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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 1999
Commission File No.: 0-22193
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LIFE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 33-0743196
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
10540 Magnolia Avenue, Suite B, Riverside, California 92505
(Address of principal executive offices)
(909) 637-4000
(Registrant's telephone number, including area code)
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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:
Common Stock, par value $0.01 per share
(Title of class)
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The registrant (1) has filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, i.e., persons other than directors and executive officers of
the registrant is $17,632,484 and is based upon the last sales price as quoted
on The Nasdaq Stock Market for March 26, 2000.
As of March 26, 2000, the Registrant had 6,668,436 shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2000 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-K.
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INDEX
Page
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PART I
ITEM 1. BUSINESS...................................................... 3
ITEM 2. PROPERTIES.................................................... 29
ITEM 3. LEGAL PROCEEDINGS............................................. 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 29
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS...................................................... 30
ITEM 6. SELECTED FINANCIAL DATA....................................... 30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 31
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 43
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE......................................... 76
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 76
ITEM 11. EXECUTIVE COMPENSATION........................................ 76
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................... 76
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 76
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K..................................................... 77
SIGNATURES.............................................................. 78
2
ITEM 1. BUSINESS
General
LIFE Financial Corporation
LIFE Financial Corporation ("LIFE Financial" or "Company"), a Delaware
corporation organized in 1997, is a saving and loan holding company that owns
100% of the capital stock of LIFE Bank (the "Bank"), the Company's principal
operating subsidiary. The Bank was incorporated and commenced operations in
1983. The Company's primary businesses includes retail banking, mortgage
banking and loan servicing.
LIFE Bank
LIFE Bank is a federally chartered stock savings bank incorporated and
licensed under the laws of the United States. The Bank is a member of the
Federal Home Loan Bank of San Francisco ("FHLB"), which is a member bank of the
Federal Home Loan Bank System. The Bank's deposit accounts are insured up to
the $100,000 maximum amount currently allowable under federal laws by the
Savings Association Insurance Fund ("SAIF"), which is a separate insurance fund
administered by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is
subject to examination and regulation by the Office of Thrift Supervision
("OTS") and the FDIC. The Bank is further subject to regulations of the Board
of Governors of the Federal Reserve System ("FRB") concerning reserves required
to be maintained against deposits and certain other matters.
The principal business of the Bank is attracting retail deposits from the
general public and investing those deposits, together with funds generated from
operations and borrowings, primarily in one- to four-family residential
mortgage loans. At December 31, 1999, the Bank had five and currently has six
retail bank branches located in Orange, San Bernardino and Riverside Counties,
California. Additionally, the Bank conducts its national mortgage banking and
loan servicing business from its corporate headquarters in Riverside,
California.
The mortgage banking business originates, purchases and sells conforming,
jumbo, non-conforming and other non-prime credit quality mortgage loans through
a network of approved correspondents and independent mortgage brokers. The
Company's originations and purchases are primarily 1st lien conforming, jumbo
and other non-conforming mortgages with approximately 75% of all originations
within the "A", "Alt A" and "A minus" credit categories. Additionally, the Bank
originates residential construction and consumer related loans.
At December 31, 1999, the loan servicing division serviced in excess of $1.8
billion in mortgage and consumer loans. The loan-servicing portfolio is
comprised of loans owned by the Bank of $458.6 million and loans serviced for
others of $1.4 billion.
The Company's principal sources of income are the net spread between
interest earned and the interest costs associated with deposits and other
borrowings used to finance its loan and investment portfolio, gains recognized
on whole loan sales, and servicing fee income.
At December 31, 1999, the Company had consolidated total assets of $547.6
million, total deposits of $468.9 million and total stockholders' equity of
$34.5 million. Additionally, the Bank met and exceeded all three regulatory
capital requirements, with ratios of core capital to total assets of 6.28%,
core capital to risk-weighted assets of 9.54%, and total capital to risk-
weighted assets of 10.34%. Based on the foregoing, the Bank qualified as a
"well capitalized" institution under the prompt corrective action rules of the
OTS.
Background
Prior to 1999, the Company's principal business was wholesale mortgage
banking. The Bank was primarily engaged in the origination of subprime
residential mortage loans and 2nd trust mortgage loans. As a result of the
issuance of Thrift Bulletin 72 in late 1998, the Company eliminated the High
LTV product and
3
focused on 1st trust mortgage loans to borrowers with non-prime credit
histories. The loans were sold directly to the secondary market in whole loan
sales or through securitization whereby the Company would retain the excess
cash flows ("Residual Mortgage-Backed Securities" or "Residuals") from each
securitization transaction. The market value of the Residuals are highly
dependent on certain assumptions related to loan prepayment speeds and the
predictability of credit losses.
In mid-1999, the Board of Directors hired a new President and Chief
Executive Officer, Mr. Robert K. Riley. Mr. Riley has and will continue to
build a full complement of professionals experienced in retail banking,
mortgage banking, loan servicing, financial management, and the core operations
of a financial services company. The Company's new management is undertaking a
comprehensive restructuring of all of the Company's operations including retail
banking, loan servicing, and mortgage banking with specific focus on reducing
the risk profile of the Company's core lending businesses and establishing core
earnings for the Company augmented by non-recurring gain-on-sale income from
its mortgage banking operations.
As part of an overall strategy to reduce the risk profile and earnings
volatility at the Company, the Company completed transactions to eliminate all
of its Residual Mortgage-Backed Securities and extinguish all short term debt
used to finance the Residuals. At December 31, 1998 the Company had five
Residuals valued at $50.3 million and $26.3 million in revolving and other
short-term debt. By completing the desecuritization of the Company's 1996-1 and
1997-1A & 1B transactions and the sale of the Company's 1997-2, 1997-3 and
1998-1A and 1B Residuals the Company was able to retire all of the Company's
short-term debt obligations during 1999.
Recent Developments
During the first quarter of 2000, the Company has consolidated its mortgage-
banking operations into its headquarters located in Riverside, California. The
consolidation included the Company's regional production offices located in
Colorado, Massachusetts and Florida. The Company retained its national team of
account executives and continues to originate mortgage loans nationwide. This
consolidation has resulted in improved service levels, cost reductions and
increased consistency in credit quality. With the centralization of mortgage-
banking operations and the sale of Residuals with related mortgage servicing
rights, the Company was able to reduce costs by lowering its staffing levels at
its Corporate Headquarters located in Riverside, California.
Competition
The Company's operating results and its growth prospects are most directly
and materially influenced by (1) the health and vibrancy of the United States
real estate markets, and the underlying economic forces which affect such
markets, (2) the overall complexion of the interest rate environment, including
the absolute level of market interest rates and the volatility of such rates,
(3) the prominence of competitive forces which provide customers, or potential
customers, of the company with alternative sources of mortgage funds or
investments which compete with the Company's products and services, and (4)
regulations promulgated by the regulatory authorities, including those of the
OTS, the FDIC and the FRB. The Company's success in identifying trends in each
of these factors, and implementing strategies to exploit such trends, strongly
influence the Company's long-term results and growth prospects.
As a purchaser and originator of mortgage loans, the Company faces intense
competition, primarily from mortgage banking companies, commercial banks,
credit unions, thrift institutions, credit card issuers and finance companies.
Many of these competitors in the financial services business are substantially
larger and have more capital and other resources than the Company. Furthermore,
certain large national finance companies and conforming mortgage originators
are adapting their conforming origination programs and allocation of resources
to the origination of alternative and non-conforming mortgage loans. In
addition, certain of these larger mortgage companies and commercial banks have
begun to offer products similar to those offered by the
4
Company targeting customers similar to those of the Company. The entrance of
these competitors into the Company's market could have a material adverse
effect on the Company's results of operations and financial condition.
Competition can take many forms, including convenience in obtaining a loan,
service, marketing and distribution channels and interest rates. Furthermore,
the current level of gains realized by the Company and its competitors on the
sale of the type of loans purchased and originated is attracting additional
competitors, including at least one quasi-governmental agency, into this market
with the effect of lowering the gains that may be realized by the Company on
future loan sales. Competition may be affected by fluctuations in interest
rates and general economic conditions. During periods of rising rates,
competitors which have "locked in" low borrowing costs may have a competitive
advantage. During periods of declining rates, competitors may solicit the
Company's borrowers to refinance their loans. During economic slowdowns or
recessions, the Company's borrowers may have new financial difficulties and may
be receptive to offers by the Company's competitors.
The Company depends largely on third-party originators ("Originators") for
its purchases and originations of new loans. The Company's competitors also
seek to establish relationships with the Company's Originators. The Company's
future results may become more exposed to fluctuations in the volume and cost
of its wholesale loans resulting from competition from other purchasers of such
loans, market conditions and other factors.
In addition, the Company faces increasing competition for deposits and other
financial products from non-bank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds and annuities. In order to
compete with these other institutions with respect to deposits and fee
services, the Company relies principally upon local promotional activities,
personal relationships established by officers, directors and employees of the
Company and specialized services tailored to meet the individual needs of the
Company's customers.
Lending Activities
General. The Company originates, purchases, sells, and services primarily
1st lien conforming, jumbo, non-conforming, and other non-prime mortgages. The
Company purchases and originates mortgage loans and other real estate secured
loans primarily through a network of Mortgage Banking Correspondents and
Mortgage Brokers on a nationwide basis. The Company's primary means of
marketing its products is direct contact between its national team of account
executives and its Correspondents and Mortgage Brokers. Each of the Company's
account executives is responsible for maintaining and expanding existing Bank
relationships within the account executive's assigned territory. Loans
originated or purchased are generally originated for whole loan sale in the
secondary mortgage market.
The underwriting and quality control functions are managed through the
Company's corporate offices in Riverside, California. The Company believes that
its underwriting process begins with its staff of experienced management and
underwriters, clear underwriting policies, loan review procedures and the
monitoring by its independent quality control group. As an integral part of its
lending operation, the Company ensures that its underwriters assess each loan
application and subject property against the Company's underwriting guidelines.
Loan Approval Procedures and Authority. The Board of Directors establishes
the lending policies of the Company and delegates authority and responsibility
for loan approvals to management. Management has adopted policies which vest
approvals with individual underwriters for limited loan size amounts.
Exceptions to Bank policy, larger loan requests and more complex transactions,
are required to be reviewed and approved or declined by senior level
underwriters, supervisors and/or managers.
The Bank will not make loans-to-one borrower that are in excess of
regulatory limits. Pursuant to Office of Thrift Supervision ("OTS")
regulations, loans-to-one borrower cannot exceed 15% of the Bank's unimpaired
capital and surplus. At December 31, 1999, the Bank's loans-to-one borrower
limit equaled $5.3 million. See "--Regulation--Federal Savings Institution
Regulation--Loans-to-One Borrower."
5
One- to Four-Family Mortgage Lending. The Bank offers both fixed-rate and
adjustable-rate mortgage loans secured by one- to four-family residences
located in its primary market area and throughout the United States, with
maturities up to thirty years. At December 31, 1999, the Bank's total (gross)
loans outstanding were $458.6 million, of which $381.9 million or 83.3% were
one- to four-family residential loans. Of the one- to four- family residential
mortgage loans outstanding at that date, 51.9% were fixed rate loans, and 48.1%
were adjustable rate mortgage loans. The Bank's policy is to originate one- to
four-family residential mortgage loans in amounts in excess of 80% of the lower
of the appraised value or the selling price of the property securing the loan
with mortgage insurance.
Multi-family Lending. The Company originates and purchases multi-family real
estate loans in its primary market area. The Company has streamlined and
standardized its processing of multi-family real estate loans with a view to
sale in the secondary market. In reaching a decision on whether to make a
multi-family loan, the Bank considers the qualifications of the borrower as
well as the underlying property. Some of the factors to be considered are: the
net operating income of the mortgaged premises before debt service and
depreciation; the debt service ratio (the ratio of net earnings to debt
service); and the ratio of the loan amount to appraised value.
When evaluating the qualifications of the borrower for a multi-family loan,
the Bank considers the financial resources and income level of the borrower and
the borrower's experience in owning and managing similar property. In making
its assessment of the creditworthiness of the borrower, the Bank generally
reviews the financial statements, employment and credit history of the
borrower, as well as other related documentation.
Construction Lending. The Company originates construction loans for owner
occupied single-family homes, single-family homes on a speculative basis and
single family tract, generally in-fill projects of 10 homes or fewer. Those
projects built on a speculative basis are to merchant builders who have
demonstrated by past performance the ability to construct and effectively
market the completed product within budget and where management is comfortable
with the underlying economic conditions. The Company's loan to value maximum
policy on a speculative residential project or a commercial project is not to
exceed 75% of completed value. All construction loans at the time are priced on
a variable rate, which is adjusted daily with a spread over Wall Street Journal
Prime. The Company generally requires that the Borrower maintain a minimum 10%
cash equity position in the project. Presently, the Company lends construction
funds only in California with a concentration in Southern California.
Construction financing is generally considered to involve a higher degree of
credit risk than financing on improved, owner-occupied real estate. Risk of
loss on a construction loan is dependent largely on the accuracy of the initial
estimate of the property's value at completion of construction or development
compared to the estimated cost (including financing) of construction. If the
estimate of value proves to be inaccurate, the Bank may be confronted with a
project, when completed, having a value which is insufficient to assure full
repayment. The Bank mitigates this risk by performing a thorough analysis of
the cost estimates and actively monitoring the project during each phase of
construction.
Consumer and Other Lending. The Company's consumer and other loans generally
consist of overdraft lines of credit, small commercial business loans and
unsecured personal loans. At December 31, 1999, the Company's consumer and
other loan portfolio was $2.7 million.
Loan Servicing. The Bank also services mortgage loans for other investors.
All of the loans currently being serviced for others are loans that were
originated and sold by the Bank. The Company's loan servicing activities
include (i) the collection and remittance of mortgage loan payments, (ii)
accounting for principal and interest and other collections and expenses, (iii)
holding and disbursing escrow or impounding funds for real estate taxes and
insurance premiums, (iv) inspecting properties when appropriate, (v) contacting
delinquent borrowers, and (vi) acting as fiduciary in foreclosing and disposing
of collateral properties. The Company receives a servicing fee for performing
these services for others. At December 31, 1999, the Bank was servicing $1.4
billion of loans for other investors.
6
Loan Portfolio Composition. At December 31, 1999, the Company's gross loans
outstanding totaled $458.6 million, of which $327.0 million, or 71.3%, were
held for sale and $131.6 million, or 28.7%, were held for investment. The types
of loans that the Company may originate are subject to federal law, state law,
and regulations. Interest rates charged by the Company on loans are affected by
the demand for such loans and the supply of money available for lending
purposes and the rates offered by competitors. These factors are, in turn,
affected by, among other things, economic conditions, monetary policies of the
federal government, including the Federal Reserve Board, and legislative tax
policies.
7
The following table sets forth the composition of the Company's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
At December 31,
--------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------------ ------------------ ------------------ ----------------- -----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- -------- -------- ------- -------- ------- --------
(Dollars in thousands)
Real estate(1):
Residential:
One-to-four family.... $381,932 83.29% $294,033 87.11% $278,205 89.02% $54,275 78.67% $54,007 84.04%
Multi-family.......... 9,851 2.15 17,380 5.15 10,653 3.41 4,752 6.89 2,412 3.75
Commercial............ 11,860 2.59 14,225 4.21 16,763 5.36 9,659 14.00 7,522 11.71
Construction.......... 52,175 11.38 8,571 2.54 -- 0.00 -- 0.00 -- 0.00
Other loans:
Loans secured by
deposit accounts...... 205 0.04 270 0.08 165 0.05 177 0.25 186 0.29
Unsecured commercial
loans................. 43 0.01 124 0.04 63 0.02 67 0.10 70 0.11
Unsecured consumer
loans................. 2,490 0.54 2,951 0.87 6,675 2.14 65 0.09 63 0.10
-------- ------ -------- ------ -------- ------ ------- ------ ------- ------
Total gross loans... 458,556 100.00% 337,554 100.00% 312,524 100.00% 68,995 100.00% 64,260 100.00%
====== ====== ====== ====== ======
Less (plus):
Undisbursed loan
funds................. 25,885 6,399 -- -- --
Deferred loan
origination (costs)
Fees and (premiums)
and discounts......... (4,406) (5,946) (8,393) (543) (298)
Allowance for
estimated loan
losses................ 2,749 2,777 2,573 1,625 1,177
-------- -------- -------- ------- -------
Loans Receivable,
net................. $434,328 $334,324 $318,344 $67,913 $63,381
======== ======== ======== ======= =======
- ----
(1) Includes second trust deeds.
8
Loan Maturity. The following table shows the contractual maturity of the
Bank's gross loans at December 31, 1999. There were $327.0 million of loans
held for sale, gross, at December 31, 1999. The table does not reflect
prepayment assumptions.
At December 31, 1999
---------------------------------------------------------------
One-to-Four Multi- Other Total Loans
Family Family Commercial Construction Loans Receivable
----------- ------- ---------- ------------ ----- -----------
(Dollars in thousands)
Amounts due:
One year or less....... $ 270 $ 21 $ 836 $51,038 $ 326 $ 52,491
After one year:
More than one year to
three years.......... 280 118 2,867 1,137 2,257 6,659
More than three years
to five years........ 152 1,062 737 -- 84 2,035
More than five years
to 10 years.......... 1,183 27 4,634 -- 45 5,889
More than 10 years to
20 years............. 123,352 5,855 1,849 -- -- 131,056
More than 20 years.... 256,695 2,770 936 -- 25 260,426
-------- ------- ------- ------- ----- --------
Total amount due..... 381,932 9,853 11,859 52,175 2,737 458,556
Less (plus):
Undisbursed loan
funds................. -- -- -- 25,885 -- 25,885
Unamortized discounts
(premiums)............ (5,858) (49) (25) -- 149 (5,783)
Deferred loan
origination fees
(costs)............... (2,477) 30 73 311 (35) (2,098)
Lower of Cost or
Market................ 2,985 63 76 334 17 3,475
Allowance for estimated
loan losses........... 2,300 58 70 306 15 2,749
-------- ------- ------- ------- ----- --------
Total loans, net..... 384,982 9,751 11,665 25,339 2,591 434,328
-------- ------- ------- ------- ----- --------
Loans held for sale,
net................... 316,052 6,126 6,228 -- 2,321 330,727
-------- ------- ------- ------- ----- --------
Loans held for
investment, net....... $ 68,930 $ 3,625 $ 5,437 $25,339 $ 270 $103,601
======== ======= ======= ======= ===== ========
The following table sets forth at December 31, 1999, the dollar amount of
gross loans receivable contractually due after December 31, 2000, and whether
such loans have fixed interest rates or adjustable interest rates. The
Company's adjustable-rate mortgage loans require that any payment adjustment
resulting from a change in the interest rate be made to both the interest and
payment in order to result in full amortization of the loan by the end of the
loan term, and thus, do not permit negative amortization.
Due After December 31, 2000
----------------------------
Fixed Adjustable Total
-------- ---------- --------
(Dollars in thousands)
Real estate loans:
Residential
One-to-four family........................... $198,273 $183,389 $381,662
Multi-family................................. 2,481 7,350 9,831
Commercial.................................... 4,884 6,140 11,024
Construction.................................. -- 1,137 1,137
Other loans................................... 2,388 23 2,411
-------- -------- --------
Total gross loans receivable............... $208,026 $198,039 $406,065
======== ======== ========
9
The following table sets forth the Company's loan originations, purchases,
sales, and principal repayments for the periods indicated:
For the Year Ended
December 31,
------------------------------
1999 1998 1997
---------- ---------- --------
(Dollars in thousands)
Gross loans(1)
Beginning balance............................... $ 337,554 $ 312,524 $ 68,995
Loans originated:
One to four family(2)......................... 387,999 440,685 341,294
Multi-family.................................. 13,591 34,596 18,019
Commercial and land........................... 10,164 22,274 13,631
Construction loans............................ 54,045 8,571 0
Other loans................................... 1,743 309 837
---------- ---------- --------
Total loans originated...................... 467,542 506,435 373,781
Loans purchased................................ 573,626 674,117 399,326
---------- ---------- --------
Sub total--Production.......................... 1,041,168 1,180,552 773,107
---------- ---------- --------
Total....................................... 1,378,722 1,493,076 842,102
Less:
Principal repayments........................... 114,944 79,085 17,289
Sales of loans................................. 799,353 610,468 94,705
Securitization of loans........................ 0 462,067 415,350
Transfer to REO................................ 5,869 3,902 2,234
---------- ---------- --------
Total Gross loans........................... 458,556 337,554 312,524
Ending balance loans held for sale.............. 326,965 238,664 280,859
---------- ---------- --------
Ending balance loans held for investment........ $ 131,591 $ 98,890 $ 31,665
========== ========== ========
- --------
(1) Gross loans includes loans held for investment and loans held for sale.
(2) Includes second trust deeds.
Delinquencies and Classified Assets. Federal regulations and the Bank's
Classification of Assets Policy require that the Bank utilize an internal asset
classification system as a means of reporting problem and potential problem
assets. The Bank has incorporated the OTS internal asset classifications as a
part of its credit monitoring system. The Bank currently classifies problem and
potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An
asset is considered "Substandard" if it is inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. "Substandard" assets include those characterized by the
"distinct possibility" that the insured institution will sustain "some loss" if
the deficiencies are not corrected. Assets classified as "Doubtful" have all of
the weaknesses inherent in those classified "Substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values,
"highly questionable and improbable." Assets classified as "Loss" are those
considered "uncollectible" and of such little value that their continuance as
assets without the establishment of a specific loss allowance is not warranted.
Assets which do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
weaknesses are required to be designated "Special Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, under current OTS policy the Bank is
required to consider establishing a general valuation allowance in an amount
deemed prudent by management. The general valuation allowance, which is a
regulatory term, represents a loss allowance which has been established to
recognize the inherent credit risk associated with lending and investing
activities, but which, unlike specific allowances, has not been allocated to
particular problem assets. When an insured institution classifies one or more
assets, or portions thereof, as "Loss," it is
10
required either to establish a specific allowance for losses equal to 100% of
the amount of the asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its assets
and the amount of its valuation allowances is subject to review by the OTS
which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation allowances. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the
portfolio in a reasonable manner; and that management has established
acceptable allowance evaluation processes that meet the objectives set forth in
the policy statement. While the Bank believes that it has established an
adequate allowance for estimated loan losses, there can be no assurance that
regulators, in reviewing the Bank's loan portfolio, will not request the Bank
to materially increase at that time its allowance for estimated loan losses,
thereby negatively affecting the Bank's financial condition and earnings at
that time. Although management believes that an adequate allowance for
estimated loan losses has been established, actual losses are dependent upon
future events and, as such, further additions to the level of allowances for
estimated loan losses may become necessary.
The Bank's Internal Asset Review Committee reviews and classifies the Bank's
assets quarterly and reports the results of its review to the Board of
Directors. The Bank classifies assets in accordance with the management
guidelines described above. REO is classified as Substandard. The following
table sets forth information concerning substandard loans, REO and total
classified assets at December 31, 1999.
At December 31, 1999
------------------------------------------------------
Total
Substandard,
Doubtful and
Loans REO Loss Assets
----------------- ------------------ -----------------
Gross Number of Gross Number of Gross Number of
Balance Loans Balance Properties Balance Assets
------- --------- ------- ---------- ------- ---------
(Dollars in thousands)
Residential:
One-to-four family.... $3,793 62 $2,330 29 $6,123 91
Multi-family.......... 198 1 -- -- 198 1
Commercial.............. -- -- -- -- -- --
Other loans............. 27 7 -- -- 27 7
------ --- ------ --- ------ ---
Total loans......... $4,018 70 $2,330 29 $6,348 99
====== === ====== === ====== ===
At December 31, 1999 the Bank had $1.3 million of assets classified as
Special Mention, $6.3 million of assets classified as Substandard, there were
no assets classified as Doubtful or Loss. As of December 31, 1999, assets
classified as Special Mention secured by one- to four-family residential
properties include 59 loans totaling $1.2 million. At December 31, 1999, the
largest loan classified as Special Mention had a loan balance of $139,000 and
is secured by a one- to four-family residential property.
