("Incentive Plan") is administered by a
committee which decides from year to year which employees of Flagstar will be
eligible to participate in the Incentive Plan and the size of the bonus pool.
DEFERRED COMPENSATION PLAN
The Deferred Compensation Plan allows employees to defer up to 25% of their
annual compensation and directors to defer all of their compensation. Funds
deferred remain the property of Flagstar and are placed in a trust. Participants
may direct that their deferred amounts be invested in stock of Flagstar. Upon
withdrawal, the participant has the option of receiving the stock or the
proceeds of its sale at the market price at the time of withdrawal.
60
61
NOTE 20--QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table represents summarized data for each of the quarters in
1998 and 1997 (in thousands except earnings per share data).
1998 1997
FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
---------------------------------------- ---------------------------------------------
Interest income $ 57,257 $ 49,618 $ 46,478 $ 37,908 $ 37,965 $ 30,711 $ 28,085 $ 25,991
Interest expense 39,787 35,985 34,003 27,412 25,437 21,012 18,338 15,246
---------------------------------------- ---------------------------------------------
Net interest income 17,470 13,633 12,475 10,496 12,528 9,699 9,747 10,745
Provision for losses 5,793 4,599 5,618 2,621 1,261 1,416 1,676 662
---------------------------------------- ---------------------------------------------
Net interest income after
Provision for losses 11,677 9,034 6,857 7,875 11,267 8,283 8,071 10,083
Loan administration income (2,704) 84 8 80 53 1,104 1,790 3,180
Net gain on loan sales 37,699 27,008 29,173 16,802 12,506 5,723 3,669 (123)
Net gain on MSR sales 731 206 999 1,884 1,623 6,990 9,167 9,315
Other non-interest income 2,624 1,423 1,285 1,111 1,927 1,449 1,249 214
Non-interest expense 33,755 19,650 18,139 15,299 17,284 13,822 15,833 15,565
---------------------------------------- ---------------------------------------------
Earnings before income taxes 16,272 18,105 20,183 12,453 10,092 9,727 8,113 7,104
Provision for federal
Income taxes 3,450 7,800 10,000 4,700 4,176 3,533 2,973 2,583
---------------------------------------- ---------------------------------------------
Net earnings $12,822 $ 10,305 $ 10,183 $ 7,753 $ 5,916 $ 6,194 $ 5,141 $ 4,521
======================================== =============================================
Basic earnings per share $ 0.93 $ 0.76 $ 0.74 $ 0.57 $ 0.45 $ 0.45 $ 0.40 $ 0.40
======================================== =============================================
Diluted earnings per share $ 0.90 $ 0.73 $ 0.73 $ 0.54 $ 0.44 $ 0.44 $ 0.40 $ 0.40
======================================== =============================================
61
62
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 21--HOLDING COMPANY ONLY FINANCIAL STATEMENTS
The following are unconsolidated financial statements for the Company. These
condensed financial statements should be read in conjunction with the
Consolidated Financial Statements and Notes thereto (in thousands).
FLAGSTAR BANCORP, INC.
CONDENSED UNCONSOLIDATED STATEMENTS OF FINANCIAL POSITION
DECEMBER 31,
1998 1997
------------------------
ASSETS
Cash and cash equivalents $ 54 $ 98
Investment in subsidiaries 163,799 126,493
Other assets 10 37
------------------------
Total assets $ 163,863 $ 126,628
========================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Other liabilities $ 11 $ 11
------------------------
Total liabilities 11 11
STOCKHOLDERS' EQUITY
Common stock 137 137
Additional paid in capital 29,988 29,988
Retained earnings 133,727 96,492
------------------------
Total stockholders' equity 163,852 126,617
------------------------
Total liabilities and stockholders' equity $ 163,863 $ 126,628
========================
FLAGSTAR BANCORP, INC.
CONDENSED UNCONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31,
1997 1997 1996
---------------------------------
Income
Dividends from subsidiaries $ 3,928 $ 690 $ 1,000
Expenses
General and administrative 171 104 8
---------------------------------
Earnings before undistributed earnings of subsidiaries 3,757 586 992
Equity in undistributed earnings of subsidiaries 37,306 21,186 16,031
---------------------------------
Net earnings $ 41,063 $ 21,772 $ 17,023
=================================
62
63
FLAGSTAR BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- --------------------------------------------------------------------------------
NOTE 20--HOLDING COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
FLAGSTAR BANCORP, INC.