Non-Accrual and Past-Due Loans. The following table sets forth information
regarding non-accrual loans, troubled-debt restructurings and REO in the
Company's loan portfolio. There was one troubled-debt restructured loan within
the meaning of SFAS 15, and 29 REO properties at December 31, 1999. The
Company's current policy is to cease accruing interest on loans 90 days or more
past due. For the years ended December 31, 1999, 1998, 1997, 1996 and 1995,
respectively, the amount of interest income that would have been recognized on
nonaccrual loans if such loans had continued to perform in accordance with
their contractual terms was $384,000, $789,000, $424,000, $179,000, and
$67,000, none of which was recognized. For the same periods, the amount of
interest income recognized on troubled debt restructurings was $0, $0, $0,
$12,000, and $11,000.
11
At December 31,
--------------------------------------
1999 1998 1997 1996 1995
------ ------ ------ ------ ------
(Dollars in thousands)
Non-accrual loans:
One-to-four family................... $2,462 $7,134 $3,245 $2,361 $1,305
Multi-family........................ 198 0 0 45 0
Commercial and land................. 0 131 131 0 82
Other loans......................... 27 279 1,750 10 10
------ ------ ------ ------ ------
Total nonaccrual loans............ 2,687 7,544 5,126 2,416 1,397
Foreclosure in process(3)............ 1,331 0 0 0 0
------ ------ ------ ------ ------
Total nonperforming loans......... 4,018 7,544 5,126 2,416 1,397
REO, net(1).......................... 2,214 1,898 1,440 561 827
------ ------ ------ ------ ------
Total nonperforming assets........ $6,232 $9,442 $6,566 $2,977 $2,224
====== ====== ====== ====== ======
Restructured loans.................... $ 0 $ 131 $ 131 $ 131 $ 131
Allowance for estimated loan losses as
a percent of gross loans
receivable(2)........................ 0.60% 0.82% 0.82% 2.36% 1.83%
Allowance for estimated loan losses as
a percent of total nonperforming
loans(3)............................. 68.43% 36.81% 50.20% 67.26% 84.25%
Nonperforming loans as a percent of
gross loans receivable(2)(3)......... 0.88% 2.23% 1.64% 3.50% 2.17%
Nonperforming assets as a percent of
total assets(3)...................... 1.14% 2.21% 1.65% 2.93% 3.00%
- --------
(1) REO balances are shown net of related loss allowances.
(2) Gross loans includes loans receivable held for investment and loans
receivable held for sale.
(3) Non-performing assets consist of non-performing loans and REO. Prior to
April 1, 1996, non-performing loans consisted of all loans 45 days or more
past due and all other non-accrual loans. Following March 31, 1996, non-
performing loans consisted of all loans 90 days or more past due and all
other non-accrual loans. At December 31, 1999, nonperforming loans
consisted of all loans 90 days or more past due, foreclosures in process
less than 90 days past due, and all other non-accrual loans.
12
The following table sets forth delinquencies in the Company's loan portfolio
as of the dates indicated:
At December 31, 1999 At December 31, 1998
--------------------------------- ---------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
---------------- ---------------- ---------------- ----------------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
------ --------- ------ --------- ------ --------- ------ ---------
(Dollars in thousands)
One to four family...... 33 $1,179 62 $3,793 6 $326 68 $7,134
Multi-family............ 0 -- 1 198 0 -- 0 --
Commercial.............. 0 -- 0 -- 0 -- 1 131
Other loans............. 26 84 7 27 36 160 61 279
--- ------ --- ------ --- ---- --- ------
Total................... 59 $1,263 70 $4,018 42 $486 130 $7,544
=== ====== === ====== === ==== === ======
Delinquent loans to
total gross loans...... 0.28% 0.88% 0.14% 2.23%
====== ====== ==== ======
At December 31, 1997
---------------------------------
60-89 Days 90 Days or More
---------------- ----------------
Number Principal Number Principal
of Balance of Balance
Loans of Loans Loans of Loans
------ --------- ------ ---------
(Dollars in thousands)
One to four family........................... 27 $2,328 33 $3,245
Multi-family................................. 0 -- 0 --
Commercial................................... 0 -- 1 131
Other loans.................................. 115 583 321 1,750
--- ------ --- ------
Total........................................ 142 $2,911 355 $5,126
=== ====== === ======
Delinquent loans to total gross loans........ 0.93% 1.64%
====== ======
Allowance for Loan Losses. The Company maintains an allowance for loan
losses to absorb losses inherent primarily in the loans held for investment
portfolio. Loans held for sale are carried at the lower of cost or estimated
market value. Net unrealized losses, if any, are recognized in a lower of cost
or market valuation allowance by charges to operations. The allowance is based
on ongoing, quarterly assessments of probable estimated losses inherent in the
loan portfolios. The Company's methodology for assessing the appropriateness of
the allowance consists of several key elements, which include the formula
allowance, specific allowance for identified problem loans and portfolio
segments and the unallocated allowance. In addition, the allowance incorporates
the results of measuring impaired loans as provided in Statement of financial
Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment
of a Loan" and SFAS No. 118 "Accounting by Creditors for Impairment of Loan-
Income Recognition and Disclosures." These accounting standards prescribe the
measurement methods, income recognition and disclosures related to impaired
loans.
The formula allowance is calculated by applying loss factors to outstanding
loans held for investment. The factors are based upon the composite industry
standards and may be adjusted for significant factors that, in management's
judgment, affect the collectibility of the portfolios as of the evaluation
date.
Specific allowances are established in cases where management has identified
significant conditions or circumstances related to a credit that management
believes indicates the probability that a loss has been incurred in excess of
the amount determined by the application of the formula allowance.
The unallocated allowance is based upon management's evaluation of various
conditions, the effect of which are not directly measured in the determination
of the formula and specific allowance. The evaluation of the inherent loss with
respect to these conditions is subject to a higher degree of uncertainty
because they are not identified with specific problem credits or portfolio
segments. The conditions evaluated in connection with the unallocated allowance
include the following conditions that existed as of the balance sheet date:
13
(1) then-existing general economic and business conditions affecting the key
lending areas of the Company, (2) credit quality trends, (3) loan volumes and
concentrations, (4) recent loss experience in particular segments of the
portfolio, and (5) regulatory examination results.
Executive management reviews the conditions quarterly in discussion with the
Company's senior officers. To the extent that any of these conditions are
evidenced by a specifically identifiable problem credit or portfolio segment as
of the evaluation date, management's estimate of the effect of such condition
may be reflected as a specific allowance applicable to such credit or portfolio
segment. Where any of these conditions is not evidenced by a specifically
identifiable problem credit or portfolio segment as of the evaluation date,
management's evaluation of the probable loss related to such condition is
reflected in the unallocated allowance. By assessing the probable estimated
losses inherent in the loan portfolios on a quarterly basis, the Company is
able to adjust specific and inherent loss estimates based upon more recent
information that has become available.
As of December 31, 1999, the Company's allowance for loan losses was $2.7
million or 0.60% of total gross loans, and 68.43% of non-performing loans
compared to an allowance for loan losses of $2.8 million at December 31, 1998
or 0.82% of gross loans and 36.81% of non-performing loans. The following table
sets forth activity in the Company's allowance for loan losses for the periods
set forth in the table.
At or for the Year
Ended December 31,
----------------------------
In thousands 1999 1998 1997
- ------------ -------- -------- --------
Balance at beginning of period.................... $ 2,777 $ 2,573 $ 1,625
Provision for loan losses......................... 5,382 4,166 1,850
Charge-offs:
Real estate:
One to four family............................ 3,163 1,023 901
Multi-family.................................. -- -- --
Commercial.................................... -- -- --
Other loans..................................... 2,677 3,048 8
-------- -------- --------
Total charge-offs............................... 5,840 4,071 909
Recoveries........................................ 430 109 7
-------- -------- --------
Balance at end of period.......................... $ 2,749 $ 2,777 $ 2,573
======== ======== ========
Average net loans outstanding..................... $411,189 $329,699 $191,140
======== ======== ========
Net charge-offs to average net loans.............. 1.31% 1.20% 0.47%
The following table sets forth the amount of the Company's allowance for
loan losses, the percent of allowance for loan losses to total allowance and
the percent of gross loans to total gross loans in each of the categories
listed at the dates indicated.
1999 1998 1997
----------------------------- ----------------------------- -----------------------------
Percent of Percent of Percent of Percent of Percent of Percent of
Allowance Gross Loans Allowance Gross Loans Allowance Gross Loans
to Total to Total to Total to Total to Total to Total
Amount Allowance Gross Loans Amount Allowance Gross Loans Amount Allowance Gross Loans
------ ---------- ----------- ------ ---------- ----------- ------ ---------- -----------
In thousands
------------ ------
One to four family...... $2,582 93.93% 83.29% $1,984 71.45% 64.54% $1,206 46.87% 89.02%
Multi-family............ 64 2.33 2.15 68 2.46 5.16 66 2.57 3.41
Commercial.............. 6 0.22 2.59 250 9.00 4.22 150 5.83 5.36
Construction............ 26 0.95 11.38 60 2.16 2.54 -- 0.00 0.00
Other................... 71 2.57 0.59 415 14.93 23.44 1,151 44.73 2.21
------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance........ $2,749 100.00% 100.00% $2,777 100.00% 100.00% $2,573 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
Real Estate Owned. At December 31, 1999, the Company had $2.2 million of
REO, net of allowances. Real estate properties acquired through or in lieu of
loan foreclosure are initially recorded at the lower of fair value or the
balance of the loan at the date of foreclosure through a charge to the
allowance for estimated loan losses. After
14
foreclosure, valuations are periodically performed by management and an
allowance for REO losses is established by a charge to operations if the
carrying value of a property exceeds its fair value less estimated cost to
sell. It is the policy of the Company to obtain an appraisal and /or a market
evaluation on all REO at the time of possession and every six months
thereafter.
Investment Activities
Federally chartered savings institutions, such as the Bank, have the
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various federal agencies, certificates of
deposit of insured banks and savings institutions, bankers' acceptances, and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Bank must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations. See
"--Regulation--Federal Savings Institution Regulation--Liquidity."
Historically, the Bank has maintained liquid assets above the minimum OTS
requirements and at a level considered to be adequate to meet its normal daily
activities.
The investment policy of the Company as established by the Board of
Directors attempts to provide and maintain liquidity, generate a favorable
return on investments without incurring undue interest rate and credit risk,
and complement the Company's lending activities. Specifically, the Company's
policies generally limit investments to government and federal agency-backed
securities and non-government guaranteed securities, including corporate debt
obligations, that are investment grade. The Company's policies provide the
authority to invest in marketable securities guaranteed by the U.S. government
and agencies thereof and other financial institutions.
At December 31, 1999 the Company had $5 thousand in its mortgage-backed
securities portfolio, all of which were insured or guaranteed by the FHLMC and
are being held-to-maturity. The Company may increase its investment in
mortgage-backed securities in the future depending on its liquidity needs and
market opportunities. Investments in mortgage-backed securities involve a risk
that actual prepayments will be greater than estimated prepayments over the
life of the security which may require adjustments to the amortization of any
premium or accretion of any discount relating to such instruments thereby
reducing the net yield on such securities. There is also reinvestment risk
associated with the cash flows from such securities. In addition, the market
value of such securities may be adversely affected by changes in interest
rates.
The following table sets forth certain information regarding the carrying
and fair values of the Company's securities at the dates indicated. There were
no securities available-for-sale at the dates indicated.
At December 31
--------------------------------------------------
1999 1998 1997
---------------- ---------------- ----------------
Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Securities
Residual mortgage-backed
securities............... $ 0 $ 0 $50,296 $50,296 $45,352 $45,352
Held to maturity:
US Treasury and other
agency securities........ 29,955 29,945 2,000 2,012 5,003 5,021
Mortgage backed
securities............... 5 5 8 8 9 9
Other securities (FHLB
Stock)................... 2,873 2,873 2,463 2,463 1,067 1,067
------- ------- ------- ------- ------- -------
Total mortgage & other
securities............. $32,833 $32,823 $54,767 $54,779 $51,431 $51,449
======= ======= ======= ======= ======= =======
At December 31, 1998, the Company had five residual mortgage-backed
securities valued at $50.3 million. By completing the desecuritization of the
Company's 1996-1 and 1997-1A and 1B transactions and the sale of the Company's
1997-2, 1997-3, and 1998-1A and 1B Residuals, the Company divested its holdings
of residual mortgage-backed securities retained from securitizations during
1999.
15
The Company sold its remaining residual mortgage-backed securities retained
from securitization and related mortgage servicing rights for an amount valued
at $19.3 million in cash and other consideration. The Company received from the
purchaser of the residual mortgage-backed securities, a contractual right to
receive 50% of any cash realized from the residual mortgage-backed securities
(the "Participation Contract"). The right to receive cash flows under the
Participation Contract begins after the purchaser recaptures their initial cash
investment of $8.1 million and a 15% internal rate of return (the "Hurdle
Amount") from the transaction. Additionally, the Company entered into a credit
guaranty related to a $14.6 million pool of sub- performing loans in the 1998-
1A and 1B securitization whereby the Company guaranteed the difference between
the December 1, 1999, unpaid principal balance and the realized value of those
loans at final disposition. At December 31, 1999, the Company estimated the
obligation under the credit guaranty at $4.3 million. Any proceeds paid to the
purchaser under the credit guaranty will be applied to the $8.1 million Hurdle
Amount for cash distributions on the Participation Contract.
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's securities
as of December 31, 1999.
At December 31, 1999
-----------------------------------------------------------------------------------------
More than One More than Five
Year to Five Years to Ten More than
One Year or Less Years Years Ten Years Total
----------------- ----------------- ----------------- ----------------- -----------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Held to maturity
investment securities
US Treasury and other
agency securities..... $29,955 5.95% $ -- 0.00% $ -- 0.00% $ -- 0.00% $29,955 5.95%
Mortgage-backed
securities............ -- 0.00 -- 0.00 -- 0.00 5 3.16 5 3.16
Other securities....... 2,723 5.30 -- 0.00 -- 0.00 150 0.00 2,873 5.02
------- ----- ----- ----- -------
Total Investment
Securities............. $32,678 5.90% $ -- 0.00% $ -- 0.00% $ 155 0.11% $32,833 5.87%
======= ===== ===== ===== =======
Sources of Funds
General. Deposits, lines of credit, loan repayments and prepayments,
proceeds from loan sales and cash flows generated from operations and
borrowings are the primary sources of the Company's funds for use in lending,
investing and for other general purposes.
Deposits. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts, money market savings accounts and certificates of deposit.
For the year ended December 31, 1999, certificates of deposit constituted 92.5%
of total average deposits. The term of the fixed-rate certificates of deposit
offered by the Company vary from 30 days to eighteen years. Specific terms of
an individual account vary according to the type of account, the minimum
balance required, the time period funds must remain on deposit and the interest
rate, among other factors. The flow of deposits is influenced significantly by
general economic conditions, changes in money market rates, prevailing interest
rates and competition. At December 31, 1999, the Company had $428.0 million of
certificate accounts maturing in one year or less.
The Company relies primarily on customer service and long-standing
relationships with customers to attract and retain local deposits; however,
market interest rates and rates offered by competing financial institutions
significantly affect the Company's ability to attract and retain deposits. From
time to time the Company utilize brokered deposits. At December 31, 1999, the
Company had no brokered deposits.
Although the Company has a significant portion of its deposits in shorter
term certificates of deposit, management monitors activity on the Company's
certificate of deposit accounts and, based on historical experience, and the
Company's current pricing strategy, believes that it will retain a large
portion of such accounts upon maturity. Further increases in short-term
certificate of deposit accounts, which tend to be more sensitive to movements
in market interest rates than core deposits, may result in the Company's
deposit base being less stable than if it had a large amount of core deposits
which, in turn, may result in further increases in the Company's cost of
deposits. Notwithstanding the foregoing, the Company believes that it will
continue to have access to sufficient amounts of certificates of deposit
accounts which, together with other funding sources, will provide it with the
necessary level of liquidity to continue to implement its business strategies.
16
The following table presents the deposit activity of the Company for the
periods indicated:
For the Year Ended
December 31,
--------------------------
1999 1998 1997
-------- -------- --------
(Dollars in thousands)
Net deposits (withdrawals)....................... $123,302 $ 97,638 $118,078
Interest credited on deposit accounts............ 22,124 14,030 7,976
-------- -------- --------
Total increase in deposit accounts............. $145,426 $111,668 $126,054
======== ======== ========
At December 31, 1999, the Company had $130.1 million in certificate accounts
in amounts of $100,000 or more maturing as follows:
Weighted
Maturity Period Amount Average Rate
--------------- ------ ------------
(Dollars in
thousands)
Three months or less................................... $ 35,962 5.55%
Over three months through 12 months.................... 93,343 6.07
Over 12 months......................................... 808 6.27
--------
Total................................................ $130,113 5.93%
========
The following table sets forth the distribution of the Company's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented.
For the Year For the Year For the Year
Ended December 31, Ended December 31, Ended December 31,
-------------------------- -------------------------- --------------------------
1999 1998 1997
-------------------------- -------------------------- --------------------------
(Dollars in Thousands)
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
-------- -------- -------- -------- -------- -------- -------- -------- --------
Passbook accounts....... $ 4,639 1.09% 2.10% $ 4,324 1.69% 2.36% $ 4,003 2.73% 2.10%
Money market accounts... 6,857 1.62 4.28 4,779 1.87 4.79 2,971 2.02 2.96
Checking accounts....... 20,337 4.80 1.51 17,966 7.01 1.72 11,756 8.00 2.37
-------- ------ -------- ------ -------- ------
Sub-total.............. 31,833 7.51 2.30 27,069 10.57 2.36 18,730 12.75 2.41
Certificate accounts:
Three months or less... 8,706 2.05 5.12 9,148 3.57 5.52 15,887 10.81 5.54
Four through 12
months................ 328,635 77.53 5.40 192,871 75.28 5.85 88,129 59.97 6.01
13 through 36 months... 50,786 11.98 5.57 22,105 8.63 5.84 18,467 12.57 5.71
37 months or greater... 3,945 0.93 6.55 4,997 1.95 6.55 5,730 3.90 6.28
-------- ------ -------- ------ -------- ------
Total certificate
accounts.............. 392,072 92.49 5.43 229,121 89.43 5.85 128,213 87.25 5.92
-------- ------ -------- ------ -------- ------
Total average
deposits.............. $423,905 100.00% 5.17% $256,190 100.00% 5.48% $146,943 100.00% 5.47%
======== ====== ======== ====== ======== ======
17
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the date indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1999.
Period to Maturity from December 31, 1999 At December 31,
--------------------------------------------------------------- -----------------
Less
than One One to Two to Three to Four to More than
Yr Two Yrs Three Yrs Four Yrs Five Yrs Five Yrs Total 1998 1997
-------- ------- --------- -------- -------- --------- -------- -------- --------
(Dollars in thousands)
Certificate Accounts:
0 to 4.00%............ $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
4.01 to 5.00%......... 31,223 125 2 64 4 48 31,466 16,436 2,344
5.01 to 6.00%......... 186,383 1,333 263 96 10 400 188,485 266,323 102,920
6.01 to 7.00%......... 209,913 121 17 6 0 115 210,172 12,648 87,009
7.01 to 8.00%......... 435 282 97 36 59 300 1,209 1,568 1,572
8.01 to 9.00%......... -- -- -- -- -- -- -- -- --
Over 9.01%............ -- -- -- -- -- -- -- -- --
-------- ------ ---- ---- --- ---- -------- -------- --------
Total............... $427,954 $1,861 $379 $202 $73 $863 $431,332 $296,975 $193,845
======== ====== ==== ==== === ==== ======== ======== ========
Borrowings. From time to time the Bank has obtained advances from the FHLB
as an alternative to retail deposit funds and internally generated funds and
may do so in the future as part of its operating strategy. FHLB advances may
also be used to acquire certain other assets as may be deemed appropriate for
investment purposes. These advances are collateralized primarily by certain of
the Bank's mortgage loans and mortgage-backed securities and secondarily by the
Bank's investment in capital stock of the FHLB. See "Regulation--Federal Home
Loan Bank System." Such advances are made pursuant to several different credit
programs, each of which has its own interest rate and range of maturities. The
maximum amount that the FHLB will advance to member institutions, including the
Bank, fluctuates from time-to-time in accordance with the policies of the OTS
and the FHLB. At December 31, 1999, the Bank had no outstanding advances from
the FHLB.
Both the Company and the Bank have the ability to enter into lines of credit
to finance mortgages, mortgage-backed securities and for other corporate
purposes. At December 31, 1999, the Bank has a warehouse line of credit in the
amount of $250.0 million, of which zero has been drawn at December 31, 1999.
The line of credit is secured by mortgage loans or mortgage-backed securities
with interest rates from LIBOR plus 50 basis points to LIBOR plus 100 basis
points. In addition, the Company has two lines of credit in the amount of
$40 million and $10 million secured by residual assets created by the Company's
securitizations and stock of the Bank, respectively. $17.9 million was
outstanding under the lines at December 31, 1999 and both lines were fully
repaid at January 31, 2000. The warehouse and residual financing lines of
credit are uncommitted and may be terminated by the lenders at will. The $10
million unsecured revolving line of credit is a committed, 364 day, facility
that matures in November 2000. These lines of credit contain affirmative,
negative and financial covenants. Due to the sale of the Company's residual
mortgage-backed securities, certain covenants related to the $40 million and
$10 million line of credit were violated. The Company was in compliance with
all other lines of credit covenants at December 31, 1999.
On March 14, 1997, the Company issued subordinated debentures (the
"Debentures") in the aggregate principal amount of $10.0 million through the
Debenture Offering. On September 15, 1998, holders of $8.5 million in
Debentures exercised their option to put their Debentures as of December 14,
1998, thereby reducing outstanding Debentures to $1.5 million. See
"Regulation--Federal Savings Institution Regulation-- Capital Requirements."
Additionally, see further detail in "Note 10 Subordinated Debentures--Notes to
Consolidated Financial Statements".
18
The following table sets forth certain information regarding the Company's
borrowed funds at or for the years ended on the dates indicated:
At or For Year Ended December 31,
------------------------------------
1999 1998 1997
----------- ----------- -----------
(Dollars in thousands)
FHLB advances
Average balance outstanding............ $ 15,363 $ 1,154 $ 8,284
Maximum amount outstanding at any
month-end during the year ............ 35,170 17,062 17,800
Balance outstanding at end of year..... -- -- 9,000
Weighted average interest rate during
the year.............................. 5.23% 5.02% 5.82%
Debentures
Average balance outstanding............ $ 1,500 $ 9,526 $ 7,997
Maximum amount outstanding at any
month-end during the year............. 1,500 10,000 10,000
Balance outstanding at end of year..... 1,500 1,500 10,000
Weighted average interest rate during
the year.............................. 14.01% 14.03% 14.09%
Lines of credit
Average balance outstanding............ $ 30,237 $ 112,886 $ 48,765
Maximum amount outstanding at any
month-end during the year............. 45,834 345,848 226,846
Balance outstanding at end of year..... 17,873 39,977 100,170
Weighted average interest rate during
the year.............................. 8.48% 6.62% 6.53%
Total borrowings
Average balance outstanding............ $ 47,100 $ 123,566 $ 65,046
Maximum amount outstanding at any
month-end during the year............. 60,757 372,910 254,646
Balance outstanding at end of year..... 19,373 41,477 119,170
Weighted average interest rate during
the year.............................. 7.59% 7.18% 7.37%
Asset Securitizations
In a securitization, the Company will generally transfer a pool of loans to
a trust with the Company retaining the excess cash flows, known as residuals,
from the securitization which consist of the difference between the interest
rate of the mortgages and the coupon rate of the securities after adjustment
for servicing and other costs such as trustee fees and credit enhancement fees.
The cash generally will be used to repay advances on lines of credit used to
finance the pool of loans that were acquired by the Company. Generally, the
holders of the securities from the asset securitization are entitled to receive
scheduled principal collected on the pool of securitized loans and interest at
the pass-through interest rate on the certificate balance. The residual asset
represents the subordinated right to receive cash flows from the pool of
securitized loans after payment of the required amounts to the holders of the
securities and the costs associated with the securitization. The Company
recognizes gain on sale of the loans in the securitization, which represents
the excess of the estimated fair value of the residuals, net of closing and
underwriting costs, less the allocated cost basis of the loans sold in the
fiscal quarter in which such loans are sold. Management believes that it has
made reasonable estimates of the fair value of the residual interests on its
balance sheets. Concurrent with recognizing such gain on sale, the Company
records the residual interests as assets on its balance sheet. The recorded
value of these residual interests are amortized as cash distributions are
received from the trust holding the respective loan pool and are marked to
market on a quarterly basis. The fair values of such residuals are based in
part on market interest rates and projected loan prepayment and credit loss
rates. See Note 1 to the consolidated financial statements for further
discussion. Increases in interest rates or higher than anticipated rates of
loan prepayments or credit losses of these or similar securities may require
the Company to write down the value of such residuals and result in a material
adverse effect on the Company's results of operations and financial condition.
The Company revalued the residuals and recorded a pre-tax unrealized loss of
$16.6 million for the year ended December 31, 1998, due to a combination of
higher-than-expected prepayment speeds and credit losses. The Company is not
aware of an active market for the residuals.
19
The Company may arrange for credit enhancement for a transaction to achieve
an improved credit rating on the securities issued if this improves the level
of profitability or cash flow generated by such transaction. This credit
enhancement may take the form of an insurance and indemnity policy, insuring
the holders of the securities of timely payment of the scheduled pass-through
of interest and principal. In addition, the pooling and servicing agreements
that govern the distribution of cash flows from the loan pool included in a
transaction typically require over-collateralization as an additional means of
credit enhancement. Over-collateralization may in some cases also require an
initial deposit, the sale of loans at less than par or retention in the trust
of collections from the pool until a specified over-collateralization amount
has been attained. The purpose of the over-collateralization is to provide a
source of payment to investors in the event of certain shortfalls in amounts
due to investors. These amounts are subject to increase up to a reserve level
as specified in the related securitization documents. Cash amounts on deposit
are invested in certain instruments as permitted by the related securitization
documents. To the extent amounts on deposit exceed specified levels,
distributions are made to the holders of the residual interest; and at the
termination of the related trust, any remaining amounts on deposit are
distributed to the holders of the residual interest. Losses resulting from
defaults by borrowers on the payment of principal or interest on the loans in a
securitization will reduce the over-collateralization to the extent that funds
are available and may result in a reduction in the value of the residual
interest. See Note 1 to consolidated financial statements.
Subsidiaries
As of December 31, 1999, the Company had three subsidiaries: the Bank, Life
Investment Holdings, Inc., and Life Financial Investment and Insurance
Services, Inc. Life Financial Investment and Insurance Services, Inc was
incorporated in California in 1999 as a service entity engaged in the sale of
insurance and insurance-related products. Life Investment Holdings, Inc. was
incorporated in Delaware in 1997 as a bankruptcy-remote entity for use in the
Company's asset securitization activities. The Bank had no subsidiaries at
December 31, 1999.
Personnel
As of December 31, 1999, the Company had 334 full-time employees and 18
part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees
to be satisfactory.
Year 2000 Compliance
General
As a financial institution operating in multiple states, the Company is
dependent on computer systems and applications to conduct its business. The
Company has prepared its systems and applications for the year 2000 (Y2k). The
Y2k issue is the result of computer programs being written using two digit year
fields instead of four digit year fields. If the computer systems cannot
distinguish between the year 1900 and the year 2000, system failures or
miscalculations could result, disrupting operations and causing, among other
things, a temporary inability to process transactions or engage in normal
business activities for both the Company and its customers.
The Program
The Company has developed, and is actively engaged in, a comprehensive risk-
based Y2k program consisting of a team involving members from various areas in
the organization. The project team has been in place since May of 1998. The
program is designed to make its computer systems and equipment Y2k ready.
"Computer systems and equipment" includes systems generally thought of as
information technology (IT) dependent, such as accounting, data processing, and
telephone equipment, as well as systems not obviously IT dependent, such as
photocopiers, facsimile machines, and security systems. The non-IT dependent
systems may contain embedded technology, and the Company has included these
systems as part of the program. Both the IT dependent and non-IT dependent
portions of the program are complete.
20
The Company defines year 2000 readiness as information technology that
accurately processes date/time data from, into, and between the years 1999 and
2000, as well as leap year calculations, with:
. All mission-critical systems and processes reviewed, renovated or
replaced, as necessary.
. All mission-critical systems and processes tested.
. All key vendors, customers, and business partners identified and
assessed for risk.
. Adequate change control procedures in place for re-testing of new or
upgraded systems.
. Contingency plans in place to support business resumption requirements.
The Y2k program consists of five stages: (i) awareness, (ii) assessment,
(iii) renovation, (iv) validation, and (v) implementation. During the awareness
phase, the Company identified the project team and responsibilities, prepared
and allocated the project budget, defined the project scope, and established
program and management policies. This phase, although complete, continues to be
reviewed. The assessment phase entailed an inventory of IT and non-IT systems,
hardware, vendors, material customers, and facilities. Inventoried systems were
also prioritized to identify critical systems. This phase is also complete, but
is reviewed continually to manage changes to systems and relationships. The
renovation, validation, and implementation phases were complete as of June 30,
1999.
To complete the five program phases, the Company primarily used internal
resources. The service bureau responsible for the Company's mission critical
business financial systems provided assistance with validation of third party
systems that interface with their systems through proxy testing.
The Company's systems use a combination of methodologies for date fields.
Where possible, date fields were expanded to a full eight digits. For date
fields that were retained in a six-digit format, a windowing technique was
used. For the Company's mission critical business financial systems, the
windowing technique is described as follows. If the last two digits of the date
are 00-49, the century is 2000. If the last two digits of the date are 50-99,
the century is 1900.
Contingency Planning
An institution-wide contingency plan is in place, with Y2k issues
incorporated, and testing completed. The contingency plan enables the Company
to continue to operate, to the extent that it can do so safely, including
performing certain processes manually and repairing or obtaining replacement
systems.
Customer Awareness
The Company has devoted significant time and effort in developing customer
awareness as part of the Y2k program. Internal training of all employees was
completed in several sessions over several months during 1999. In addition, the
company provides informational brochures to customers as part of its program
activities, regular program updates to third parties with which the Company has
material relationships, and program status reports as part of its customer and
employee newsletter.
Costs
Through 1999, the amount of approximately $231,378 incurred and expensed for
developing and implementing the Y2k program has not had a material effect on
the Company's operations. There are no additional costs expected as a result of
the Y2k program. None of the Company's other information technology projects
have been delayed or deferred as a result of implementing the Y2k program.
Risks
The Company believes that implementation of completed renovations on its
internal systems and equipment will allow it to be Y2k compliant in a timely
manner. There can be no assurances, however, that the
21
Company's internal systems or equipment, or those of third parties on which the
Company relies, will be Y2k compliant in a timely manner, or that the Company's
or third parties' contingency plans will mitigate the effects of noncompliance.
The Company has initiated communications with its critical external
relationships to determine the extent to which the Company will assess and
attempt to mitigate its risks with respect to the failure of these entities to
be Y2k ready. The effect, if any, on the Company's results of operations from
the failure of such parties to be Y2k ready cannot reasonably be estimated.
The Company is part of a regulated industry which has issued standards for
Y2k readiness and is conducting audits to ensure compliance with those
standards. To date, the Company has satisfied its regulators as to its
compliance with Y2k standards. The Company believes its most likely worst case
scenario is that customers could experience some manual processes or an
inability to access their cash immediately. Although the Company does not
believe that this scenario will occur, it is assessing the effect of such
scenarios by using current financial data. In the event that this scenario does
occur, the Company does not expect that it would have a material adverse effect
on the Company's financial position, liquidity, and results of operations.
Forward-looking Statements
The preceding Y2k issue discussion contains various forward-looking
statements which represent the Company's beliefs or expectations regarding
future events. When used in the Y2k issue discussion, the words "believes,"
"expects," "estimates," and similar expressions are intended to identify
forward-looking statements. Forward-looking statements include, without
limitation, the Company's expectations as to when it will complete the
renovation, validation, and implementation phases of its Y2k program, as well
as its contingency plans; its estimated cost of achieving Y2k readiness; and
the Company's belief that its internal systems and equipment will be Y2k
compliant in a timely manner. All forward-looking statements involve a number
of risks and uncertainties that could cause the actual results to differ
materially from the projected results. Factors that may cause these differences
include, but are not limited to: the availability of qualified personnel and
other information technology resources, the ability to identify and renovate
all data sensitive lines of computer code or to replace embedded computer chips
in affected systems and equipment, and the actions of government agencies and
other third parties with respect to Y2k readiness.
REGULATION
General
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of
the OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition,
the activities of savings institutions, such as the Bank, are governed by the
HOLA and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its primary federal regulator, and the FDIC, as the deposit
insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB") System and
its deposit accounts are insured up to applicable limits by the SAIF managed by
the FDIC. The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with, or
acquisitions of, other savings institutions. The OTS and/or the FDIC conduct
periodic examinations to test the Bank's safety and soundness and compliance
with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the OTS, the FDIC or Congress, could have a material
adverse impact on the Company, the Bank
22
and their operations. Certain of the regulatory requirements applicable to the
Bank and to the Company are referred to below or elsewhere herein. The
description of statutory provisions and regulations applicable to savings
institutions and their holding companies set forth in this Form 10-K does not
purport to be a complete description of such statutes and regulations and their
effects on the Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company
within the meaning of the HOLA. As a unitary savings and loan holding company,
the Company generally is not restricted under existing laws as to the types of
business activities in which it may engage, provided that the Bank continues to
be a qualified thrift lender ("QTL"). See "Federal Savings Institution
Regulation--QTL Test." Upon any non-supervisory acquisition by the Company of
another savings institution or savings bank that meets the QTL test and is
deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. 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 Section 4-C-(8) of the Bank Holding Company Act ("BHC Act"),
subject to the prior approval of the OTS, and certain activities authorized by
OTS regulation, and no multiple savings and loan holding company may acquire
more than 5% the voting stock of a company engaged in impermissible activities.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS or acquiring or retaining control of
a depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on
subsidiary savings institutions as described below. The Bank must notify the
OTS 30 days before declaring any dividend to the Company. In addition, the
financial impact of a holding company on its subsidiary institution is a matter
that is evaluated by the OTS and the agency has authority to order cessation of
activities or divestiture of subsidiaries deemed to pose a threat to the safety
and soundness of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 4% leverage (core) capital ratio and an 8% risk-based capital ratio.
Core capital is defined as common stockholders' equity (including retained
earnings), certain noncumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights and credit card
relationships. The OTS regulations require that, in meeting the tangible,
leverage (core) and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities as
principal that are not permissible for a national bank.
23
The risk-based capital standard for savings institutions requires the
maintenance of total capital (which is defined as core capital and
supplementary capital) to risk-weighted assets 8%. In determining the amount of
risk-weighted assets, all assets, including certain off-balance sheet assets,
are multiplied by a risk-weight factor of 0% to 100%, as assigned by the OTS
capital regulation based on the risks OTS believes are inherent in the type of
asset. The components of core capital are equivalent to those discussed earlier
under the 4% leverage standard. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and, within specified limits, the allowance for loan and lease
losses. Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100% of core capital.
The OTS regulatory capital requirements also incorporate an interest rate
risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash
flows from assets, liabilities and off-balance sheet contracts) that would
result from a hypothetical 200 basis point increase or decrease in market
interest rates divided by the estimated economic value of the institution's
assets, as calculated in accordance with guidelines set forth by the OTS. A
savings institution whose measured interest rate risk exposure exceeds 2% must
deduct an amount equal to one-half of the difference between the institution's
measured interest rate risk and 2%, multiplied by the estimated economic value
of the institution's assets. The dollar amount is deducted from an
institution's total capital in calculating compliance with its risk-based
capital requirement. Under the rule, there is a two quarter lag between the
reporting date of an institution's financial data and the effective date for
the new capital requirement based on that data. A savings institution with
assets of less than $300 million and risk-based capital ratios in excess of 12%
is not subject to the interest rate risk component, unless the OTS determines
otherwise. The Director of the OTS may waive or defer a savings institution's
interest rate risk component on a case-by-case basis. For the present time, the
OTS has deferred implementation of the interest rate risk component. At
December 31, 1999, the Bank met each of its capital requirements.
The following table presents the Bank's capital position at December 31,
1999.
Capital Ratios
----------------
Actual Required Excess Actual Required
Capital Capital Amount Percent Percent
------- -------- ------- ------- --------
(Dollars in thousands)
Tangible......................... $32,473 $ 7,755 $24,718 6.28% 1.50%
Core (leverage).................. 32,473 20,680 11,793 6.28% 4.00%
Risk-based....................... 35,222 27,245 7,977 10.34% 8.00%
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
regulations, the OTS is required to take certain supervisory actions against
undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution
that has a total risk-based capital of less than 8% or a leverage ratio or a
Tier 1 capital ratio that is less than 4% is considered to be
"undercapitalized." A savings institution that has a total risk-based capital
ratio less than 6%, a Tier 1 capital ratio is less than 3% or a leverage ratio
that is less than 3% is considered to be "significantly undercapitalized" and a
savings institution that has a tangible capital to asset ratio equal to or less
than 2% is deemed to be "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company. In addition, numerous
mandatory supervisory actions become immediately applicable to the institution
depending upon its category, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Bank are presently insured by
the SAIF. The FDIC maintains a risk-based assessment system by which
institutions are assigned to one of three categories based on
24
their capitalization and one of three subcategories based on examination
ratings and other supervisory information. An institution's assessment rate
depends on the categories to which it is assigned. Assessment rates for SAIF
member institutions are determined semiannually by the FDIC and currently range
from zero basis points for the healthiest institutions to 27 basis points for
the riskiest.
In addition to the assessment for deposit insurance, institutions are
required to pay on bonds issued in the late 1980s by the Financing Corporation
("FICO") to recapitalize the predecessor to the SAIF. During 1984, FICO
payments for SAIF members approximated 6.10 basis points, while Bank Insurance
Fund ("BIF"--the deposit insurance fund that covers most commercial bank
deposits) members paid 1.22 basis points. By law, there will be equal sharing
of FICO payments between the members of both insurance funds on the earlier of
January 1, 2000 or the date the two insurance funds merge.
Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
Thrift Rechartering Legislation. Various proposals to eliminate the federal
thrift charter, create a uniform financial institutions charter and abolish the
OTS have been introduced in Congress. Some bills would require federal savings
institutions to convert to a national bank or some type of state charter by a
specified date under some bills, or they would automatically become national
banks. Under some proposals, converted federal thrifts would generally be
required to conform their activities to those permitted for the charter
selected and divestiture of nonconforming assets would be required over a two
year period, subject to two possible one year extensions. State chartered
thrifts would become subject to the same federal regulation as applies to state
commercial banks. A more recent bill passed by the House Banking Committee
would allow savings institutions to continue to exercise activities being
conducted when they convert to a bank regardless of whether a national bank
could engage in the activity. Holding companies for savings institutions would
become subject to the same regulation as holding companies that control
commercial banks, with some limited grandfathering, including savings and loan
holding company activities. The grandfathering would be lost under certain
circumstances such as a change in control of the Company. The Bank is unable to
predict whether such legislation would be enacted or the extent to which the
legislation would restrict or disrupt its operations.
Loans-to-One Borrower. Under the HOLA, savings institutions are generally
subject to the limits on loans-to-one borrower applicable to national banks.
Generally, savings institutions may not make a loan or extend credit to a
single or related group of borrowers in excess of 15% of its unimpaired capital
and surplus. An additional amount may be lent, equal to 10% of unimpaired
capital and surplus, if such loan is secured by readily-marketable collateral,
which is defined to include certain financial instruments and bullion. At
December 31, 1999, the Bank's limit on loans to one borrower was $5.3 million.
At December 31, 1999, the Bank's largest aggregate outstanding balance of
loans-to-one borrower was $1.3 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings association is required to maintain at least 65% of its
"portfolio assets" (total assets less: (i) specified liquid assets up to 20% of
total assets; (ii) intangibles, including goodwill; and (iii) the value of
property used to conduct business) in certain "qualified thrift investments"
(primarily residential mortgages and related investments, including certain
mortgage-backed securities) in at least 9 months out of each 12 month period.
A savings association that fails the QTL test must convert to a bank charter
or operate under certain restrictions. As of December 31, 1999, the Bank
maintained 99.99% of its portfolio assets in qualified thrift investments and,
therefore, met the QTL test. Recent legislation has expanded the extent to
which education loans, credit card loans and small business loans may be
considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon
all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments
25
to shareholders of another institution in a cash-out merger and other
distributions charged against capital. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that exceeds all fully phased-in capital requirements before and
after a proposed capital distribution ("Tier 1 Bank") and has not been advised
by the OTS that it is in need of more than normal supervision, could, after
prior notice but without obtaining approval of the OTS, make capital
distributions during a calendar year equal to the greater of (i) 100% of its
net earnings 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 (ii)
75% of its net income for the previous four quarters. Any additional capital
distributions would require prior regulatory approval. In the event the Bank's
capital fell below its regulatory requirements or the OTS notified it that it
was in need of more than normal supervision, the Bank's ability to make capital
distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice. At December 31, 1999, the Bank was a
Tier 1 Bank.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus short-
term borrowings. Monetary penalties may be imposed for failure to meet these
liquidity requirements. The Bank's average liquidity ratio for the quarter
ended December, 1999 was 5.07%, which exceeded the applicable requirements. The
Bank has never been subject to monetary penalties for failure to meet its
liquidity requirements.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (e.g., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and
23B of the Federal Reserve Act ("FRA"). Section 23A restricts the aggregate
amount of covered transactions with any individual affiliate to 10% of the
capital and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to be
secured by collateral in an amount and of a type described in Section 23A and
the purchase of low quality assets from affiliates is generally prohibited.
Section 23B generally provides that certain transactions with affiliates,
including loans and asset purchases, must be on terms and under circumstances,
including credit standards, that are substantially the same or at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on
an insured institution. Formal enforcement action may range from the issuance
of a capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information
26
systems and audit systems, loan documentation, credit underwriting, interest
rate risk exposure, asset growth, and compensation, fees , benefits and such
other operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. The Guidelines set forth the
safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before capital
becomes impaired. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by FDI Act. The final rule
establishes deadlines for the submission and review of such safety and
soundness compliance plans.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally required for 1999 that reserves be maintained against
aggregate transaction accounts as follows: for accounts aggregating $44.3
million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement was 3%; and for accounts aggregating greater than $44.3
million, the reserve requirement was $1.33 million plus 10% (subject to
adjustment by the Federal Reserve Board between 8% and 14%) against that
portion of total transaction accounts in excess of $44.3 million. The first
$5.0 million of otherwise reservable balances (subject to adjustments by the
Federal Reserve Board) were exempted from the reserve requirements. The Bank
maintained compliance with the foregoing requirements. The balances maintained
to meet the reserve requirements imposed by the Federal Reserve Board may be
used to satisfy liquidity requirements imposed by the OTS.
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank report their income on a consolidated
basis and the accrual method of accounting, and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS. For its 1999
taxable year, the Bank is subject to a maximum federal income tax rate of
35.0%.
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1996,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans (generally secured
by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture (i.e.,
take into income) certain portions of their accumulated bad debt reserves. The
1996 Act repeals the reserve method of accounting for bad debts effective for
tax years beginning after 1995. Thrift institutions that would be treated as
small banks are allowed to utilize the Experience Method applicable to such
institutions, while thrift institutions that are treated as large banks (those
generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
27
To the extent the allowable bad debt reserve balance using the thrift's
historical computation method exceeds the allowable bad debt reserve method
under the newly enacted provisions, such excess is required to be recaptured
into income under the provisions of Code Section 481(a). Any Section 481(a)
adjustment required to be taken into income with respect to such change
generally will be taken into income ratably over a six-taxable year period,
beginning with the first taxable year beginning after 1995, subject to the
residential loan requirement.
Under the residential loan requirement provision, the recapture required by
the 1996 Act will be suspended for each of two successive taxable years,
beginning with the Bank's current taxable year, in which the Bank originates a
minimum of certain residential loans based upon the average of the principal
amounts of such loans made by the Bank during its six taxable years preceding
its current taxable year.
Under the 1996 Act, the Bank is permitted to use the Experience Method to
compute its allowable addition to its reserve for bad debts for the current
year. The Bank's bad debt reserve as of December 31, 1995 was computed using
the permitted Experience Method computation and was therefore not subject to
the recapture of any portion of its bad debt reserve as discussed above.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and
then from the Bank's supplemental reserve for losses on loans, to the extent
thereof, and an amount based on the amount distributed (but not in excess of
the amount of such reserves) will be included in the Bank's income. Non-
dividend distributions include distributions in excess of the Bank's current
and accumulated earnings and profits, as calculated for federal income tax
purposes, distributions in redemption of stock, and distributions in partial or
complete liquidation. Dividends paid out of the Bank's current or accumulated
earnings and profits will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves.
28
ITEM 2. PROPERTIES
Original Net Book Value of
Year Date of Property or Leasehold
Leased or Leased or Lease Improvements at
Location Owned Acquired Expiration December 31, 1999
-------- --------- --------- ---------- ---------------------
Corporate Headquarters:
10540 Magnolia Avenue,
Suites B & C
Riverside, CA Leased 1997 2003 1,196,000
Regional Lending Center:
2600 South Parker Road,
Suite 6-300
Aurora, CO Leased 1997 2000 6,000
Regional Lending Center:
8031 Philips Highway
Jacksonville, FL Leased 1997 2002 3,000
Regional Lending Center:
19 Park Street
Attleboro, MA Leased 1998 2003 22,000
Consumer Finance:
4110 Tigris Way
Riverside, CA Owned 1996 -- 572,000
Branch Office:
1598 E Highland Avenue
San Bernadino, CA Leased 1986 2001 164,000
Branch Office:
10530 Magnolia Avenue, Suite A
Riverside, CA Leased 1997 2002 10,000
Branch Office:
1526 Barton Road
Redlands, CA Leased 1998 2003 87,000
Branch Office:
9971 Adams Avenue
Huntington Beach CA Leased 1998 2006 62,000
Branch Office:
13928 Seal Beach Blvd.
Seal Beach, CA Leased 1999 2004 108,000
ITEM 3. LEGAL PROCEEDINGS
In December 1999, certain shareholders of Life Financial Corporation filed a
federal securities lawsuit against the Company, various officers and directors
of the Company, and certain other third parties. The lawsuit was filed in the
United States District Court for the Southern District of New York, and
purports to assert claims against the defendants under the Securities Exchange
Act of 1934 and the Securities Act of 1933. The defendants are not required to
answer or otherwise respond to the Complaint until April 28, 2000.