CONDENSED UNCONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
1998 1997 1996
--------------------------------------
OPERATING ACTIVITIES
Net earnings $ 41,063 $ 21,772 $ 17,023
Adjustments to reconcile net earnings to net cash provided by
Operating activities
Equity in undistributed earnings (37,306) (21,186) (15,982)
Change in other assets 27 1 38
Change in other liabilities -- 11 (1)
--------------------------------------
Net cash provided by operating activities 3,784 598 1,078
INVESTING ACTIVITIES
Net increase in investment in subsidiaries -- (26,999) --
--------------------------------------
Net cash used in investment activities -- (26,999) --
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (3,828) (820) (1,000)
Additional capital provided by initial public offering -- 27,197 --
--------------------------------------
Net cash provided by (used in) financing activities (3,828) 26,377 (1,000)
Net (decrease) increase in cash and cash equivalents (44) (24) 78
Cash and cash equivalents at beginning of period 98 122 44
--------------------------------------
Cash and cash equivalents at end of period $ 54 $ 98 $ 122
======================================
63
64
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained under the section captioned "Proposal 1 - Election of
Directors" in the Company's definitive proxy statement for the Company's 1998
Annual Meeting of Shareholders (the "Proxy Statement") is incorporated herein by
reference. Reference is also made to the information appearing in Part I
"Executive Officers," which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the
sections of the Proxy Statement captioned "Compensation of Directors",
"Executive Compensation and Other Information", "1998 Compensation Committee
Report on Executive Compensation", and "Comparison of Cumulative Total Return
Among Flagstar Bancorp, Inc., Russell 1000 Index, NASDAQ US Composite, S&P 600
Small Cap Index."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to the
section of the Proxy Statement captioned "Outstanding Voting Securities."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the
section of the Proxy Statement captioned "Compensation of Directors" and
"Transactions with Related Parties."
64
65
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
(a) The following documents are filed as a part of this report:
1. The following consolidated financial statements of the Company are
included this Form 10-K under Item 8:
Management's Report
Independent Auditors' Report
Consolidated Statements of Financial Condition - December 31, 1998 and
1997
Consolidated Statements of Earnings - Years Ended December 31, 1998,
1997, and 1996
Consolidated Statements of Cash Flows - Years Ended December 31, 1998,
1997, and 1997
Consolidated Statements of Stockholders' Equity - Years Ended December
31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements
2. All of the schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
either not required under the related instructions, the required
information is contained elsewhere in this Form 10-K, or the schedules
are inapplicable and, therefore, have been omitted.
27. Financial Data Schedule (Edgar filing only).
Flagstar Bancorp, Inc., will furnish to any stockholder a copy of any of the
exhibits listed above upon written request and upon payment of a specified
reasonable fee, which fee shall be equal to the Company's reasonable expenses in
furnishing the exhibit to the stockholder. Requests for exhibits and information
regarding the applicable fee should be directed to: Michael W. Carrie, Executive
Vice President, at the address of the principal executive offices set forth on
the cover of this Report on Form 10-K.
65
66
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 March 19, 1998.
FLAGSTAR BANCORP, INC.
By: /s/ THOMAS J. HAMMOND
----------------------------------
Thomas J. Hammond
Chairman of the Board
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 indicated on March 19, 1999.
SIGNATURE TITLE
- ------------------------------------------------------------------------------------
By: /s/ THOMAS J. HAMMOND Chairman of the Board
---------------------------- and Chief Executive Officer
Thomas J. Hammond
By: /s/ MARK T. HAMMOND Vice Chairman of the Board
------------------------------- and President
Mark T. Hammond
By: /s/ MICHAEL W. CARRIE Director, Executive Vice President and Chief
-------------------------------- Financial Officer (Principal Financial and
Michael W. Carrie Accounting Officer)
By: /s/ JOAN H. ANDERSON Executive Vice President
--------------------------------- and Director
Joan H. Anderson
By: /s/ JAMES D. COLEMAN Director
---------------------------------
James D. Coleman
By: /s/ RICHARD S. ELSEA Director
---------------------------------
Richard S. Elsea
By: /s/ C. MICHAEL KOJAIAN Director
---------------------------------
C. Michael Kojaian
By: /s/ JAMES D. ISBISTER Director
---------------------------------
James D. Isbister
By: /s/ JOHN R. KERSTEN Director
---------------------------------
John R. Kersten
66
67
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
--- -----------
1 The following consolidated financial statements of the Company are included this Form 10-K under Item 8:
Management's Report
Independent Auditors' Report
Consolidated Statements of Financial Condition - December 31, 1998 and 1997
Consolidated Statements of Earnings - Years Ended December 31, 1998, 1997, and 1996
Consolidated Statements of Cash Flows - Years Ended December 31, 1998, 1997, and 1996
Consolidated Statements of Stockholders' Equity - Years Ended December 31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements
27. Financial Data Schedule (Edgar filing only).
67