The Company intends to vigorously defend against the claims asserted in the
litigation. The Company believes that the litigation will not have a material
adverse impact on the results of operations or financial condition of the
Company or the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
29
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company has been quoted on the Nasdaq National
Market under the symbol "LFCO" since the Company's IPO on June 30, 1997. As of
March 26, 2000 there were approximately 296 holders of record of the Common
Stock. The following table summarized the range of the high and low closing
sale prices per share of Common Stock as quoted by Nasdaq for the periods
indicated.
Year Ended December 31, 1999
-----------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High...................... $4.69 $ 5.50 $ 5.63 $ 5.63
Low....................... $3.36 $ 3.81 $ 3.06 $ 3.13
Year Ended December 31, 1998
-----------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High...................... $6.06 $20.56 $25.38 $20.19
Low....................... $2.25 $ 5.00 $17.25 $10.75
ITEM 6. SELECTED FINANCIAL DATA
At December 31,
---------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(In thousands, except per share data)
Selected Balance Sheet
Data:
Total assets.............. $ 547,608 $ 428,078 $ 397,071 $ 101,763 $ 74,136
Securities held-to-
maturity and FHLB stock.. 32,833 4,471 6,079 8,837 2,700
Loans held for sale....... 330,727 243,497 289,268 31,018 21,688
Loans held for
investment............... 106,350 93,604 31,649 38,520 42,870
Allowance for estimated
loan losses.............. 2,749 2,777 2,573 1,625 1,177
Residual assets at fair
value.................... -- 50,296 45,352 4,691 --
Mortgage servicing
rights................... 6,431 13,119 8,526 2,645 683
Deposit accounts.......... 468,859 323,433 211,765 85,711 67,535
Borrowings................ 19,373 41,477 119,170 3,278 --
Stockholders' equity...... 34,462 51,998 50,886 7,716 4,268
Book value per share (1).. $ 5.18 $ 7.92 $ 7.77 $ 2.40 $ 2.29
Shares outstanding (1).... 6,653,436 6,562,396 6,546,716 3,211,716 1,866,216
Selected Operating Data:
Interest income........... $ 46,378 $ 41,104 $ 21,146 $ 6,928 $ 5,825
Interest expense.......... 25,577 22,915 12,830 3,766 3,448
--------- --------- --------- --------- ---------
Net interest income....... 20,801 18,189 8,316 3,162 2,377
Provision for estimated
loan losses.............. 5,382 4,166 1,850 963 1,194
--------- --------- --------- --------- ---------
Net interest income after
provision for estimated
loans losses............. 15,419 14,023 6,466 2,199 1,183
Net gains from mortgage
banking.................. 10,675 7,664 25,730 5,708 3,575
Other noninterest income
(loss)................... (27,853) 6,519 1,500 760 445
Noninterest expense....... 27,485 26,419 15,990 8,681 4,389
--------- --------- --------- --------- ---------
Income (loss) before
income tax provision
(benefit)................ (29,244) 1,787 17,706 (14) 814
Income tax provision
(benefit)................ (11,405) 728 7,382 38 294
--------- --------- --------- --------- ---------
Net income (loss)......... $ (17,839) $ 1,059 $ 10,324 $ (52) $ 520
========= ========= ========= ========= =========
Basic earnings (loss) per
share (2)................ $ (2.71) $ 0.16 $ 2.11 $ (0.02) $ 0.28
========= ========= ========= ========= =========
Diluted earnings (loss)
per share (2)............ $ (2.71) $ 0.16 $ 2.02 $ (0.02) $ 0.28
========= ========= ========= ========= =========
Basic weighted average
shares outstanding (2)... 6,575,189 6,554,743 4,884,993 2,370,779 1,866,216
========= ========= ========= ========= =========
Diluted weighted average
shares outstanding (2)... 6,575,189 6,805,827 5,107,951 2,370,779 1,866,216
========= ========= ========= ========= =========
30
In the year ended and December 31,
------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- -------- -------- --------
(In thousands, except per share data)
Selected Financial
Ratios and Other Data
(3)
Performance Ratios:
Return on average
assets................ (3.16)% 0.23% 4.19% (0.06)% 0.69%
Return on average
equity................ (32.13) 1.92 40.45 (0.90) 13.64
Average equity to
average assets........ 9.82 12.14 10.35 6.77 5.04
Equity to total assets
at end of period...... 6.29 12.15 12.82 7.58 5.76
Average interest rate
spread (4)............ 3.95 3.83 3.30 3.78 3.09
Net interest margin
(5)................... 4.21 4.36 3.68 3.95 3.25
Average interest-
earning assets to
average interest
bearing liabilities... 105.01 109.81 106.65 103.64 103.50
Efficiency Ratio (6)... 757.77 80.96 44.63 88.50 67.78
Loan Originations and
Purchases.............. $1,041,168 $1,180,552 $773,107 $222,553 $134,772
Bank Regulatory Capital
Ratios (7):
Tangible capital....... 6.28 7.21 5.38 7.57 5.68
Core capital........... 6.28 7.21 5.38 7.57 5.68
Risk-based capital..... 10.34 10.90 10.52 8.09 10.17
Asset Quality Ratios:
Non-performing assets
as a percent of total
assets (8)............ 1.14 2.21 1.65 2.93 3.00
Allowance for estimated
loan losses as a
percent of non-
performing loans...... 68.42 36.81 50.20 67.26 84.25
- --------
(1) Book value per share is based upon the shares outstanding at the end of
each period, adjusted retroactively for a 100% stock dividend which
occurred during 1996. Book value per share is then adjusted for the
exchange of three shares of Company Common Stock for one share of Bank
common stock in the Reorganization in 1996.
(2) Earnings (loss) per share is based upon the weighted average shares
outstanding during the period, adjusted retroactively for a 100% stock
dividend which occurred during 1996. Earnings (loss) per share is then
adjusted for the exchange of three shares of Company Common Stock for one
share of Bank common stock in the Reorganization in 1996.
(3) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average daily or average month-end balances during the indicated periods.
(4) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
(5) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(6) The efficiency ratio represents noninterest expense less (gain) loss on
foreclosed real estate divided by noninterest income plus net interest
income before provision for estimated loan losses.
(7) For definitions and further information relating to the Bank's regulatory
capital requirements, see "Item 1--Business--Regulation."
(8) Non-performing assets consist of non-performing loans and REO.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Summary
The principal business of the Bank is attracting retail deposits from the
general public and investing those deposits, together with funds generated from
operations and borrowings, primarily in one- to- four family residential
mortgage loans. The mortgage banking business originates, purchases and sells
conforming, jumbo and other non-conforming mortgage loans and other real estate
secured loans in market niches which generally provide higher yields of return
through a network of approved correspondent and independent mortgage brokers.
The Company's originations and purchases are primarily 1st lien conforming,
jumbo and other non-conforming mortgages with approximately 80% of all
originations within the "A", "Alt A", and "A minus" credit categories. The
Company funds substantially all of the loans which it originates or purchases
through deposits, other borrowings, internally generated funds and FHLB
advances. Deposit flows and cost of funds are influenced by prevailing market
rates of interest primarily on competing investments, account maturities and
the levels of savings in the Company's market area. The Company's ability to
purchase or sell loans is influenced by the general level of product available
from its correspondent and broker relationships and the willingness of
investors to purchase the loans at an acceptable price to the Company. The
Company's results of operations are also affected by the Company's provision
for loan losses and the level of operating expenses. The Company's operating
expenses primarily consist of employee compensation and benefits, premises and
occupancy expenses, and other general expenses. The Company's results of
operations are also affected by prevailing economic conditions, competition,
government policies and actions of regulatory agencies. See "Item 1--Business--
Regulation."
31
Average Balance Sheets
The following tables set forth certain information relating to the Company at
December 31, 1999 and for the years ended December 31, 1998, and 1997. The
yields and costs are derived by dividing income or expense by the average
balance of assets or liabilities, respectively, for the periods shown. Unless
otherwise noted, average balances are measured on a daily basis. The yields
and costs include fees which are considered adjustments to yields.
Year Ended December 31,
--------------------------------------------------------------------------------------
1999 1998 1997
---------------------------- ---------------------------- ----------------------------
Average Average Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost
-------- -------- ---------- -------- -------- ---------- -------- -------- ----------
(Dollars in thousands)
Assets:
Cash and cash
equivalents............ $ 21,433 $ 1,128 5.27% $ 29,268 $ 1,499 5.12% $ 9,709 $ 635 6.54%
Investment securities
(1).................... 16,951 959 5.66 6,267 374 5.98 8,694 496 5.70
Residual mortgage-
backed securities (1).. 45,049 3,300 7.33 51,789 6,984 13.49 16,549 2,269 13.71
Loans receivable, net
(2).................... 411,189 40,991 9.97 329,699 32,247 9.78 191,140 17,746 9.28
-------- ------- -------- ------- -------- ------
Total interest
earning assets...... 494,622 46,378 9.38 417,023 41,104 9.86 226,092 21,146 9.35
Non-interest-earning
assets (3)............ 70,483 37,708 20,471
-------- -------- --------
Total assets (3)... $565,105 $454,731 $246,563
======== ======== ========
Passbook accounts, money
mkt, and checking,...... $ 31,833 730 2.30 $ 27,069 640 2.36 $ 18,730 451 2.41
Certificate accounts.... 392,072 21,270 5.43 229,121 13,408 5.85 128,213 7,587 5.92
-------- ------- -------- ------- -------- ------
Total interest bearing
deposits............... 423,905 22,000 5.19 256,190 14,048 5.48% 146,943 8,038 5.47
Loan and securities
repurchase advances..... 20,145 1,088 5.40 99,368 6,168 6.21
Subordinated notes and
other borrowings........ 26,955 2,489 9.23 24,198 2,699 11.15 65,046 4,792 7.37
-------- ------- -------- ------- -------- ------
Total interest-bearing
liabilities............. 471,005 25,577 5.43 379,756 22,915 6.03 211,989 12,830 6.05
------- ------- ------
Non-interest-bearing
liabilities (3)....... 38,579 19,760 9,052
-------- -------- --------
Total liabilities
(3)................ 509,584 399,516 221,041
Equity (3)........ 55,521 55,215 25,522
-------- -------- --------
Total liabilities and
equity (3)........... $565,105 $454,731 $246,563
======== ======== ========
Net interest income..... $20,801 $18,189 $8,316
======= ======= ======
Net interest rate spread
(4)..................... 3.95% 3.83% 3.30%
Net interest margin
(5)..................... 4.21% 4.36% 3.68%
Ratio of interest-
earning assets to
interest-bearing
liabilities............. 105.01% 109.81% 106.65%
- ----
(1) Includes unamortized discounts and premiums and certificates of deposit.
(2) Amount is net of deferred loan origination fees, unamortized discounts,
premiums and allowance for estimated loan losses and includes loans held
for sale and non-performing loans. See "Business--Lending Overview."
(3) Average balances are measured on a month-end basis.
(4) Net interest rate spread represents the difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average
interest-earning assets.
32
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected the Company's interest income
and interest expense during the periods indicated. Information is provided in
each category with respect to: (i) changes attributable to changes in volume
(changes in volume multiplied by prior rate); (ii) changes attributable to
changes in rate (changes in rate multiplied by prior volume); and (iii) the net
change. The changes attributable to the combined impact of volume and rate have
been allocated proportionately to the changes due to volume and the changes due
to rate.
Year Ended
Year Ended December 31, December 31, 1998
1999 Compared to Year Compared to Year Ended
Ended December 31, 1998 December 31, 1997
------------------------- ------------------------
Increase (decrease) Increase (decrease)
due to due to
------------------------- ------------------------
Average Average
Volume Rate Net Volume Rate Net
------- ------- ------- ------- ------ -------
(Dollars in thousands)
Interest earning assets:
Interest earning
deposits and short term
investments............ $ (415) $ 46 $ (369) $ 1,029 $ (165) $ 864
Investment securities... 603 (19) 584 (144) 22 (122)
Residual mortgage-backed
securities............. (817) (2,867) (3,684) 4,753 (38) 4,715
Loans receivable,
net (1)................ 8,113 631 8,744 13,497 1,004 14,501
------- ------- ------- ------- ------ -------
Total interest earning
assets............... 7,484 (2,209) 5,275 19,135 823 19,958
Interest bearing
liabilities:
Passbook accounts....... 9 (13) (4) 70 71 141
Money market accounts... 84 (21) 63 7 11 18
Checking accounts....... 40 (8) 32 120 (90) 30
Certificate accounts.... 8,761 (899) 7,862 5,912 (91) 5,821
Borrowings.............. (5,841) 551 (5,290) 4,202 (127) 4,075
------- ------- ------- ------- ------ -------
Total interest bearing
deposits............. 3,053 (390) 2,663 10,311 (226) 10,085
------- ------- ------- ------- ------ -------
Change in net interest
income................... $ 4,431 $(1,819) $ 2,612 $ 8,824 $1,049 $ 9,873
======= ======= ======= ======= ====== =======
- --------
(1) Includes interest on loans held for sale.
Comparison of Operating Results for the Year Ended December 31, 1999 and
December 31, 1998
General
For the year ended December 31, 1999 the Company reported a net loss of
$17.8 million or $2.71 per share, compared to net income of $1.1 million or
$0.16 per diluted share, for the year ended December 31, 1998. The decrease in
net income was the result of three primary factors. The sale of the Parent
Company's residual mortgage-backed securities related to three remaining
securitizations resulted in a one-time after tax charge of approximately $16.8
million. A lower of cost or market reserve was recorded in the amount of $3
million against the Company's held-for-sale loan portfolio. Additionally, the
Company provided an additional $2.7 million for loan losses in the fourth
quarter.
Interest Income
Interest income for the year ended December 31, 1999 was $46.4 million,
compared to $41.1 million for the year ended December 31, 1998. The increase of
$5.3 million, or 12.9%, is due to an increase in average balance of
interest-earning assets, partially offset by a lower realized yield on the
Company's residual mortgage backed securities.
Interest income on loans receivable increased $8.8 million to $41.0 million
for the year ended December 31, 1999 from $32.2 million for the year ended
December 31, 1998. The increase in interest income was primarily the result of
an $81.5 million increase in average loans receivable.
33
Interest Expense
Interest expense for the year ended December 31, 1999 was $25.6 million,
compared to $22.9 million for the year ended December 31, 1998. The $2.7
million increase reflects $91.3 million higher average interest-bearing
liabilities to support the growth in the company's assets. The increase in
retail deposits over wholesale deposits coupled with increased usage of the
FHLB line of credit resulted in a decrease in the average cost of interest-
bearing liabilities to 5.43% for the year ended December 31, 1999 compared to
6.03% for the year ended December 31, 1998.
Net Interest Income
Net interest income was $20.8 million for the year ended December 31, 1999,
compared to $18.2 million for the year ended December 31, 1998. The increase in
net interest income is reflective of higher average assets combined with lower
cost of funds from increased retail deposits, resulting in higher net interest
margins for the period. The Bank's net interest margin for the year ending
December 31, 1999 was 4.21% compared to 4.36% for the year earlier period.
Provision for Estimated Loan Losses
The provision for loan losses increased from $4.2 million for year ended
December 31, 1998 to $5.4 million for the year ended December 31, 1999. The
29.2% increase over the previous year reflects a change in the Company's loan
loss reserve policy primarily based on actual experience of charge-offs and
recoveries related to the Company's high loan-to-value 2nd trust and sub-prime
1st trust mortgage product. The Company exited the 125% loan-to-value 2nd trust
mortgage business in the fourth quarter of 1998. At December 31, 1999, the
Company owned $76.1 million of 2nd trust mortgage products with loan-to-values
in excess of 90%.
Non-Interest Income (Loss)
Non-interest income (loss) was ($17.2) million for the year ended December
31, 1999, compared to $14.2 million for the year ended December 31, 1998.
Eliminating the one-time charge of $34.0 million related to the sale of the
Company's residual mortgage-backed securities and related mortgage servicing
rights, non-interest income would have been $16.8 million for the year ended
December 31, 1999.
The Company sold its remaining residual mortgage-backed securities retained
from securitization and related servicing rights for an amount valued at $19.3
million in cash and other consideration. The transaction, which was executed on
December 31, 1999, includes the Company's remaining residual securities and
mortgage servicing for the following securitizations:
LIFE Financial Home Loan Owner Trust 1997-2,
LIFE Financial Home Loan Owner Trust 1997-3, and
LIFE Bank Asset Backed Certificates, Series 1998-1.
Additionally, the Company provided a reserve of $3.0 million against the
held-for-sale loan portfolio to adjust the value to the lower of cost or
market. The reserve is related to certain sub- and non-performing loans. The
reserve was established in conjunction with review of the age, composition and
specific performance of the Company's available-for-sale loans.
Non-Interest Expense
Noninterest expense for the year ended December 31, 1999 was $27.4 million
compared to $26.4 million for the year ended December 31, 1998. The $1.0
million increase in expense was a combination of premises and occupancy expense
associated with the expansion of branch facilities and a contractual one-time
severance payment made during the third quarter of 1999.
34
Income Taxes
The provision for income taxes decreased to a credit (tax receivable) of
$11.4 million for the year ended December 31, 1999 compared to $728 thousand
expense for the year ended December 31, 1998. Income before income tax
provision decreased to ($29.2) million for the year ended December 31, 1999
compared to $1.8 million for the year ended December 31, 1998 primarily due to
the loss associated with the sale of the Company's residual mortgage-backed
securities. The effective tax rate decreased to 39.0% for the year ended
December 31, 1999 compared to 40.7% for the year ended December 31, 1998.
Comparison of Financial Condition at December 31, 1999 and December 31, 1998
Total assets of the Company and the Bank were $547.6 million at December 31,
1999 compared to $428.1 million at December 31, 1998. The 27.9% increase in
total assets of the Company was primarily the result of a 30% or $100 million
increase in the loan portfolio partially offset by a reduction in the Company's
investment securities due to the sale of the residual mortgage-backed
securities.
Total Bank deposits at December 31, 1999 were $468.9 million compared to
$323.4 million at December 31, 1998. The 44.9% increase in deposits is the
result of growth of 137.0% in the Bank's retail deposits. During 1999, the
Bank's strategy focused heavily on increasing retail and core deposits to
reduce reliance on wholesale certificates of deposit and other borrowings. Core
deposits during the year grew from $26.5 million at December 31, 1998 to $37.5
million at December 31, 1999, an increase of 38.4%. Additionally, the ratio of
retail deposits to total deposits increased to 52.4% for the period ended
December 31, 1999, compared to 33.0% at December 31, 1998. The cost of the
Bank's retail deposits at December 31, 1999 was 5.33% versus 4.73% for the year
earlier period.
The allowance for loan losses was $2.7 million at December 31, 1999,
compared to $2.8 million at December 31, 1998. The December 31, 1999 allowance
for loan losses as a percent of non-performing loans was 68.4%, not inclusive
of the $3.0 million lower-of-cost-or-market reserve, compared to 36.8% at
December 31, 1998. The Bank's net credit loss rate for the year ended December
31, 1998 was 1.31% versus 1.22% for the year earlier period. LIFE Bank's 30+
day delinquency rate at December 31, 1999 was 1.96%, compared to 5.41% at
December 31, 1998. The reduced delinquency rate was the result of the sale of
sub- and non-performing loans held in the Bank's investment and available-for-
sale loan portfolios.
Comparison of Operating Results for the Year Ended December 31, 1998 and
December 31, 1997
General
For the year ended December 31, 1998 the Company recorded net income of $1.1
million compared to $10.3 million for the year ended December 31, 1997. The
basic and diluted earnings per share for the year ended December 31, 1998 were
$0.16 and $0.16, respectively, compared to $2.11 and $2.02 respectively, for
the year ended December 31, 1997. The decrease in net income was due to write-
downs of residual mortgage-backed securities and mortgage servicing rights, an
increase to the provision for loan losses, as well as a lower of cost or market
adjustment related to the transfer of loans from Loans Held for Sale to Loans
Held for Investment.
Interest Income
Interest income for the year ended December 31, 1998 was $41.1 million,
compared to $21.1 million for the year ended December 31, 1997, due to an
increase in the average balance of interest earning assets, combined with an
increase in the yield on those assets. Average interest earning assets
increased to $417.0 million for the year ended December 31, 1998 compared to
$226.1 million for the year ended December 31, 1997. The yield on interest
earning assets increased to 9.86% for the year ended December 31, 1998 compared
to 9.35% for the year ended December 31, 1997. The largest single component of
interest earning assets was average loans receivable, net, which were $329.7
million with a yield of 9.78% for the year ended December 31, 1998 compared to
$226.1 million with a yield of 9.35% for the year ended December 31, 1997. The
increase in the average balance of loans receivable was attributable to growth
of the Company's mortgage financing operations.
35
Interest Expense
For the year ended December 31, 1998, interest expense was $22.9 million,
compared to $12.8 million for the year ended December 31, 1997 due to an
increase in the average balance of interest bearing liabilities combined with a
slight decrease in the cost of those liabilities. Average interest bearing
liabilities were $379.8 million at an average cost of 6.03% for the year ended
December 31, 1998 compared to $212.0 million at an average cost of 6.05% for
the year ended December 31, 1997.
The largest component of average interest bearing liabilities was
certificate accounts, which averaged $229.1 million with an average cost of
5.85% compared to $128.2 million with an average cost of 5.92% for the year
ended December 31, 1997. The second largest component of interest bearing
liabilities is borrowings, which increased to an average balance of $123.6
million with an average cost of 7.18% for the year ended December 31, 1998
compared to $65.0 million with an average cost of 7.37% for the year ended
December 31, 1997. During 1998, increased borrowings include two warehouse
lines of credit in the amount of $375.0 million which are indexed to LIBOR. In
addition, the Company entered into a residual financing line of credit in the
amount of $40.0 million, which is also indexed to LIBOR. In the fourth quarter
of 1998, the Company entered into a $10 million revolving line of credit to pay
off certain subordinated debentures.
Net Interest Income Before Provision for Estimated Loan Losses
Net interest income before provision for estimated loan losses for the year
ended December 31, 1998 was $18.2 million compared to $8.3 million for the year
ended December 31, 1997. This increase was the net effect of an increase in
average interest earning assets and average interest bearing liabilities, as
well as an increase in the ratio of interest earning assets to interest bearing
liabilities. Average interest earning assets increased to $417.0 million for
the year ended December 31, 1998 compared to $226.1 million for the year ended
December 31, 1997. Average interest bearing liabilities increased to $379.8
million with an average cost of 6.03% for the year ended December 31, 1998
compared to $212.0 million with an average cost of 6.05% for the year ended
December 31, 1997. The ratio of interest earning assets to interest bearing
liabilities was 109.81% for the year ended December 31, 1998 compared to
106.65% for the year ended December 31, 1997.
Provision for Estimated Loan Losses
Provision for estimated loan losses was $4.2 million for the year ended
December 31, 1998 compared to $1.9 million for the year ended December 31,
1997. The increase in provision was based on an evaluation of the composition
of the Company's loan portfolio and an increase in non-performing loans. Charge
offs net of recoveries for the year ended December 31, 1998 were $4.0 million
compared to $902,000 for the year ended December 31, 1997. The Company had non-
accrual loans at December 31, 1998 of $7.5 million, compared to $5.1 million at
December 31, 1997. Management believes that the allowance for loan losses at
December 31, 1998 was adequate to absorb known and inherent risks in the
Company's loan portfolio. No assurance can be given, however, that economic
conditions which may adversely affect the Company's or the Bank's service areas
or other circumstances will not be reflected in increased losses in the loans
portfolio. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance or
to take charge-offs (reductions in the allowance) in anticipation of losses.
See "Item 1--Business--Lending Overview--Delinquencies and Classified Assets"
and "--Lending Overview--Allowance for Loan Losses."
Non-Interest Income
For the year ended December 31, 1998, net gains from mortgage financing
operations totaled $7.7 million compared to $25.7 million for the year ended
December 31, 1997. The 1998 net gain includes a pre-tax unrealized loss of
$16.6 million, due to an adjustment to the valuation of the residual assets as
a result of the higher-than-estimated prepayment speeds and credit losses. See
"Item 1--Business-Asset Securitizations." There was an overall increase in the
level of mortgage financing operations, with loans sold or securitized
36
totaling $1.1 billion for the year ended December 31, 1998 compared to $510.1
million for the year ended December 31, 1997. This increase in percentage
reflected the effects of the securitization of loans compared to whole loan
sales. During the year ended December 31, 1998, loans securitized represented
43.1% of loan sales and securitizations, while during the year ended December
31, 1997, loans securitized represented 81.5% of loan sales and
securitizations. Loans originated and purchased totaled $1.2 billion for the
year ended December 31, 1998 compared to $773.1 million for the year ended
December 31, 1997.
Non-Interest Expense
For the year ended December 31, 1998, non-interest expense was $26.4 million
compared to $16.0 million for the year ended December 31, 1997. The increase
was due primarily to an increase in compensation and benefits and other
operating expenses resulting from the expansion of the mortgage financing
operations. New loans originated and purchased totaled $1.2 billion for the
year ended December 31, 1998 compared to $773.1 million for the year ended
December 31, 1997.
For the year ended December 31, 1998, compensation and benefits were $11.6
million compared to $9.2 million for the year ended December 31, 1997. These
costs are directly related to the expansion of the mortgage financing
operations and the corresponding increase in personnel, to an average of 310
for the year ended December 31, 1998 compared to 230 for the year ended
December 31, 1997.
Premises and occupancy expenses were $3.4 million for the year ended
December 31, 1998 compared to $1.4 million for the year ended December 31, 1997
due to the expansion of the mortgage financing operation and the addition of
the regional operating centers in the Boston, Massachusetts and San Jose,
California metropolitan areas, the addition of five low cost retail lending
offices in California, and the opening of two new retail Bank branches in
Redlands, and Huntington Beach, California.
As a result of the expansion of the mortgage financing operations, other
operating expenses increased as well. Data processing increased to $1.5 million
for the year ended December 31, 1998 compared to $809,000 for the year ended
December 31, 1997. Marketing, telephone, professional services and other
expenses were $2.4 million, $1.4 million, $1.6 million and $4.2 million,
respectively, for the year ended December 31, 1998 compared to $301,000,
$650,000, $467,000 and $3.0 million for the year ended December 31, 1997. Other
expense for the year ended December 31, 1998 included a write down of the
servicing asset in the amount of $1.2 million. This write down is the result of
an increase in prepayment speeds on adjustable rate mortgage loans which are
being serviced by the Company for other investors. Management performs a
quarterly analysis of the Company's servicing assets and believes that the
servicing assets are properly valued at December 31, 1998.
Income Taxes
The provision for income taxes decreased to $728,000 for the year ended
December 31, 1998 compared to $7.4 million for the year ended December 31,
1997. Income before income tax provision decreased to $1.8 million for the year
ended December 31, 1998 compared to $17.7 million for the year ended
December 31, 1997. The effective tax rate decreased to 40.7% for the year ended
December 31, 1998 compared to 41.7% for the year ended December 31, 1997.
Comparison of Financial Condition at December 31, 1998 and December 31, 1997
Total assets increased to $428.1 million as of December 31, 1998 compared to
$397.1 million as of December 31, 1997. Loans held for sale totaled $243.5
million as of December 31, 1998 compared to $289.3 million as of December 31,
1997. This decrease was partially offset by a increase in loans held for
investment to $90.8 million as of December 31, 1998 compared to $29.1 million
as of December 31, 1997. During the year ended December 31, 1998 and 1997, the
Company sold or securitized $1.1 billion of loans (including $610.5 million in
whole loan sales) and sold or securitized $510.1 million of loans (including
$94.7 million in whole loan sales), respectively. The increase in loans held
for sale also resulted in an increase in accrued interest receivable to $2.8
million as of December 31, 1998 compared to $2.6 million as of December 31,
1997.
37
As a result of the Company's loan securitization activities, residual
mortgage-backed securities increased to $50.3 million as of December 31, 1998
compared to $45.4 million as of December 31, 1997. Mortgage servicing rights
also increased to $13.1 million as of December 31, 1998 compared to $8.5
million as of December 31, 1997 as a result of the securitization and whole
loan sales with servicing retained.
Cash and cash equivalents were $8.2 million as of December 31, 1998 compared
to $3.5 million as of December 31, 1997. During the year ended December 31,
1998, the Company invested in leasehold improvements on the new servicing
department area as well as adding the Attleboro, Massachusetts and San Jose
regional lending centers and two new retail banking branches in California
increasing premises and equipment to $7.1 million as of December 31, 1998
compared to $4.8 million as of December 31, 1997. Real estate owned increased
to $1.9 million as of December 31, 1998 compared to $1.4 million as of December
31, 1997 as part of the Company's continuing effort to resolve problem loans.
The Company increased its liabilities by increasing deposit accounts to
$323.4 million as of December 31, 1998 compared to $211.8 million as of
December 31, 1997. The major component of deposit accounts is certificates of
deposit, which increased to $297.0 million as of December 31, 1998 compared to
$193.8 million as of December 31, 1997. The additional funds were used to fund
loans held for investment during the year ended December 31, 1998. The Company
also increased its use of FHLB advances and other borrowings to fund loans held
for sale. During 1998, the Company increased its two warehouse lines of credit
from a combined credit limit of $250.0 million. to $375.0 million. During 1998,
an additional line of credit was added with a credit limit of $10.0 million.
The availability of such borrowings permits the Company to access sufficient
cash to originate and hold loans pending securitization or sale and to
thereafter repay the lines of credit following securitization or sale of the
loans. Other borrowings decreased to $40.0 million as of December 31, 1998
compared to $100.2 million as of December 31, 1997, while FHLB advances were
zero as of December 31, 1998 and were $9.0 million as of December 31, 1997.
Interest rates on the warehouse lines of credit range between LIBOR plus 50
basis points to LIBOR plus 100 basis points, while the residual financing line
of credit has an interest rate of LIBOR plus 235 basis points.
During the year ended December 31, 1997 the Bank issued $10.0 million in
subordinated debentures in order to increase its risk based capital.. The
subordinated debentures have a coupon rate of 13.5%. During 1998, these
debentures were transferred to the Company. As of September 30, 1998, holders
exercised their option to have the Company purchase $8.5 million of Debentures.
On December 14, 1998, $8.5 million of these debentures were redeemed.
Stockholders' equity increased to $52.0 million as of December 31, 1998
compared to $50.9 million as of December 31, 1997 due to net income of $1.1
million.
Management of Interest Rate Risk
The principal objective of the Company's interest rate risk management
function is to evaluate the interest rate risk included in certain balance
sheet accounts, determine the level of appropriate risk given the Company's
business focus, operating environment, capital and liquidity requirements and
performance objectives and manage the risk consistent with Board approved
guidelines through the establishment of prudent asset concentration guidelines.
Through such management, management of the Company seeks to reduce the
vulnerability of the Company's operations to changes in interest rates.
Management of the Company monitors its interest rate risk as such risk relates
to its operational strategies. The Company's Board of Directors reviews on a
quarterly basis the Company's asset/liability position, including simulations
of the effect on the Company's capital of various interest rate scenarios. The
extent of the movement of interest rates, higher or lower, is an uncertainty
that could have a negative impact on the earnings of the Company.
Between the time the Company originates loans and purchase commitments are
issued, the Company is exposed to both upward and downward movements in
interest rates which may have a material adverse effect on the Company. The
Board of Directors of the Company recently implemented a hedge management
policy
38
primarily for the purpose of hedging the risks associated with loans held for
sale in the Company's mortgage pipeline. In a flat or rising interest rate
environment, this policy enables management to utilize mandatory forward
commitments to sell fixed rate assets as the primary hedging vehicles to
shorten the maturity of such assets. In a declining interest rate environment,
the policy enables management to utilize put options. The hedge management
policy also permits management to extend the maturity of its liabilities
through the use of short financial futures positions, purchase of put options,
interest rate caps or collars, and entering into "long" interest rate swap
agreements. Management may also utilize "short" interest rate swaps to shorten
the maturity of long-term liabilities when the net cost of funds raised by
using such a strategy is attractive, relative to short-term CD's or borrowings.
Management is continuing to evaluate and refine its hedging policies. No
hedging positions were outstanding at December 31, 1999.
Net Portfolio Value. The Bank's interest rate sensitivity is monitored by
management through the use of a model which estimates the change in net
portfolio value ("NPV") over a range of interest rate scenarios. NPV is the
present value of expected cash flows from assets, liabilities and off-balance
sheet contracts. An NPV Ratio, in any interest rate scenario, is defined as the
NPV in that scenario divided by the market value of assets in the same
scenario. The sensitivity measure is the decline in the NPV Ratio, in basis
points, caused by a 2% increase or decrease in rates, whichever produces a
larger decline (the "Sensitivity Measure"). The higher an institution's
Sensitivity Measure is, the greater its exposure to interest rate risk is
considered to be. The Bank utilizes a market value model prepared by the OTS
(the "OTS NPV model"), which is prepared quarterly, based on the Bank's
quarterly Thrift Financial Reports filed with the OTS. The OTS NPV model
measures the Bank's interest rate risk by estimating the Bank's NPV, which is
the net present value of expected cash flows from assets, liabilities and any
off-balance sheet contracts, under various market interest rate scenarios which
range from a 300 basis point increase to a 300 basis point decrease in market
interest rates. The OTS has incorporated an interest rate risk component into
its regulatory capital rule. Under the rule, an institution whose Sensitivity
Measure in the event of a 200 basis point increase or decrease in interest
rates exceeds 2% would be required to deduct an interest rate risk component in
calculating its total capital for purpose of the risk-based capital
requirement. See "Item 1--Business--Regulation--Federal Savings Institution
Regulation." As of December 31, 1999, the most recent date for which the
relevant data is available, the Bank's Sensitivity Measure, as measured by the
OTS, resulting from a 200 basis point increase in interest rates was 146 basis
points and would result in a $9.2 million reduction in the NPV of the Bank. The
OTS has postponed indefinitely the date the component will first be deducted
from an institution's total capital. See "Item 1--Business--Federal Savings
Institution Regulation."
The following table shows the NPV and projected change in the NPV of the
Bank at December 31, 1999 assuming an instantaneous and sustained change in
market interest rates of 100, 200, and 300 basis points ("bp").
Interest Rate Sensitivity of Net Portfolio Value (NPV)
Net Portfolio Value NPV as % of Portfolio
- ------------------------------------------- Value of Assets
Change in Rates $ Amount $ Change % Change NPV Ratio % Change (BP)
- --------------- -------- -------- -------- --------- ---------------------
+300 BP 42,366 (16,987) -29% 8.15% -277 BP
+200 BP 50,114 (9,239) -16% 9.46% -146 BP
+100 BP 55,810 (3,544) -6% 10.38% -54 BP
Static 59,353 10.92%
-100 BP 61,704 2,351 4% 11.25% +34 BP
-200 BP 65,036 5,683 10% 11.74% +82 BP
-300 BP 69,916 10,563 18% 12.46% +154 BP
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in NPV requires the making of
certain assumptions that may tend to oversimplify the manner in which actual
yields and costs respond to changes in market interest rates. First, the models
assume that the composition of the Bank's interest sensitive assets and
liabilities existing at the beginning of a period remains constant over the
period being measured. Second, the models assume that a particular change in
39
interest rates is reflected uniformly across the yield curve regardless of the
duration to maturity or repricing of specific assets and liabilities. Third,
the model does not take into account the impact of the Bank's business or
strategic plans on the structure of interest-earning assets and interest-
bearing liabilities. Although the NPV measurement provides an indication of the
Bank's interest rate risk exposure at a particular point in time, such
measurement is not intended to and does not provide a precise forecast of the
effect of changes in market interest rates on the Bank's net interest income
and will differ from actual results.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, FHLB advances, other
borrowings, principal and interest payments on loans, cash proceeds from the
sale of loans, and to a lesser extent, interest payments on investment
securities and proceeds from the maturation of investment securities. While
maturities and scheduled amortization of loans are a predictable source of
funds, deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition. However, the Bank has
continued to maintain the required minimum levels of liquid assets as defined
by OTS regulations. This requirement, which may be varied at the direction of
the OTS depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required ratio is
currently 4%. The Bank's average liquidity ratios were 5.70%, 7.04%, and 10.4%
for the years ended December 31, 1999, 1998 and 1997, respectively.
The Company's most liquid assets are cash and short-term investments. The
levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At December 31, 1999,
cash and short-term investments totalled $20.3 million. The Company has other
sources of liquidity if a need for additional funds arises, including the
utilization of FHLB advances. At December 31, 1999, the Bank had no advances
outstanding from the FHLB. Other sources of liquidity include investment
securities maturing within one year. The Bank also has a warehouse line of
credit available in the amount of $250.0 million of which zero had been drawn
upon at December 31, 1999. The Company has a $10 million revolving line of
credit of which $2.5 million has been drawn upon at December 31, 1999.
The OTS capital regulations requires savings institutions to meet three
minimum capital requirements: a 1.5% tangible capital ratio, a 3.0% leverge
(core capital) ratio, and an 8.0% risk-based capital ratio. At December 31,
1999, the Bank exceeded all of its regulatory capital requirements and was
therefore considered "well capitalized". See "Item 1--Regulation--Federal
Savings Institution Regulation--Capital Requirements."
The Company had no material contractual obligations or commitments for
capital expenditures at December 31, 1999. At December 31, 1999 the Company had
$8.4 million outstanding commitments to originate or purchase mortgage loans
compared to $11.0 million at December 31, 1998. The Company anticipates that it
will have sufficient funds available to meet its current and anticipated loan
origination commitments. Certificates of deposit which are scheduled to mature
in one year or less from December 31, 1999, totalled $428.0 million. The
Company expects that a substantial portion of the maturing certificates of
deposit will be retained by the Company at maturity.
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
("GAAP"), which require the measurement of financial position and operating
results in terms of historical dollar amounts 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 industrial companies, nearly all of 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 price of goods and services.
40
Impact of New Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. This
statement establishes accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those derivatives
at fair value. The accounting for gains and losses resulting from changes in
the value of those derivatives will depend on the intended use of the
derivative and whether it qualifies for hedge accounting. On June 23, 1999, the
FASB voted to approve a proposal to delay the effective date of SFAS No. "133"
to fiscal years beginning after June 15, 2000 (calendar year 2001 for the
Company). The adoption of this standard is not expected to have a material
effect on the Company's financial condition, results of operations and cash
flows.
41
Quantitative and Qualitative Disclosures about Market Risk
The following table provides information regarding the Company's primary
categories of assets and liabilities which are sensitive to changes in interest
rates for the years ended December 31, 1999 and 1998. The information presented
reflects the expected cash flows of the primary categories by year including
the related weighted average interest rate. The cash flows for loans and
mortgage-backed securities are based on maturity date and are adjusted for
expected prepayments which are based on historical and current market
information. The loans and mortgage-backed securities which have adjustable
rate features are presented in accordance with their next interest-repricing
date. Cash flow information on interest-bearing liabilities such as passbooks,
NOW accounts and money market accounts also is adjusted for expected decay
rates which are based on historical information. Also, for purposes of cash
flow presentation, premiums or discounts on purchased assets, mark-to-market
adjustments and loans on non-accrual are excluded from the amounts presented.
Investment securities are presented as to maturity date as are all certificates
of deposit and borrowings.
Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
At December 31, 1999 ------ ------ ------ ------ ------ ----------
(Dollars in thousands)
Selected Assets:
Investments and Fed
Funds................. $ 32,955 $ -- $ -- $ -- $ 150 $ --
Average interest
rates................. 3.89% 0.00% 0.00% 0.00% 0.00% 0.00%
Mortgage-backed
securities............
Adjustable Rate...... $ 6 $ -- $ -- $ -- $ -- $ --
Average Interest
Rate................ 6.63% 0.00% 0.00% 0.00% 0.00% 0.00%
Loans--fixed rate...... $ 841 $ 376 $ 982 $1,466 $ 105 $205,096
Average interest
rate.................. 7.41% 17.23% 17.09% 15.71% 17.23% 11.26%
Loans--adjustable
rate.................. $146,845 $55,533 $43,631 $1,664 $1,790 $ 229
Average interest
rate.................. 9.44% 9.62% 9.72% 9.90% 8.81% 9.56%
Participation
Contract.............. -- -- 4,350 3,446 2,589 7,579
Average interest
rate.................. 15.00% 15.00% 15.00% 15.00% 15.00% 15.00%
Mortgage Servicing
Rights................ $ 2,820 $ 1,803 $ 1,047 $ 582 $ 335 $ 422
Average Interest
Rate.................. 13.50% 13.50% 13.50% 13.50% 13.50% 13.50%
Selected Liabilities:
Interest-bearing NOW
passbook and MMDA's... $ 7,505 $ 6,004 $ 4,803 $3,843 $3,074 $ 12,296
Average interest
rate.................. 1.94% 1.94% 1.94% 1.94% 1.94% 1.94%
Certificates of
deposit................ $427,954 $ 1,861 $ 379 $ 202 $ 73 $ 863
Average interest rate... 5.86% 6.09% 6.19% 5.67% 7.38% 6.40%
FHLB Advances.......... $ -- $ -- $ -- $ -- $ -- $ --
Average interest
rate.................. 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Lines of Credit and
Sub-Debentures........ $ 17,873 $ -- $ -- $ -- $ -- $ 1,500
Average interest
rate.................. 8.48% 0.00% 0.00% 0.00% 0.00% 13.50%
Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
At December 31, 1998 -------- ------- ------- ------ ------ ----------
(Dollars in thousands)
Selected Assets:
Investments and Fed
Funds................. $ 2,000 $ -- $ -- $ -- $ -- $ --
Average interest
rate.................. 6.13% 0.00% 0.00% 0.00% 0.00% 0.00%
Mortgage-backed
securities--
Adjustable rate....... $ 8 $ -- $ -- $ -- $ -- $ --
Average interest
rate.................. 7.25% 0.00% 0.00% 0.00% 0.00% 0.00%
Loans--fixed rate...... $ 1,396 $ 468 $ 561 $ 657 $1,866 $213,743
Average interest
rate.................. 9.18% 11.92% 15.08% 15.65% 16.35% 10.85%
Loans--adjustable
rate.................. $ 60,267 $41,686 $16,322 $ 587 $ -- $ --
Average interest
rate.................. 9.16% 9.46% 10.18% 10.18% 0.00% 0.00%
Residual mortgage-
backed securities..... $ 1,610 $ 6,938 $ 8,149 $7,338 $5,761 $ 20,500
Average Interest
Rate.................. 13.50% 13.50% 13.50% 13.50% 13.50% 13.50%
Mortgage Servicing
Rights................ $ 4,250 $ 3,186 $ 2,075 $1,326 $ 848 $ 1,434
Average Interest
Rate.................. 13.50% 13.50% 13.50% 13.50% 13.50% 13.50%
Selected Liabilities:
Interest-bearing NOW
passbook and MMDA's... $ 5,292 $ 4,233 $ 3,387 $2,709 $2,168 $ 8,820
Average interest
rate.................. 2.74% 2.74% 2.74% 2.74% 2.74% 2.74%
Certificates of
deposit................ $291,118 $ 4,048 $ 708 $ 383 $ 139 $ 578
Average interest rate... 5.51% 5.76% 6.43% 5.94% 5.90% 6.80%
Warehousing lines of
credit and
subordinated
debentures............ $ 39,977 $ -- $ -- $ -- $ -- $ 1,500
Average interest
rate.................. 7.56% 0.00% 0.00% 0.00% 0.00% 13.50%
The Company does not have any foreign exchange exposure nor any commodity
exposure and therefore does not have any market risk exposure for these issues.
42
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Life Financial Corporation
We have audited the accompanying consolidated statement of financial
condition of Life Financial Corporation and subsidiaries (the "Company") as of
December 31, 1999, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Life Financial Corporation and subsidiaries as of December 31, 1999, and the
consolidated results of their operations and their consolidated cash flows for
the year then ended, in conformity with generally accepted accounting
principles.
/s/ Grant Thornton LLP
Irvine, California
March 24, 2000
43
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
LIFE Financial Corporation
Riverside, California
We have audited the accompanying consolidated statement of financial
condition of LIFE Financial Corporation and subsidiaries (the Company) as of
December 31, 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the two 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
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of LIFE Financial Corporation and
subsidiaries as of December 31, 1998, and the results of their operations and
their cash flows for each of the two years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
COSTA MESA, CALIFORNIA
March 26, 1999
44
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
As of December 31, 1999 and 1998
(dollars in thousands)
1999 1998
-------- --------
ASSETS
------
Cash and cash equivalents................................... $ 20,315 $ 8,152
Securities held to maturity, estimated fair value of $32,823
(1999) and $4,483 (1998)................................... 32,833 4,471
Residual mortgage-backed securities, at fair value.......... -- 50,296
Loans held for sale......................................... 330,727 243,497
Loans held for investment, net.............................. 103,601 90,827
Mortgage servicing rights................................... 6,431 13,119
Accrued interest receivable................................. 3,676 2,762
Foreclosed real estate--net................................. 2,214 1,898
Premises and equipment, net................................. 6,003 7,145
Current tax receivable...................................... 18,653 --
Accounts receivable, mortgage-backed securities residual
sale....................................................... 10,127 --
Other assets................................................ 13,028 5,911
-------- --------
TOTAL ASSETS.............................................. $547,608 $428,078
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
LIABILITIES:
Deposit accounts.......................................... $468,859 $323,433
Other borrowings.......................................... 17,873 39,977
Subordinated debentures................................... 1,500 1,500
Accrued expenses and other liabilities.................... 24,914 11,170
-------- --------
Total liabilities......................................... 513,146 376,080
COMMITMENTS AND CONTINGENCIES (Note 12)..................... -- --
STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value; 5,000,000 shares
authorized; no shares outstanding.......................... -- --
Common stock, $.01 par value; 25,000,000 shares authorized;
6,653,436 (1999) and 6,562,396 (1998) shares issued and
outstanding................................................ 67 66
Additional paid-in capital................................ 42,525 42,223
Retained earnings (deficit)............................... (8,130) 9,709
-------- --------
Total stockholders' equity................................ 34,462 51,998
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $547,608 $428,078
======== ========
See notes to consolidated financial statements.
45
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For Each of the Three Years in the Period Ended December 31, 1999
(dollars in thousands, except per share data)
1999 1998 1997
--------- --------- ---------
INTEREST INCOME:
Loans....................................... $ 40,991 $ 32,247 $ 17,746
Other interest-earning assets............... 5,387 8,857 3,400
--------- --------- ---------
Total interest income..................... 46,378 41,104 21,146
INTEREST EXPENSE:
Interest-bearing deposits................... 22,000 14,048 8,038
Loan and securities repurchase advances..... 1,088 6,168 3,665
Subordinated debentures and other........... 2,489 2,699 1,127
--------- --------- ---------
Total interest expense.................... 25,577 22,915 12,830
--------- --------- ---------
NET INTEREST INCOME BEFORE PROVISION FOR
ESTIMATED LOAN LOSSES........................ 20,801 18,189 8,316
PROVISION FOR ESTIMATED LOAN LOSSES........... 5,382 4,166 1,850
--------- --------- ---------
NET INTEREST INCOME AFTER PROVISION FOR
ESTIMATED LOAN LOSSES........................ 15,419 14,023 6,466
NONINTEREST INCOME:
Loan servicing and mortgage banking fee
income..................................... 4,967 5,340 959
Bank and other fee income................... 355 179 130
Net gain from mortgage banking.............. 10,675 24,214 24,210
Net gain/(loss) on residual mortgage-backed
securities................................. (33,964) (16,550) 1,520
Other income................................ 789 1,000 411
--------- --------- ---------
Total noninterest income (loss)........... (17,178) 14,183 27,230
NONINTEREST EXPENSE:
Compensation and benefits................... 12,394 11,570 9,210
Premises and occupancy...................... 4,037 3,419 1,360
Data processing and communications.......... 1,642 1,495 809
Net loss on foreclosed real estate.......... 31 211 126
Other expense............................... 9,381 9,724 4,485
--------- --------- ---------
Total noninterest expense................. 27,485 26,419 15,990
--------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAX
PROVISION/(BENEFIT).......................... (29,244) 1,787 17,706
INCOME TAX PROVISION (BENEFIT)................ (11,405) 728 7,382
--------- --------- ---------
NET INCOME (LOSS)............................. $ (17,839) $ 1,059 $ 10,324
========= ========= =========
EARNINGS (LOSS) PER SHARE:
Basic earnings (loss) per share............. $ (2.71) $ 0.16 $ 2.11
========= ========= =========
Diluted earnings (loss) per share........... $ (2.71) $ 0.16 $ 2.02
========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic earnings per share.................... 6,575,189 6,554,743 4,884,993
========= ========= =========
Diluted earnings per share.................. 6,575,189 6,805,827 5,107,951
========= ========= =========
See notes to consolidated financial statements.
46
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For Each of the Three Years in the Period Ended December 31, 1999
(dollars in thousands)
Common Stock Additional Retained Total
---------------- Paid-in Earnings Stockholders'
Shares Amount Capital (Deficit) Equity
--------- ------ ---------- --------- -------------
Balance, January 1,
1997.................... 3,211,716 32 $ 9,358 $ (1,674) $ 7,716
Net proceeds from
issuance of common
stock................... 3,335,000 33 32,813 -- 32,846
Net income............... -- -- -- 10,324 10,324
--------- --- ------- -------- -------
Balance, December 31,
1997.................... 6,546,716 65 42,171 8,650 50,886
Exercise of stock
options................. 15,680 1 52 -- 53
Net income............... -- -- -- 1,059 1,059
--------- --- ------- -------- -------
Balance, December 31,
1998.................... 6,562,396 66 42,223 9,709 51,998
Exercise of stock
options................. 91,040 1 302 -- 303
Net income (loss)........ -- -- -- (17,839) (17,839)
--------- --- ------- -------- -------
Balance, December 31,
1999.................... 6,653,436 67 $42,525 $ (8,130) $34,462
========= === ======= ======== =======
See notes to consolidated financial statements.
47
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Each of the Three Years in the Period Ended December 31, 1999
(dollars in thousands)
1999 1998 1997
----------- ----------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................... $ (17,839) $ 1,059 $ 10,324
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Depreciation and amortization........... 1,810 1,931 683
Provision for estimated loan losses..... 5,382 4,166 1,850
Amortization of deferred fees........... 482 (31) (26)
Provision for estimated losses on
foreclosed real estate................. 16 24 108
(Gain) loss on sale of foreclosed real
estate................................. 842 46 (74)
Gain on sale and securitization of loans
held for sale.......................... (16,183) (24,214) (24,210)
Net unrealized and realized losses
(gains) on residual mortgage-backed
securities and related mortgage
servicing rights....................... 33,964 16,550 (1,520)
Net accretion of residual mortgage-
backed securities...................... (3,313) (6,984) (2,269)
Provision for lower of cost or market... 3,000 -- --
Impairment of mortgage servicing
rights................................. 2,178 0 1,281
Change in valuation allowance on
mortgage servicing rights.............. (420) 1,168 0
Amortization of mortgage servicing
rights................................. 4,711 2,689 958
Purchase and origination of loans held
for sale, net of loan fees............. (1,012,269) (1,180,552) (773,107)
Proceeds from the sales of and principal
payments from loans held for sale...... 799,353 1,075,862 489,540
Increase in accrued interest
receivable............................. (914) (124) (2,101)
Decrease (increase) in other assets..... (15,090) 262 (11,082)
(Increase) decrease in deferred income
taxes.................................. (5,682) (7,961) 8,125
Increase in accrued expenses & other
liabilities............................ 13,742 3,853 9,423
Federal Home Loan Bank (FHLB) stock
dividend............................... (136) (99) (58)
----------- ----------- --------
Net cash used in operating
activities........................... (206,366) (112,355) (292,155)
CASH FLOW FROM INVESTING ACTIVITIES
Net decrease in loans..................... 107,159 82,728 8,586
Principal payments on securities.......... 2 -- --
Proceeds from the sale of foreclosed real
estate................................... 4,661 2,601 1,034
Purchase of securities held to maturity... (30,105) -- (2,000)
Proceeds from maturities of securities
held to maturity......................... 2,000 3,000 5,000
Additions to premises and equipment ...... (669) (4,020) (3,814)
Purchase of FHLB stock.................... (124) (1,297) (195)
Cash received on desecuritization of
residual mortgage-backed securities...... 11,980 -- --
----------- ----------- --------
Net cash provided by investing
activities........................... 94,904 83,012 8,611
CASH FLOW FROM FINANCING ACTIVITIES:
Net increase in deposit accounts.......... 145,426 111,668 126,054
(Repayment of) proceeds from other
borrowings............................... (22,104) (60,193) 96,892
(Repayment of) proceeds from FHLB
advances................................. (9,000) 9,000
Net proceeds from issuance of common
stock.................................... 303 53 32,846
Net proceeds from issuance of
subordinated debentures.................. -- -- 9,644
Repurchase of subordinated debentures..... -- (8,500) --
----------- ----------- --------
Net cash provided by financing
activities........................... 123,625 34,028 274,436
----------- ----------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................... 12,163 4,685 (9,108)
CASH AND CASH EQUIVALENTS, beginning of
year...................................... 8,152 3,467 12,575
----------- ----------- --------
CASH AND CASH EQUIVALENTS, end of year..... $ 20,315 $ 8,152 $ 3,467
=========== =========== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the year for:
Interest................................ $ 26,018 $ 23,826 $ 11,298
Income taxes............................ 7,138 3,328 3,616
NONCASH INVESTING ACTIVITIES DURING THE
PERIOD:
Transfers from loans held for sale to
loans held for investment................ $ -- $ 76,135 $ --
Transfers from loans to foreclosed real
estate................................... 5,869 3,129 2,234
Loans to facilitate sales of foreclosed
real estate.............................. -- 394 287
Sale of residual mortgage-backed
securities and related servicing in
exchange for an accounts receivable and
net participation contract............... 15,121 -- --
See notes to consolidated financial statements.
48
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Each of the Three Years in Period Ended December 31, 1999
1. Description of Business and Summary of Significant Accounting Policies
Basis of Presentation and Description of Business--The consolidated
financial statements include the accounts of LIFE Financial Corporation (LIFE)
and its wholly-owned subsidiaries, Life Bank (formerly Life Savings Bank,
Federal Savings Bank) (the Bank), Life Investment Holdings, Inc. (Life
Investment), and Life Financial Investment and Insurance Services, Inc. (Life
Insurance), (collectively, the Company). All significant intercompany accounts
and transactions have been eliminated in consolidation.
LIFE Financial Corporation ("LIFE Financial" or "Company"), a Delaware
corporation organized in 1997, is a savings and loan holding company that owns
100% of the capital stock of LIFE Bank (the "Bank"), the Company's principal
operating subsidiary. The Bank was incorporated and commenced operations in
1983. The Company's primary businesses includes retail banking, mortgage
banking and loan servicing.
LIFE Bank is a federally chartered stock savings bank incorporated and
licensed under the laws of the United States. The Bank is member of the Federal
Home Loan Bank of San Francisco ("FHLB"), which is a member bank of the Federal
Home Loan Bank System.
Currently, the principal business of the Bank is attracting retail deposits
from the general public and investing those deposits, together with funds
generated from operations and borrowings, primarily in one- to four-family
residential mortgage loans. At December 31, 1999, the Bank had five retail bank
branches located in Orange, San Bernardino and Riverside Counties, California.
The Bank opened its sixth retail bank branch in January, 2000 in Orange County,
California Additionally, the Bank conducts its national mortgage banking and
loan servicing business from its corporate headquarters in Riverside,
California.
Prior to 1999, the Company's principal business was wholesale mortgage
banking. The Bank was primarily engaged in the origination of subprime
residential mortgage loans with a specific emphasis in 2nd trust mortgage loans
with loan-to-value ratios in excess of 125% of the appraised property value. As
a result of the issuance of Thrift Bulletin 72 in late 1998, the Company
eliminated the 125% loan-to-value product and focused on 1st trust mortgage
loans to borrowers with non-prime credit histories. The Company sold loans
through whole loan sales and securitization whereby the Company would retain
the excess cash flows from each securitization transaction.
Securities Held to Maturity--Investments in debt securities that management
has the positive intent and ability to hold to maturity are reported at cost
and adjusted for premiums and discounts that are recognized in interest income
using the interest method over the period to maturity. The Company designates
securities as held to maturity upon acquisition.
Loans Held for Investment--The Company's real estate loan portfolio consists
primarily of long-term loans secured by first and second trust deeds on single-
family residences.
Loans held for investment are carried at amortized cost and net of deferred
loan origination fees and costs and allowance for estimated loan losses. Net
deferred loan origination fees and costs on loans are amortized or accreted
using the interest method over the expected lives of the loans. Amortization of
deferred loan fees is discontinued for nonperforming loans. Loans held for
investment are not adjusted to the lower of cost or estimated market value
because it is management's intention, and the Company has the ability, to hold
these loans to maturity.
Interest on loans is credited to income as earned. Interest receivable is
accrued only if deemed collectible. Generally, allowances are established for
uncollected interest on loans on which payments are more than 90 days past due.
49
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The Company considers a loan impaired when it is probable that the Company
will be unable to collect all contractual principal and interest payments under
the terms of the original loan agreement. Loans are evaluated for impairment as
part of the Company's normal internal asset review process. However, in
determining when a loan is impaired, management also considers the loan
documentation, current loan to value ratios and the borrower's current
financial position. Included as impaired loans are all loans delinquent 90 days
or more, all loans that have a specific loss allowance applied to adjust the
loan to fair value, and foreclosures in process less than 90 days delinquent.
The accrual of interest on impaired loans is discontinued after a 90-day
delinquent period or when, in management's opinion, the borrower may be unable
to meet payments as they become due. When the interest accrual is discontinued,
all unpaid accrued interest is reversed. Interest income is subsequently
recognized only to the extent cash payments are received. Where impairment is
considered other than temporary, a charge-off is recorded; where impairment is
considered temporary, an allowance is established. Impaired loans which are
performing under the contractual terms are reported as performing loans, and
cash payments are allocated to principal and interest in accordance with the
terms of the loans.
Allowances for Estimated Loan Losses--It is the policy of the Company to
maintain an allowance for estimated loan losses at a level deemed appropriate
by management to provide for known or inherent risks in the portfolio. Specific
loss allowances are established for loans if the fair value of the loan or the
collateral is estimated to be less than the gross carrying value of the loan.
In estimating losses, management considers the estimated sales price, cost of
refurbishment, payment of delinquent taxes, cost of holding the property (if an
extended period is anticipated) and cost of disposal. Additionally, a general
valuation allowance for loan losses has been established. Management's
determination of the adequacy of the loan loss allowances is based on an
evaluation of the composition of the portfolio, actual loss experience, current
and prospective economic conditions, industry trends and other relevant factors
in the area in which the Company's lending and real estate activities are
based. These factors may affect the borrowers' ability to pay and the value of
the underlying collateral. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to recognize
additions to the allowance based on judgments different from those of
management.
Although management uses the best information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory and other conditions that may be beyond the
Company's control.
Mortgage Banking and Loan Servicing Operations--The Company primarily
originates mortgage loans for sale in the secondary market. At origination or
purchase, mortgage loans are designated as held for sale or held for
investment. Loans held for sale are carried at the lower of cost or estimated
market value determined on an aggregate basis by outstanding investor
commitments or current investor requirements. Cost includes related loan
origination costs and fees, as well as premiums or discounts for purchased
loans. Net unrealized losses, if any, are recognized in a valuation allowance
by charges to operations. Any transfers of loans held for sale to the
investment portfolio are recorded at the lower of cost or estimated market
value on the transfer date. At December 31, 1999 and 1998, the gross principal
balance of loans held for sale consists of $312,154,000 and $211,478,000,
respectively, in single-family residential mortgage loans; $6,102,000 and
$15,426,000, respectively, in multi-family residential mortgage loans;
$6,274,000 and $9,150,000, respectively, in commercial mortgage loans; and
$2,435,000 and $2,610,000, respectively, in other loans.
The Company sells its loans held for sale with servicing retained and
servicing released. Under the servicing agreements, the investor is paid its
share of the principal collections together with interest at an agreed-upon
rate, which generally differs from the loans' contractual interest rate. The
loan-servicing portfolio is comprised of loans owned by the Bank and loans sold
by the Bank to other investors on a servicing retained basis.
50
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
At December 31, 1999, the loan servicing division serviced in excess of $1.4
billion in mortgage and consumer loans.
The Company evaluates its capitalized mortgage servicing rights (MSRs) for
impairment based on the fair value of those rights. The Company's periodic
evaluation is performed on a disaggregated basis whereby MSRs are stratified
based on type of interest rate (variable or fixed), loan type and original loan
term. Impairment is recognized in a valuation allowance for each pool in the
period of impairment. The Company determines fair value based on the present
value of estimated net future cash flows related to servicing income. In
estimating fair values at December 31, 1999 and 1998, the Company utilized a
weighted average prepayment assumption of 31.8% and 26.1%, respectively, and a
weighted average discount rate of 13.5% and 13.5%, respectively. The cost
allocated to servicing rights is amortized in proportion to, and over the
period of, estimated net future servicing fee income.
In 1998, and 1997, the Company completed the securitization and sale of
approximately $462.1 million, and $415.4 million, respectively, in loans in the
form of mortgage pass-through certificates and recognized gains of
approximately $9.3 million and $22.5 million, respectively. These certificates
are held in a trust independent of the Company. The Company will act as
servicer for the trust and receive a stated servicing fee. The Company has also
retained a beneficial interest in the form of an interest-only strip (residual
mortgage-backed security) which represents the subordinated right to receive
cash flows from the pool of securitized loans after payment of the required
amounts to the holders of the securities and the costs associated with the
securitization. This interest-only strip receivable is classified as a trading
security and recorded at fair value with any unrealized gains or losses
recorded in the results of operations in the period of the change in fair
value. For the years ended December 31, 1998, and 1997, net unrealized gains
(losses) of ($16.6 million), and $1.5 million, respectively, resulted from
changes in fair value and are also included in results of operations.
Valuations at origination and at each reporting period are based on
discounted cash flow analyses. The cash flows are estimated as the excess of
the weighted average coupon on each pool of loans sold over the sum of the
pass-through interest rate, a servicing fee, a trustee fee, an insurance fee,
and an estimate of annual future credit losses related to the prepayment,
default, loss, and interest rate assumptions that market participants would use
for similar financial instruments subject to prepayment, credit and interest
rate risk, and are discounted using an interest rate that a purchaser unrelated
to the seller of such a financial instrument would demand. At origination, the
Company utilized prepayment assumptions ranging from 12% to 35%, an estimated
annual loss factor assumption ranging from 0.5% to 2.5%, and a discount rate of
13.5% to value residuals. At December 31, 1998, the Company utilized prepayment
assumptions ranging from 7.4% to 53%, an estimated annual loss factor
assumption ranging from 0.7% to 6.0%, and a discount rate of 13.5% to value
residuals. The valuation includes consideration of characteristics of the loans
including loan type and size, interest rate, origination date, term, and
geographic location. The Company also uses other available information such as
externally prepared reports on prepayment rates, collateral value, economic
forecasts, and historical default and prepayment rates of the portfolio under
review. To the Company's knowledge, there is no active market for the sale of
residuals. The range of values attributable to the factors used in determining
fair value is broad. Accordingly, the Company's estimate of fair value is
subjective.
In connection with the first two of its securitization transactions, the
Company initially deposited cash with a trustee and will subsequently deposit a
portion of the servicing spread collected on the related loans. Such amounts
serve as credit enhancement for the related trust. The amounts set aside are
available for distribution to investors in the event of certain shortfalls in
amounts due to investors. These amounts are subject to increase
51
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
up to a reserve level as specified in the related securitization documents.
Cash amounts on deposit are invested in certain instruments as permitted by the
related securitization documents. To the extent amounts on deposit exceed
specified levels, distributions are made to the Company; and at the termination
of the related trust, any remaining amounts on deposit are distributed to the
Company. The gross amount on deposit at December 31, 1998 is $12.9 million and
is included in residual mortgage-backed securities in the accompanying
consolidated statements of financial condition at its fair value.
On December 31, 1999, the Company sold its remaining residual mortgage-
backed securities retained from securitization and related mortgage servicing
rights for $19.3 million in cash and other consideration. The other
consideration consists of a contractual right from the purchases of the
residual mortgage-backed securities to receive 50% of any cash realized from
the residual mortgage-backed securities (the "Participation Contract"). The
Company valued the contractual right at its estimated fair value of $9.3
million at December 31, 1999. The right to receive cash flows under the
contract begins after the purchaser recaptures their initial cash investment of
$8.1 million and a 15% internal rate of return (the "Hurdle amount") from the
transaction. Additionally, the Company entered into a credit guaranty related
to a $14.6 million pool of sub-performing loans in the 1998-1A and 1B
securitization whereby the Company guaranteed the difference between the
December 1, 1999, unpaid principal balance and the realized value of those
loans at final disposition. At December 31, 1999, the Company estimated the
obligation under the credit guaranty at $4.3 million. Any proceeds paid to the
purchaser under the credit guaranty will be applied to the Hurdle Amount for
cash distributions on the Participation Contract. Included in other assets in
the consolidated statements of financial condition at December 31, 1999 is an
asset of approximately $5 million which represents the estimated fair value of
the contractual right, net of the estimated credit guarantee amount.
Foreclosed Real Estate--Real estate properties acquired through, or in lieu
of, loan foreclosure are initially recorded at fair value at the date of
foreclosure through a charge to the allowance for estimated loan losses. After
foreclosure, valuations are periodically performed by management; and an
allowance for losses is established by a charge to operations if the carrying
value of a property exceeds its fair value less estimated cost to sell. Revenue
and expenses from operations and changes in the valuation allowance are
included in net loss on foreclosed real estate in the consolidated statement of
operations.
Premises and Equipment--Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
computed using both the straight-line and accelerated methods over the
estimated useful lives of the assets, which range from 31 years for buildings,
15 years for leasehold improvements, 7 years for furniture, fixtures and
equipment, and 3 years for computer equipment.
The Company periodically evaluates the recoverability of long-lived assets,
such as premises and equipment, to ensure the carrying value has not been
impaired.
Income Taxes--Deferred tax assets and liabilities are recorded for the
expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, all expected future events other than enactments of changes in
the tax law or rates are considered. If necessary, a valuation allowance is
established based on management's determination of the likelihood of
realization of deferred tax assets.
Presentation of Cash Flows--For purposes of reporting cash flows, cash and
cash equivalents include cash and federal funds sold. Generally, federal funds
are sold for one-day periods. At December 31, 1999, the Bank had $3.0 million
in federal funds sold, compared with $0 at December 31, 1998.
Use of Estimates--The preparation of the consolidated financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported
52
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
amounts of assets and liabilities, 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.
Stock-Based Compensation--SFAS No. 123, Accounting for Stock-Based
Compensation, issued in 1995, encourages companies to account for stock
compensation awards based on their fair value at the date the awards are
granted. SFAS No. 123 does not require the application of the fair value method
and allows for the continuance of current accounting methods, which require
accounting for stock compensation awards based on their intrinsic value as of
the grant date. However, SFAS No. 123 requires pro forma disclosure of net
income and, if presented, earnings per share, as if the fair value based method
of accounting defined in this statement had been applied. The Company did not
adopt the fair value accounting method in SFAS No. 123 with respect to its
stock option plans and continues to account for such plans in accordance with
Accounting Principles Board (APB) Opinion No. 25.
Recent Accounting Developments--In June 1998, the Financial Accounting
Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts, and hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those derivatives at fair value. The accounting for gains and
losses resulting from changes in the value of those derivatives will depend on
the intended use of the derivative and whether it qualifies for hedge
accounting. The FASB delayed the effective date of SFAS No. 133 to fiscal years
beginning after June 15, 2000 (calendar year 2001 for the Company). The
adoption of this standard is not expected to have a material effect on the
Company's financial condition, results of operations and cash flows.
Reclassifications--Certain reclassifications have been made to the 1998 and
1997 consolidated financial statements to conform to the 1999 presentation.
2. Regulatory Capital Requirements And Other Regulatory Matters
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined) and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1999 and 1998,
that the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1999 and 1998, the most recent notification from the OTS
categorized the Bank as well-capitalized under the regulatory framework for
prompt corrective action. To be categorized as well-capitalized, the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or events since
December 31, 1999 that management believes have changed the Bank's category.
53
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The Bank's actual capital amounts and ratios are also presented in the
table.
To be adequately To be well
capitalized under capitalized under
prompt corrective prompt corrective
Actual action provisions action provisions:
------------- ------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ---------- -------- ---------- ---------
(Dollars in thousands)
As of December 31, 1999
Total Capital (to
risk-weighted
assets).............. $35,222 10.34% $ 27,245 8.00% $ 34,056 10.00%
Core capital (to
Adjusted tangible
assets).............. 32,473 6.28% 20,680 4.00% 25,850 5.00%
Tangible Capital (to
tangible assets)..... 32,473 6.28% 7,755 1.50% N.A. N.A.
Tier 1 capital (to
risk-weighted
assets).............. 32,473 9.54% N.A. N.A. 20,434 6.00%
As of December 31, 1998
Total Capital (to
risk-weighted
assets).............. $29,952 10.90% $ 21,978 8.00% $ 27,473 10.00%
Core capital (to
Adjusted tangible
assets).............. 27,311 7.21% 15,143 4.00% 18,928 5.00%
Tangible Capital (to
tangible assets)..... 27,311 7.21% 5,678 1.50% N.A. N.A.
Tier 1 capital (to
risk-weighted
assets).............. 27,311 9.94% N.A. N.A. 16,484 6.00%
December 31, 1998 ratios were based upon quarterly average balances.
December 31, 1999 ratios were calculated based upon end of period balances.
Management believes that, under current regulations, the Bank will continue
to meet its minimum capital requirements in the coming year. However, events
beyond the control of the Bank, such as changing interest rates or a downturn
in the economy in the areas where the Bank has most of its loans, could
adversely affect future earnings and, consequently, the ability of the Bank to
meet its future minimum capital requirements.
At periodic intervals, both the OTS and the Federal Deposit Insurance
Corporation (FDIC) routinely examine the Bank's financial statements as part of
their legally prescribed oversight of the savings and loan industry. Based on
these examinations, the regulators can direct that the Bank's financial
statements be adjusted in accordance with their findings. The OTS concluded an
examination of the Bank in March 1999.
OTS regulations impose limitations upon all capital distributions by savings
institutions, such as 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. The rule
establishes three tiers of institutions, which are based primarily on an
institution's capital level. An institution that exceeds all fully phased-in
regulatory capital requirements before and after a proposed capital
distribution and has not been advised by the OTS that it is in need of more
than normal supervision, could, after prior notice to, but without the approval
of the OTS, make capital distributions during a calendar year equal to the
greater of: (i) 100% of its net earnings 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 (ii) 75% of its net earnings for the previous four
quarters. Any additional capital distributions would require prior OTS
approval. In the event the Bank's capital fell below its capital requirements
or the OTS notified it that it was in need of more than normal supervision, the
Bank's ability to make capital distributions could be restricted. In addition,
the OTS could prohibit a proposed capital distribution by any institution,
which would otherwise be permitted by the regulation, if the OTS determines
that such distribution would constitute an unsafe or unsound practice.
54
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
3. Mortgage and Other Securities
The amortized cost and estimated fair value of securities held to maturity
and residual mortgage-backed securities were as follows at December 31 (in
thousands):
December 31, 1999
------------------------------------------
Amortized Unrealized Unrealized Estimated
Cost Gain Loss Fair Value
--------- ---------- ---------- ----------
Residual mortgage-backed securities.. $ -- $ -- $ -- $ --
Securities held to maturity
US Treasury and other agency
securities........................ 29,955 -- 10 29,945
Mortgage-backed securities......... 5 -- -- 5
Other securities................... 2,873 -- -- 2,873
------- ----- ----- -------
Total Securities held to
maturity........................ 32,833 -- 10 32,823
------- ----- ----- -------
$32,833 $ -- $ 10 $32,823
======= ===== ===== =======
December 31, 1998
------------------------------------------
Amortized Unrealized Unrealized Estimated
Cost Gain Loss Fair Value
--------- ---------- ---------- ----------
Residual mortgage-backed securities.. $50,296 $ -- $ -- $50,296
Securities held to maturity
US Treasury and other agency
securities........................ 2,000 12 -- 2,012
Mortgage-backed securities......... 8 -- -- 8
Other securities................... 2,463 -- -- 2,463
------- ----- ----- -------
Total Securities held to
maturity........................ 4,471 12 -- 4,483
------- ----- ----- -------
$54,767 $ 12 $ -- $54,779
======= ===== ===== =======
The weighted average interest rates on total investment securities held to
maturity were 5.87% and 6.13% at December 31, 1999 and 1998, respectively. At
December 31, 1999, $32.7 million of the total $32.8 million investment
securities matures in one year or less.
55
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
4. Loans Held for Investment
Loans held for investment consisted of the following at December 31 (in
thousands):
1999 1998
-------- -------
Real estate:
Residential:
One-to-four family...................................... $ 69,778 $82,555
Multi-family............................................ 3,749 1,954
Commercial.............................................. 5,586 5,075
Construction............................................ 52,175 8,571
Other loans:
Loans secured by deposit accounts....................... 205 270
Unsecured commercial loans.............................. 43 124
Unsecured consumer loans................................ 55 341
-------- -------
Total gross loans..................................... 131,591 98,890
Less (plus):
Undisbursed loan funds................................... 25,885 6,399
Deferred loan origination (costs)........................ (1,119) (1,588)
Discounts................................................ 475 475
Allowance for estimated loan losses...................... 2,749 2,777
-------- -------
Loans held for investment, net............................ $103,601 $90,827
======== =======
During 1998, the Company transferred loans with a carrying value of $76.1
million from loans held for sale to loans held for investment. In connection
with this transfer, a new cost basis was established for these loans of $75.7
million. The Company grants residential and commercial loans held for
investment to customers located primarily in Southern California. Consequently,
a borrowers ability to repay may be impacted by economic factors in the region.
The following summarizes activity in the allowance for estimated loan losses
for the years ended December 31 (in thousands):
1999 1998 1997
------- ------- ------
Balance, beginning of year....................... $ 2,777 $ 2,573 $1,625
Provision for estimated loan losses.............. 5,382 4,166 1,850
Recoveries....................................... 430 109 7
Charge-offs...................................... (5,840) (4,071) (909)
------- ------- ------
Balance, end of year............................. $ 2,749 $ 2,777 $2,573
======= ======= ======
The Company had nonaccrual and nonperforming loans at December 31, 1999,
1998, and 1997 of $4,018,000, $7,544,000, and $5,126,000, respectively. If such
loans had been performing in accordance with their original terms, the Company
would have recorded interest income of $41,375,000, $33,036,000, and
$18,170,000, respectively, instead of interest income actually recognized of
$40,991,000, $32,247,000, and $17,746,000, respectively, for the years ended
December 31, 1999, 1998, and 1997.
56
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
At December 31, 1999 and 1998, the Company had impaired loans totaling
$4,018,000 and $8,239,000, respectively, with related reserves of $2,019,000
and $1,320,000, respectively. During the years ended December 31, 1999, 1998,
and 1997, the average recorded investment in impaired loans was $8,344,000,
$7,875,000, and $3,413,000, respectively. Total cash collected on impaired
loans during the years ended December 31, 1999, 1998, and 1997 was $4,834,000,
$4,595,000, and $1,498,000, respectively, of which $3,996,000, $3,771,000, and
$1,329,000, respectively, was credited to principal. Interest income of
$838,000, $824,000, and $169,000 on impaired loans was recognized for cash
payments received during the years ended December 31, 1999, 1998, and 1997,
respectively.
The Company is not committed to lend additional funds to debtors whose loans
have been modified.
The Bank is subject to numerous lending-related regulations. Under FIRREA,
the Bank may not make real estate loans to one borrower in excess of 15% of its
unimpaired capital and surplus except for loans not to exceed $500,000. This
15% limitation results in a dollar limitation of approximately $5,284,000 at
December 31, 1999.
Activity in loans to directors and executive officers during the year ended
December 31 are as follows (in thousands):
1999 1998 1997
----- ----- -----
(Dollars in
thousands)
Balance, beginning of year............................ $ 250 $ 413 $ --
Originations.......................................... 214 -- 778
Principal payment, loans sold......................... (464) (163) (365)
----- ----- -----
Balance, end of year.................................. $ -- $ 250 $ 413
===== ===== =====
5. Mortgage Banking and Loan Servicing Operations
Loans serviced for others at December 31, 1999, 1998, and 1997 totaled
$1,382,000,000, $1,001,699,000, and $536,726,000, respectively.
In connection with mortgage servicing activities, the Company held funds in
trust for others totaling approximately $22,832,000 and $22,133,000 at December
31, 1999 and 1998, respectively. At December 31, 1999 and 1998, $9,635,000 and
$1,326,000, respectively, of these funds are maintained in deposit accounts of
the Bank (subject to FDIC insurance limits) and are included in the assets and
liabilities of the Company.
Although the Company sells without recourse substantially all of the
mortgage loans it originates or purchases, the Company retains some degree of
risk on substantially all of the loans it sells. In addition, during the period
of time that the loans are held for sale, the Company is subject to various
business risks associated with the lending business, including borrower
default, foreclosure, and the risk that a rapid increase in interest rates
would result in a decline of the value of loans held for sale to potential
purchasers.
In connection with its whole loan sales, the Company enters into agreements
which generally require the Company to repurchase or substitute loans in the
event of a breach of a representation or warranty made by the Company to the
loan purchaser, any misrepresentation during the mortgage loan origination
process or, in some cases, upon any fraud or early default on such mortgage
loans. The remedies available to a purchaser of mortgage loans from the Company
are generally broader than those available to the Company against the sellers
of such loans; and if a loan purchaser enforces its remedies, the Company may
not be able to enforce whatever remedies the Company may have against such
sellers. If the loans were originated directly by the Company, the Company will
be solely responsible for any breaches of representations or warranties.
57
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The following is a summary of activity in mortgage servicing rights for the
years ended December 31 (in thousands):
1999 1998 1997
-------- ------- -------
Balance, beginning of year..................... $ 13,119 $ 8,526 $ 2,645
Additions through originations................. 7,238 8,450 8,120
Amortization................................... (4,711) (2,689) (958)
Sale of servicing rights....................... (7,456) -- --
Adjustment in valuation allowance.............. 420 (1,168) --
Direct writedowns.............................. (2,179) -- (1,281)
-------- ------- -------
Balance, end of year........................... $ 6,431 $13,119 $ 8,526
======== ======= =======
The following is a summary of activity in the valuation allowance for
mortgage servicing rights for the years ended December 31 (in thousands):
1999 1998 1997
-------- ------- -------
Balance, beginning of year..................... $ 1,169 $ 1 $ 1
Sale of servicing rights....................... (1,297) 0 0
Additions charged to operations................ 877 1,168 0
-------- ------- -------
Balance, end of year........................... $ 749 $ 1,169 $ 1
======== ======= =======
6. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in
thousands):
1999 1998
------ ------
Premises................................................... $ 656 $ 635
Leasehold improvements..................................... 2,996 2,753
Furniture, fixtures and equipment.......................... 7,595 7,191
Automobiles................................................ 24 24
------ ------
Subtotal................................................... 11,271 10,603
Less: accumulated depreciation and amortization............ (5,268) (3,458)
------ ------
Total...................................................... $6,003 $7,145
====== ======
7. Foreclosed Real Estate
Activity in the allowance for estimated real estate losses is summarized as
follows for the years ended December 31 (in thousands):
1999 1998 1997
------- ------- -------
Balance, beginning of year..................... $ 100 $ 79 $ 65
Provision for estimated real estate loan
losses........................................ 16 24 108
Recoveries..................................... -- -- 2
Charge-offs.................................... -- (3) (96)
------- ------- -------
Balance, end of year........................... $ 116 $ 100 $ 79
======= ======= =======
58
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
8. Deposit Accounts
Deposit accounts consisted of the following at December 31, (in thousands):
1999 1998
---------------------- ----------------------
Weighted Weighted
Average Average
Balance Interest Rate Balance Interest Rate
-------- ------------- -------- -------------
Checking accounts............ $ 27,377 1.51% $ 14,088 1.72%
Passbook accounts............ 4,541 2.10 4,642 2.35
Money market accounts........ 5,609 4.28 7,729 4.84
Certificate accounts:
Under $100,000............. 301,219 5.80 214,943 5.98
$100,000 and over.......... 130,113 5.93 82,031 5.50
-------- --------
$468,859 5.53% $323,433 5.48%
======== ========
The aggregate annual maturities of certificate accounts at December 31 are
approximately as follows (in thousands):
1999 1998
-------- --------
Within one year.......................................... $427,954 $291,118
One to two years......................................... 1,861 4,048
Two to three years....................................... 379 708
Three to four years...................................... 202 383
Four to five years....................................... 73 139
Thereafter............................................... 863 578
-------- --------
$431,332 $296,974
======== ========
Interest expense on deposit accounts for the years ended December 31 is
summarized as follows (in thousands):
1999 1998 1997
------- ------- ------
Checking accounts................................... $ 340 $ 309 $ 279
Passbook accounts................................... 98 102 84
Money market accounts............................... 292 229 88
Certificate accounts................................ 21,270 13,408 7,587
------- ------- ------
$22,000 $14,048 $8,038
======= ======= ======
9. Advances from Federal Home Loan Bank and Other Borrowings
As of December 31, 1999 and 1998, the Company had an available line of
credit with the Federal Home Loan Bank of San Francisco (FHLB) of $48,009,000
and $7,635,000, respectively, use of which is contingent upon continued
compliance with the Advances and Security Agreement and other eligibility
requirements established by the FHLB. Advances and/or the line of credit are
collateralized by pledges of certain real estate loans and securities with an
aggregate principal balance of $63,293,000 and $6,946,000 at December 31, 1999
and 1998, respectively.
59
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The following table summarizes activities in advances from the FHLB for the
years ended December 31:
At or For Year Ended
December 31,
---------------------------
1999 1998 1997
------- -------- --------
(Dollars in thousands)
Average balance outstanding................... $15,363 $ 1,154 $ 8,284
Maximum amount outstanding at any month-end
during the year ............................. 35,170 17,062 17,800
Balance outstanding at end of year............ -- -- 9,000
Weighted average interest rate during the year
............................................. 5.23% 5.02% 5.82%
At December 31, 1999, the Company had three lines of credit available to it
from commercial banks and national investment banking firms. The allowable
draw amounts of the three credit lines are individually $250,000,000,
$10,000,000, and $40,000,000 with expiration dates, respectively, of October
2000, November 2000, and a revolving maturity date.
These lines of credit, which were obtained during 1997 and 1998 and renewed
in 1999, bear interest at a variable rate based on LIBOR. Outstandings under
the $250 million line of credit at the Bank are collateralized by loans held
for sale and mortgage-backed securities. Outstandings under the $40 million
and $10 million lines of credit at Life Financial are collateralized by
residuals and the stock of the Bank. Subsequent to December 31, 1999, the Life
Financial $40,000,000 line of credit with a revolving maturity was paid to
zero and terminated and the $10,000,000 line of credit due November 2000 was
paid to zero.
These lines of credit contain certain affirmative, negative and financial
covenants. Due to the sale of the residual mortgage-backed securities, the
Company was in violation of certain covenants related to the $40 million and
$10 million lines of credit. The Company was in compliance with all other
lines of credit covenants at December 31, 1999.
The following summarizes activities in the lines of credit:
At or For Year Ended
December 31,
--------------------------
1999 1998 1997
------- -------- -------
(Dollars in thousands)
Average balance outstanding.................... $30,237 $112,886 $48,765
Maximum amount outstanding at any month-end
during the year............................... 45,834 345,848 226,846
Balance outstanding at end of year ............ 17,873 39,977 100,170
Weighted average interest rate during the
year.......................................... 8.48% 6.62% 6.53%
10. Subordinated Debentures
On March 14, 1997, the Bank issued subordinated debentures (Debentures) in
the aggregate principal amount of $10,000,000 through a private placement and
pursuant to a Debenture Purchase Agreement. The Debentures will mature on
March 15, 2004 and bear interest at the rate of 13.5% per annum, payable semi-
annually. The Debentures qualified as supplementary capital under regulations
of the OTS, which capital may be used to satisfy risk-based capital
requirements, until March 1998 when the Bank substituted the Company in its
place as obligor on the Debentures. The Debentures are direct, unconditional
obligations ranking with all other existing and future unsecured and
subordinated indebtedness. They are subordinated on liquidation, as to
principal and interest, and premium, if any, to all claims having the same
priority as savings account holders or any higher priority.
60
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The Debentures are redeemable at the option of the Company, in whole or in
part, at any time after September 15, 1998, at the aggregate principal amount
thereof, plus accrued and unpaid interest, if any. Holders of the Debentures
also have the option at September 15, 1998 to require the Company to purchase
all or part of the holder's outstanding Debentures at a price equal to 100% of
the principal amount repurchased plus accrued interest through the repurchase
date.
On September 15, 1998, holders of $8.5 million in Debentures exercised their
option to have the Company repurchase their Debentures as of December 14, 1998,
thereby reducing outstanding Debentures to $1.5 million. The gain resulting
from extinguishment of this debt was not material.
11. Income Taxes
Income taxes for the years ended December 31 consisted of the following (in
thousands):
1999 1998 1997
-------- ------- ------
Current provision (benefit):
Federal........................................ $ (4,280) $ 5,818 $ (317)
State.......................................... (1,443) 2,871 (426)
-------- ------- ------
(5,723) 8,689 (743)
-------- ------- ------
Deferred (benefit) provision:
Federal........................................ (4,724) (5,287) 5,685
State.......................................... (958) (2,674) 2,440
-------- ------- ------
(5,682) (7,961) 8,125
-------- ------- ------
Total income tax provision (benefit)......... $(11,405) $ 728 $7,382
======== ======= ======
A reconciliation from statutory federal income taxes to the Company's
effective income taxes for the years ended December 31 are as follows:
1999 1998 1997
-------- ------- ------
Statutory federal taxes.......................... $(10,235) $ 625 $6,199
State taxes, net of federal income tax benefit... (1,561) 128 1,315
Other............................................ 391 (25) (132)
-------- ------- ------
$(11,405) $ 728 $7,382
======== ======= ======
61
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
Deferred tax assets (liabilities) were comprised of the following at
December 31 (in thousands):
1999 1998
------ -------
Deferred tax assets:
Depreciation............................................. $ 10 $ 83
Accrued expenses......................................... 272 297
Allowance for loan losses................................ 859 915
Capital loss carryforward................................ 60 36
Loans held for sale...................................... 3,414 1,586
Other.................................................... -- 649
------ -------
4,615 3,566
Deferred tax liabilities:
Gain on sale of loans.................................... -- (3,604)
Originated servicing rights.............................. -- (1,149)
Federal Home Loan Bank Stock............................. (248) (168)
Other.................................................... (76)
------ -------
(324) (4,921)
------ -------
4,291 (1,355)
Less valuation allowance................................... -- (36)
------ -------
Net deferred tax asset (liability)......................... $4,291 $(1,391)
====== =======
At December 31, 1999, the net deferred tax asset is included in other assets
in the accompanying consolidated statements of financial condition. At December
31, 1998, the net deferred tax liability is included in other liabilities in
the accompanying consolidated statements of financial condition.
At December 31, 1998, a valuation allowance was recorded against the
deferred tax asset related to the capital loss carryforward, as it is more
likely than not that such benefit would not be realized. At December 31, 1999,
the valuation allowance was no longer determined to be necessary.
The Company's stockholders' equity includes tax bad debt deductions for
which no provision for federal income taxes has been made. If distributions to
shareholders are made in excess of current or accumulated earnings and profits
or if stock of the Company is partially redeemed, this tax bad debt reserve
which approximates $330,000 at December 31, 1999, will be recaptured into
income at the then prevailing federal income tax rate. The related unrecognized
deferred tax liability is approximately $116,000. It is not contemplated that
the Company will make any disqualifying distributions that would result in the
recapture of these reserves.
12. Commitments, Contingencies and Concentrations of Risk
Legal Proceedings. In December 1999, certain shareholders of Life Financial
Corporation filed a federal securities lawsuit against the Company, various
officers and directors of the Company, and certain other third parties. The
lawsuit was filed in the United States District Court to assert claims against
the defendants under the Securities Exchange Act of 1934 and the Securities Act
of 1933. The defendants are not required to answer or otherwise respond to the
Complaint until April 28, 2000.
62
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The Company intends to vigorously defend against the claims asserted in the
litigation. The Company believes that the litigation will not have a material
adverse impact on the results of operations or financial condition of the
Company or the Bank.
The Company and the Bank are not involved in any pending legal proceedings
other than legal proceedings occurring in the ordinary course of business.
Management believes that none of these legal proceedings, individually or in
the aggregate, will have a material adverse impact on the results of operations
or financial condition of the Company or the Bank.
Lease Commitments. The Company leases a portion of its facilities from
nonaffiliates under operating leases expiring at various dates through 2006.
The following schedule shows the minimum annual lease payments, excluding
property taxes and other operating expenses, due under these agreements (in
thousands):
Year ending December 31:
2000.............................................................. $ 923
2001.............................................................. 830
2002.............................................................. 633
2003.............................................................. 279
2004.............................................................. 192
Thereafter........................................................ 142
------
$2,999
======
Rental expense under all operating leases totaled $974,000, $1,095,000, and
$424,000 for the years ended December 31, 1999, 1998, and 1997, respectively.
Employment Agreements. The Company and the Bank have negotiated employment
agreements with their executive officers. These agreements provide for the
payment of a base salary, a bonus based upon performance of the Company, and
the payment of severance benefits upon termination.
Lending Activities. The Company has been actively involved in the
origination, purchase and sale to institutional investors of real estate
secured loans. Generally, the profitability of such mortgage banking operations
depends on maintaining a sufficient volume of loans for sale and the
availability of purchasers. Changes in the level of interest rates and economic
factors affect the amount of loans originated or available for purchase by the
Company, and thus the amount of gains on sale of loans and servicing fee
income. Changes in the purchasing policies of institutional investors or
increases in defaults after funding could substantially reduce the amount of
loans sold to such investors. Any such changes could have a material adverse
effect on the Company's results of operations, financial condition and cash
flows.
The Company's ability to originate, purchase and sell loans through its
mortgage banking operations is also significantly impacted by changes in
interest rates. Increases in interest rates may also reduce the amount of loan
and commitment fees received by the Company. A significant decline in interest
rates could also decrease the size of the Company's servicing portfolio and the
related servicing income by increasing the level of prepayments. The Company
does not currently utilize any specific hedging instruments to minimize
exposure to fluctuations in the market price of loans and interest rates with
regard to loans held for sale in the secondary mortgage market. Therefore,
between the time the Company originates the loans or purchase commitments are
issued, the Company is exposed to downward movements in the market price of
such loans due to upward movements in interest rates.
63
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The Company depends largely on mortgage brokers and correspondents for its
purchases and originations of new loans. The Company's competitors also seek to
establish relationships with the Company's mortgage brokers and correspondents.
The Company's future results may become increasingly exposed to fluctuations in
the volume and cost of its wholesale loans resulting from competition from
other purchasers of such loans.
Availability of Funding Sources--The Company funds substantially all of the
loans which it originates or purchases through deposits, internally-generated
funds, FHLB advances or other borrowings. The Company competes for deposits
primarily on the basis of rates, and, as a consequence, the Company could
experience difficulties in attracting deposits to fund its operations if the
Company does not continue to offer deposit rates at levels that are competitive
with other financial institutions. The Company also uses the proceeds generated
by the Company in selling loans in the secondary market to fund subsequent
originations or purchases. On an ongoing basis, the Company explores
opportunities to access credit lines as an additional source of funds. To the
extent that the Company is not able to maintain its currently available funding
sources or to access new funding sources, it would have to curtail its loan
production activities or sell loans earlier than is optimal. Any such event
could have a material adverse effect on the Company's results of operations,
financial condition and cash flows.
13. Benefit Plans
401(k) Plan--The Company maintains an Employee Savings Plan (the Plan) which
qualifies under section 401(k) of the Internal Revenue Code. Under the Plan,
employees may contribute from 1% to 15% of their compensation. The Company will
match, at its discretion, 25% of the amount contributed by the employee up to a
maximum of 8% of the employee's salary. The amount of contributions made to the
Plan by the Company were not material for the years ended December 31, 1999,
1998 and 1997.
Cash Bonus Plan--The Company adopted a cash bonus plan (the Bonus Plan)
effective February 1996. All employees except for commissioned employees and
employees with employment contracts are eligible to participate. There was no
cash bonus recorded during 1999 and 1998. Approximately $1,480,000 in expense
was recorded pursuant to the Bonus Plan during the year ended December 31,
1997.
Stock Option Plans--On November 21, 1996, the Board of Directors of the Bank
adopted the Life Bank 1996 Stock Option Plan (the 1996 Option Plan). The 1996
Option Plan authorizes the granting of options equal to 321,600 shares of
common stock for issuance to executives, key employees, officers and directors.
The 1996 Option Plan will be in effect for a period of ten years from the
adoption by the Board of Directors. Options granted under the 1996 Option Plan
will be made at an exercise price equal to the fair market value of the stock
on the date of grant. Awards granted to officers and employees may include
incentive stock options, nonstatutory stock options and limited rights which
are exercisable only upon a change in control of the Bank, which change in
control did not include the reorganization of the Bank into the holding company
(the "Reorganization"). Awards granted to nonemployee directors are
nonstatutory options. Stock options will become vested and exercisable in the
manner specified by the Board of Directors. The options granted under the 1996
Option Plan will vest at a rate of 33.3% per year, beginning on November 21,
1999.
64
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The components of the 1996 Option Plan as of December 31, 1999, 1998, and
1997, and changes during the years then ended (as adjusted for the
Reorganization), consist of the following:
1999 1998 1997
------------------ ----------------- -----------------
Weighted Weighted Weighted
average average Average
exercise exercise Exercise
Shares price Shares price Shares price
-------- -------- ------- -------- ------- --------
Options outstanding at
the beginning of the
year................... 282,160 $3.33 316,200 $3.33 321,600 $3.33
Granted................ -- -- -- -- -- --
Exercised.............. (91,040) 3.33 (15,680) 3.33 -- --
Forfeited.............. (126,860) 3.33 (18,360) 3.33 (5,400) 3.33
-------- ------- -------
Options outstanding at
the end of the year.... 64,260 3.33 282,160 3.33 316,200 3.33
======== ======= =======
Options exercisable at
the end of the year.... 31,404 3.33 6,040 3.33 27,540 3.33
Weighted average
remaining contractual
life of options
outstanding at end of
year................... 7 years 8 years 9 years
Weighted average
information for options
granted during the
year:
Fair value............. N/A N/A N/A
The fair value of options granted under the 1996 Option Plan during 1996 was
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions used: no dividend yield, no
volatility, risk-free interest rate of 7% and expected lives of 10 years.
Options exercisable as of December 31, 1997 were due to the retirement of
three directors. Upon retirement, their options immediately vested. As of June
27, 1997, the date of the Reorganization, the 1996 Option Plan became the
amended and restated LIFE Financial Corporation 1996 Stock Option Plan. Stock
options with respect to shares of the Bank's common stock granted under the
1996 Option Plan and outstanding prior to completion of the Reorganization
automatically became options to purchase three shares of the Company's common
stock upon identical terms and conditions. The Company assumed all of the
Bank's obligations with respect to the 1996 Option Plan.
The Board of Directors of the Company adopted the LIFE Financial Corporation
1997 Stock Option Plan (the 1997 Option Plan), which became effective upon the
Reorganization (the 1996 Option Plan and the 1997 Option Plan will sometimes
hereinafter be referred to as the Option Plans). The Board of Directors of the
Company has reserved shares equal to 10% of the issued and outstanding shares
of the Company giving effect to the Reorganization and the initial public
offering, including Company options that were exchanged for Bank options
pursuant to the 1996 Option Plan for issuance under the Option Plans.
65
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
After the Reorganization, the Option Plans became available to directors,
officers and employees of the Company, and to directors, officers and employees
of its direct or indirect subsidiaries. The options granted pursuant to the
1997 Option Plan will vest at a rate of 33.3% per year, beginning on June 30,
2000. The following is a summary of activity in the 1997 Option Plan during
1999, 1998 and 1997.
1999 1998 1997
----------------- ----------------- -----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- -------- ------- -------- ------- --------
Options outstanding at
the beginning of the
year.................... 173,500 $11.15 193,000 $11.14 -- --
Granted................ 60,000 $11.00 8,000 $11.62 194,000 $11.14
Forfeited.............. (87,000) $11.30 (27,500) $11.16 (1,000) $11.00
------- ------- -------
Options outstanding at
end of the year......... 146,500 $11.00 173,500 $11.15 193,000 $11.14
======= ======= =======
Options exercisable at
the end of the year..... 0 15,000 17,500
======= ======= =======
Weighted average
information on options
granted during the
year--fair value........ $2.67 $7.60 $8.37
Options exercisable as of December 31, 1998 were due to the resignation of a
senior officer. Upon resignation, the options immediately vested. Options
exercisable as of December 31, 1997 were due to the retirement of one director.
Upon retirement, the options immediately vested.
The fair value of options granted under the 1997 Option Plan during 1999,
1998, and 1997 was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used: no
dividend yield for any year, volatility rate of 23.9%, 45.72% and 55.92%,
respectively, risk-free interest rate of 6.5%, 5.59% and 6.45% , respectively
and expected lives of 10 years for each years.
66
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its Option Plans. Accordingly, no compensation cost has been
recognized for its Option Plans. Had compensation cost for the Option Plans
been determined based on the fair value at the grant date for awards under the
Plans based on the fair value method of SFAS No. 123, the Company's net income
(loss) and earnings (loss) per share for the years ended December 31, 1999,
1998 and 1997 would have been reduced to the pro forma amounts indicated below
(dollars in thousands, except per share data):
1999 1998 1997
-------- ------ -------
Net income (loss) to common stockholders:
As reported.................................... $(17,839) $1,059 $10,324
Pro forma...................................... $(18,088) $ 619 $ 9,778
Basic earnings (loss) per share:
As reported.................................... $ (2.71) $ 0.16 $ 2.11
Pro forma...................................... $ (2.75) $ 0.09 $ 2.00
Diluted earnings (loss) per share:
As reported.................................... $ (2.71) $ 0.16 $ 2.02
Pro forma...................................... $ (2.75) $ 0.09 $ 1.91
14. Financial Instruments with Off Balance Sheet Risk
The Company is a party to financial instruments with off balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit in the form of
originating loans or providing funds under existing lines of credit. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the accompanying consolidated
statements of financial condition.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual or notional amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates and may require payment of a fee. Since
many commitments are expected to expire, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's credit worthiness on a case-by-case basis. The Company's commitments
to extend credit at December 31, 1999 and 1998 totaled $8,438,000 and
$10,969,000, respectively.
The Company regularly enters into commitments to sell certain dollar amounts
of loans to third parties under specific, negotiated terms. The terms include
the minimum maturity of the loans, yield to purchaser, servicing spread to the
Company, and the maximum principal amount of the individual loans. The Company
typically satisfies these commitments from its current production of loans.
These commitments have fixed expiration dates and may require a fee. There were
no outstanding commitments to sell loans at December 31, 1999 or December 31,
1998.
67
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
15. Fair Value of Financial Instruments
The following disclosures of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures About Fair Value of Financial Instruments. The estimated fair value
amounts have been determined by the Company using available market information
and appropriate valuation methodologies. However, considerable judgment is
necessarily required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
1999
-------------------
Carrying Estimated
amount Fair value
-------- ----------
(in thousands)
Assets:
Cash and cash equivalents................................. $ 20,315 $ 20,315
Securities held to maturity............................... 32,833 32,823
Residual mortgage-backed securities....................... -- --
Loans held for sale....................................... 330,127 334,410
Loans held for investment, net............................ 103,601 103,414
Participation contract, net............................... 4,996 4,996
Mortgage servicing rights................................. 6,431 8,729
Accrued interest receivable .............................. 3,676 3,676
Liabilities:
Deposit accounts.......................................... 468,859 468,985
Other borrowings.......................................... 17,873 17,873
Subordinated debentures................................... 1,500 1,500
Accrued interest payable.................................. 155 155
Off-balance sheet unrealized gain on commitments............ -- --
1998
-------------------
Carrying Estimated
Amount Fair value
-------- ----------
(in thousands)
Assets:
Cash and cash equivalents................................. $ 8,152 $ 8,152
Securities held to maturity............................... 4,471 4,483
Residual mortgage-backed securities....................... 50,296 50,296
Loans held for sale....................................... 243,497 245,625
Loans held for investment, net............................ 90,827 91,163
Mortgage servicing rights................................. 13,119 15,699
Accrued interest receivable............................... 2,762 2,762
Liabilities:
Deposit accounts.......................................... 323,433 323,664
Other borrowings.......................................... 39,977 39,977
Subordinated debentures................................... 1,500 1,500
Accrued interest payable.................................. 408 408
Off-balance sheet unrealized gain on commitments............ -- 178
68
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
The Company utilized the following methods and assumptions to estimate the
fair value of each class of financial instruments for which it is practicable
to estimate that value:
Cash and Cash Equivalents--The carrying amount approximates fair value.
Securities Held to Maturity--Fair values are based on quoted market prices.
Loans Held for Sale--Fair values are based on quoted market prices or
dealer quotes.
Loans Held for Investment--The fair value of gross loans receivable has
been estimated using the present value of cash flow method, discounted
using the current rate at which similar loans would be made to borrowers
with similar credit ratings and for the same maturities, and giving
consideration to estimated prepayment risk and credit loss factors.
Residual Mortgage-backed securities and Mortgage Servicing Rights--Fair
values are estimated using discounted cash flows based on current market
values.
Participation Contract--Fair values are estimated using discounted cash
flows based on the internal rate of return required by the obligor. The
value is presented net of obligations under the credit guaranty.
Accrued Interest Receivable/Payable--The carrying amount approximates fair
value.
Deposit Accounts--The fair value of checking, passbook and money market
accounts is the amount payable on demand at the reporting date. The fair
value of certificate accounts is estimated using the rates currently
offered for deposits of similar remaining maturities.
Other Borrowings and Subordinated Debentures--The carrying amount
approximates fair value as the interest rate currently approximates market.
Financial Instruments with Off-Balance Sheet Risk--As of December 31, 1999
and 1998, fair values are based on quoted market prices or dealer quotes.
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1999 and 1998. Although management
is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been comprehensively revalued for purposes
of these financial statements since that date; and, therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
69
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
16. Segment Information
The Company's reportable segments within the financial services industry are
banking, mortgage banking, and loan servicing. During 1999, the Company
redefined its reportable segments and restated 1998 and 1997 for comparability
purposes. Also included are the original disclosures as previously reported.
Information about these segments as of or for the years ended December 31,
1999, 1998 and 1997 is as follows (dollars in thousands):
For the Year Ended December 31, 1999
--------------------------------------
Mortgage Loan
Bank Banking Servicing Total
-------- -------- --------- --------
Non-Interest Revenues............... $ 1,096 $(23,063) $ 4,789 $(17,178)
Interest Earned..................... 46,378 0 0 46,378
Interest Charges.................... (25,566) 0 (11) (25,577)
-------- -------- ------- --------
Net Interest Income (expense)... 20,812 0 (11) 20,801
-------- -------- ------- --------
Total revenue................... $ 21,908 $(23,063) $ 4,778 $ 3,623
======== ======== ======= ========
Pre-tax segment earnings (loss)..... $ 6,365 $(35,678) $ 69 $(29,244)
Segment assets...................... $499,453 $ 39,366 $ 8,789 $547,608
For the Year Ended December 31, 1998
(unaudited)
--------------------------------------
Mortgage Loan
Bank Banking Servicing Total
-------- -------- --------- --------
Non-Interest Revenues............... $ 816 $ 9,493 $ 3,874 $ 14,183
Interest Earned..................... 41,104 0 0 41,104
Interest Charges.................... (22,907) 0 (8) (22,915)
-------- -------- ------- --------
Net Interest Income expense..... 18,197 0 (8) 18,189
-------- -------- ------- --------
Total revenue................... $ 19,013 $ 9,493 $ 3,866 $ 32,372
======== ======== ======= ========
Pre-tax segment earnings (loss)..... $ 8,810 $ (6,609) $ (414) $ 1,787
Segment assets...................... $357,755 $ 54,972 $15,351 $428,078
For the Year Ended December 31, 1997
(unaudited)
--------------------------------------
Mortgage Loan
Bank Banking Servicing Total
-------- -------- --------- --------
Non-Interest Revenues............... $ 507 $ 25,416 $ 1,307 $ 27,230
Interest Earned..................... 21,146 0 0 21,146
Interest Charges.................... (12,823) 0 (7) (12,830)
-------- -------- ------- --------
Net interest Income (expense)... 8,323 0 (7) 8,316
-------- -------- ------- --------
Total revenue................... $ 8,830 $ 25,416 $ 1,300 $ 35,546
======== ======== ======= ========
Pre-tax segment earnings (loss)..... $ 2,194 $ 16,966 $(1,454) $ 17,706
Segment assets...................... $339,962 $ 46,752 $10,357 $397,071
70
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
Information regarding previously reported segments for 1998 and 1997 are
presented below. 1999 is presented for comparability purposes.
For the Year Ended
--------------------------------------
December 31, 1999
--------------------------------------
Mortgage Mortgage Mortgage
Financing Financing Financing
Bank Portfolio Liberator Other Total
------- --------- --------- --------- --------
Revenue for the year...... $ 3,320 $ 5,175 $ 15,315 $ 5,391 $ 29,201
Interest income........... 2,799 8,714 25,789 9,077 46,379
Interest expense.......... 22,044 707 2,091 735 25,577
Net income (loss) for the
year..................... (20,743) 581 1,719 604 (17,839)
Assets employed at year
end...................... $66,087 $96,042 $270,342 $115,137 $547,608
For the Year Ended
-------------------------------------
December 31, 1998
-------------------------------------
Mortgage Mortgage Mortgage
Financing Financing Financing
Bank Portfolio Liberator Other Total
------ --------- --------- --------- -------
Revenue for the year......... $4,037 $13,069 $32,644 $5,537 $55,287
Interest income.............. 3,440 9,737 24,123 3,804 41,104
Interest expense............. 1,962 5,139 13,142 2,672 22,915
Net income (loss) for the
year........................ (2,557) 1,387 2,767 (538) 1,059
Assets employed at year-end.. 36,121 110,074 247,375 34,517 428,078
For the Year Ended
-------------------------------------
December 31, 1997
-------------------------------------
Mortgage Mortgage Mortgage
Financing Financing Financing
Bank Portfolio Liberator Other Total
------ --------- --------- --------- -------
Revenue for the year......... $4,897 $9,330 $29,377 $4,772 $48,376
Interest income.............. 2,779 3,342 10,513 4,512 21,146
Interest expense............. 2,252 1,924 6,055 2,599 12,830
Net income (loss) for the
year........................ (2,039) 3,639 11,566 (2,842) 10,324
Assets employed at year-end.. 50,547 83,698 236,821 26,005 397,071
71
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
17. Earnings (Loss) Per Share
A reconciliation of the numerators and denominators used in basic and
diluted earnings (loss) per share computations is as follows (in thousands,
except per share data):
Earnings per share has been adjusted retroactively to reflect the three-for-
one stock exchange effected pursuant to the Reorganization. The per share
amounts and weighted average shares outstanding included in the accompanying
consolidated financial statements have been restated to reflect the
Reorganization.
Loss Shares Per share
(numerator) (denominator) amount
----------- ------------- ---------
Year ended December 31, 1999:
Net loss applicable to loss per
share............................... $(17,839)
--------
Basic per share
Loss available to common
stockholders........................ (17,839) 6,575 $(2.71)
======
Effect of dilutive securities
Stock option plans anti-dilutive..... 0
-----
Diluted loss per share
Loss available to common
stockholders........................ $(17,839) 6,575 $(2.71)
======== ===== ======
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ---------
Year ended December 31, 1998:
Net earnings applicable to earnings
per share........................... $ 1,059
--------
Basic earnings per share
Earnings available to common
stockholders........................ 1,059 6,555 $ 0.16
======
Effect of dilutive securities
Stock option plans................... 251
-----
Diluted earnings per share
Earnings available to common
stockholders plus assumed
conversions......................... $ 1,059 6,806 $ 0.16
======== ===== ======
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ---------
Year ended December 31, 1997:
Net earnings applicable to earnings
per share........................... $ 10,324
--------
Basic earnings per share
Earnings available to common
stockholders........................ 10,324 4,885 $ 2.11
======
Effect of dilutive securities
Stock option plans................... 223
-----
Diluted earnings per share
Earnings available to common
stockholders plus assumed
conversions......................... $ 10,324 5,108 $ 2.02
======== ===== ======
72
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
18. Parent Company Financial Information
LIFE FINANCIAL CORPORATION
(Parent company only)
December 31,
------------------
1999 1998
-------- --------
STATEMENTS OF FINANCIAL CONDITION
ASSETS:
Cash and cash equivalents......................... $ 441 $ 566
Residual mortgage backed securities............... -- 50,296
Investment in subsidiaries........................ 32,545 27,315
Other assets...................................... 23,990 4,109
-------- --------
TOTAL ASSETS.................................... $ 56,976 $ 82,286
======== ========
LIABILITIES:
Other borrowings.................................. $ 19,373 $ 27,832
Accrued expenses and other liabilities............ 3,141 2,456
-------- --------
TOTAL LIABILITIES............................... 22,514 30,288
TOTAL STOCKHOLDERS' EQUITY...................... 34,462 51,998
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...... $ 56,976 $ 82,286
======== ========
Year ended December 31,
---------------------------
1999 1998 1997
-------- -------- -------
STATEMENTS OF OPERATIONS:
INTEREST INCOME..................................... $ 3,310 $ 6,461 $ 185
INTEREST EXPENSE.................................... 2,489 2,440 80
-------- -------- -------
Net interest income............................. 821 4,021 105
NONINTEREST INCOME (LOSS)........................... (32,058) (10,233) 14,088
NONINTEREST EXPENSE................................. 3,091 1,903 1,308
EQUITY IN NET EARNINGS (LOSS) OF SUBSIDIARIES....... 3,075 5,763 2,760
-------- -------- -------
EARNINGS (LOSS) BEFORE INCOME TAX EXPENSE........... (31,253) (2,352) 15,645
INCOME TAX EXPENSE (BENEFIT)........................ (13,414) (3,411) 5,321
-------- -------- -------
NET EARNINGS (LOSS)................................. $(17,839) $ 1,059 $10,324
======== ======== =======
73
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
LIFE FINANCIAL CORPORATION
(Parent company only)
SUMMARY STATEMENTS OF CASH FLOWS
1999 1998 1997
-------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................ $(17,839) $ 1,059 $ 10,324
Adjustments to reconcile net income (loss) to
cash provided by (used in) operating
activities:
Gain (loss) on sale and securitization of
loans held for sale....................... -- 10,616 (13,631)
Equity in net earnings (loss) of
subsidiaries.............................. (3,075) (5,763) (2,760)
Purchase of loans held for sale, net of
loan fees................................. -- (462,074) (324,795)
Proceeds from sales and securitization of
loans held for sale....................... -- 436,948 319,941
Net accretion of residual mortgage-backed
securities................................ (3,313) (6,984) (1,622)
Net unrealized and realized losses/(gains)
on residual mortgage-backed securities ... 36,471 16,550 (448)
(Decrease) increase in accrued expenses and
other liabilities......................... (1,480) (896) 3,352
Increase in other assets................... (12,558) (2,171) (3,493)
-------- --------- ---------
Net cash provided by (used in) operating
activities.............................. (1,794) (12,715) (13,132)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of residual mortgage-backed
securities from the Bank.................... -- -- (23,243)
Capital contributions to subsidiaries........ (2,155) -- (11,075)
Cash received on desecuritization of residual
mortgage-backed securities.................. 11,980 -- --
-------- --------- ---------
Net cash used in investing activities.... 9,825 -- (34,318)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from other borrowings........... (8,459) 12,295 15,537
Net proceeds from issuance of common stock... 303 53 32,846
-------- --------- ---------
Net cash provided by (used in) financing
activities.............................. (8,156) 12,348 48,383
-------- --------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS...... (125) 367 933
CASH AND CASH EQUIVALENTS, beginning of year... 566 933
-------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year......... $ 441 $ 566 $ 933
======== ========= =========
74
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1999
19. Quarterly Results of Operations (Unaudited)
The following is a summary of quarterly results for the years ended December
31.
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share
data)
1999
Interest Income.............................. $11,329 $12,696 $10,432 $11,921
Interest Expense............................. 5,783 6,565 6,156 7,073
Provision for estimated loan losses.......... 458 1,750 430 2,744
Noninterest income........................... 1,979 4,787 6,354 (30,298)
Net earnings (loss).......................... 684 1,759 1,037 (21,319)
Earnings (loss) per share:
Basic...................................... 0.10 0.27 0.16 (3.23)
Diluted.................................... 0.10 0.27 0.16 (3.23)
1998
Interest Income.............................. $ 9,371 $10,145 $11,842 $ 9,746
Interest Expense............................. 5,340 5,554 6,951 5,070
Provision for estimated loan losses.......... 1,630 -- 736 1,800
Noninterest income........................... 9,325 4,507 7,384 (7,033)
Net earnings (loss).......................... 3,715 1,521 2,535 (6,712)
Earnings (loss) per share:
Basic...................................... 0.57 0.23 0.39 (1.02)
Diluted.................................... 0.54 0.22 0.37 (1.01)
During the quarter ended December 31, 1998, the Company recorded net
unrealized losses on residual mortgage-backed securities of $9.9 million.
During the quarter ended December 31, 1999, transactions consisted of:
(1) On December 31, 1999, the Company sold its residual mortgage-backed
securities resulting in a one-time after tax charge of $16.8
million.
(2) The Company recorded a provision for loan losses of $2.7 million.
(3) The Company recorded an unrealized loss in its loans held for sale
portfolio of $3.0 million related to lower of cost or market
adjustments.
75
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As reported in 8-K dated October 7, 1999, Deloitte & Touche LLP, resigned as
the Company's independent accountant. During the Company's two most recent
fiscal years and through October 7, 1999, there were no disagreements with
Deloitte & Touche LLP on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Deloitte & Touche LLP,
would have caused it to make reference to the subject matter of the
disagreement in connection with its report.
Deloitte & Touche LLP's reports on the Company's financial statements for
the fiscal years ended December 31, 1998 and 1997, did not contain an
adverse opinion or a disclaimer of opinion, and were not qualified or
modified as to uncertainty, audit scope or accounting principles.
During the Company's two most recent fiscal years and through October 7,
1999, Deloitte & Touche LLP did not advise the Company of any "reportable
events" as defined in Item 304(a)(1)(v) of Regulation S-K.
As reported in 8-K dated October 22, 1999, Grant Thornton LLP was engaged as
the Company's independent accountants for the fiscal year ended December 31,
1999, to audit the Company's financial statements.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on June 14, 2000,
which will be filed with the Securities and Exchange Commission within 120 days
after the end of the Registrant's fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation and directors'
compensation is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on June 14, 2000,
excluding the Stock Performance Graph and Compensation Report. The Proxy
Statement will be filed within 120 days after the end of the Registrant's
fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial owners
and management is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on June 14, 2000,
which will be filed within 120 days after the end of the Registrant's fiscal
year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related transactions
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on June 14, 2000, which will be filed
within 120 days after the end of the Registrant's fiscal year.
76
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Company are included
herein at Item 8.
(2) All schedules are omitted because they are not required or
applicable, or the required information is shown in the
consolidated financial statements or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report:
3.1 Certificate of Incorporation of LIFE Financial Corporation*
3.2 Bylaws of LIFE Financial Corporation*
4.0 Stock Certificate of LIFE Financial Corporation*
21.0 Subsidiary information is incorporated herein by reference to
"Part I--Subsidiaries"
23.1 Consent of Deloitte & Touche LLP
23.2 Consent of Grant Thornton LLP
27.0 Financial Data Schedule
(b) Reports on Form 8-K
- --------
* Incorporated herein by reference into this document from the Exhibits to Form
S-4 Registration Statement, filed on January 27, 1997 and any amendments
thereto, Registration No. 333-20497.
77
SIGNATURES
Pursuant to the requirements of Section 13 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.
LIFE FINANCIAL CORPORATION
/s/ Robert K. Riley
By: _________________________________
President and Chief Executive
Officer
DATED: March 31, 2000
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this Report has been signed by the following persons in the capacities and on
the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Robert K. Riley President and Chief March 31, 2000
____________________________________ Executive Officer
Robert K. Riley (principal executive
officer)
/s/ W. Todd Peterson Executive Vice President and March 31, 2000
____________________________________ Chief Financial Officer
W. Todd Peterson (principal financial and
accounting officer)
/s/ Ronald G. Skipper Chairman of the Board March 31, 2000
____________________________________
Ronald G. Skipper
/s/ John D. Goddard Director March 31, 2000
____________________________________
John D. Goddard
/s/ Milton E. Johnson Director March 31, 2000
____________________________________
Milton E. Johnson
/s/ Edgar C. Keller Director March 31, 2000
____________________________________
Edgar C. Keller
78