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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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, 1998
Commission File No.: 0-22193
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)
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)
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 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 $3.38 and is based upon the last sales price as quoted on The
Nasdaq Stock Market for March 26, 1999.
As of March 26, 1999, the Registrant had 6,562,396 shares outstanding
(excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-K.
INDEX
Page
PART I
======
Item 1. Business................................................................................. 1
Additional Item. Executive Officers of the Registrant.................................... 46
Item 2. Properties............................................................................... 47
Item 3. Legal Proceedings........................................................................ 48
Item 4. Submission of Matters to a Vote of Security Holders...................................... 48
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 49
Item 6. Selected Financial Data.................................................................. 49
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 51
Item 8. Financial Statements and Supplementary Data.............................................. 64
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..... 101
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 101
Item 11. Executive Compensation................................................................... 101
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 101
Item 13. Certain Relationships and Related Transactions........................................... 101
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 101
SIGNATURES 102
5
ITEM 1. BUSINESS
General
LIFE Financial Corporation (the "Company") is a Delaware chartered savings
and loan holding company, headquartered in Riverside, California. The Company
became the parent company of Life Bank (formerly "Life Savings Bank, Federal
Savings Bank") (the "Bank") pursuant to the holding company reorganization of
the Bank (the "Reorganization") undertaken in connection with the Company's
initial public offering of its Common Stock (the "IPO"). The Company completed
the IPO on June 30, 1997. Together with shares issued subsequent to that date
pursuant to the exercise of the underwriter's overallotment option, the Company
issued a total of 3,335,000 shares of Common Stock in the IPO at a price of
$11.00 per share. Net proceeds from the IPO amounted to $32.8 million.
The Company originates, purchases, sells, securitizes and services primarily
alternative mortgage loans principally secured by first and second mortgages on
one- to four-family residences. The Company makes Liberator Series loans, which
are for the purchase or refinance of residential real property by borrowers who
could generally qualify for Fannie Mae ("FNMA") or Freddie Mac ("FHLMC")
loans ("alternative borrowers") but required relief from the more stringent
documentation that those quasi-governmental agencies require. Through October
1998, the Company also made portfolio series loans, which are debt consolidation
loans for borrowers whose credit history qualifies them for FNMA and FHLMC loans
("Agency Qualified Borrowers") with loan-to-value ratios up to 125%. The
Liberator Series of loans is now the Company's "core product." The Company
also originates primarily on a retail basis through the Income Capital Group
multi-family residential, commercial and construction loans. A new division, the
Consumer Finance Group, was introduced in the fourth quarter of 1998 with the
express mandate to create private label and joint venture relationships to
finance various direct to the consumer lending products.
The Company conducts its business from thirteen locations: the Company's
corporate headquarters and Western regional lending center in Riverside,
California, four additional regional lending centers located in Jacksonville,
Florida, the Denver, Colorado metropolitan area, San Jose, California, as well
as the Boston metropolitan area. The national servicing center is located in
Riverside, California adjacent to the corporate headquarters with the Consumer
Finance Group domiciled in a company owned facility in Riverside, California.
LIFE bank branch offices are located in the Southern California cities of San
Bernardino, Riverside, Redlands and Huntington Beach.. In addition, the Company
has recently entered into a lease for an additional Southern California bank
branch in the Orange County community of Seal Beach that is expected to open in
May of 1999.
At December 31, 1998, the Company had consolidated total assets of $428.1
million, total deposits of $323.4 million and total stockholders' equity of
$52.0 million. During the year ended December 31, 1998, the Company originated
or purchased, through a network of approved correspondents and independent
mortgage brokers (the "Originators"), $1.2 billion of mortgage loan products,
and sold or securitized $1.1 billion of such products. The Bank's deposits are
insured up to the maximum allowable amount by the Savings Association Insurance
Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The
Company's headquarters are located at 10540 Magnolia Avenue, Suite B, Riverside,
California 92505, and its telephone number at that location is (909) 637-4000.
Historical Strategy of the Company
During the early 1990's, as a result of reduced employment levels and
corporate relocations in Southern California and the general weakness of the
national economy, the Company's market area experienced a weakening of real
estate values and a reduction in home sales and construction. When confronted
with increased competition and nominal growth during this same period, the
Company's results of operations were adversely impacted and the Company began to
experience increases in total non-performing loans held for investment. In
response, in 1994, the Company retained new management experienced in mortgage
lending to redirect its business focus, revise its underwriting policies and
procedures and enhance its related servicing capabilities. A plan was developed
pursuant
6
to which the Company reorganized its lending operations from that of a thrift
solely emphasizing mortgage banking and portfolio lending to that of a
diversified financial services operation focusing on the origination for sale or
securitization, with servicing retained, of various alternative loan products to
include Liberator Series of residential mortgage loans, as well as the Income
Capital Group which provides commercial, multi-family and real estate
construction loans. The Company also adopted revised underwriting policies and
instituted more aggressive procedures for resolving problem loans and for
reducing the level of non-performing assets. As a result of these steps, the
Company improved its profitability.
As part of the Company's strategic plan, the Bank developed an internal
structure of operating divisions, each with distinct objectives and management
focus. The six divisions include (i) the Financial Services Division which
emphasizes the wholesale origination of the Bank's core products; (ii) the
Income Capital Services Group which originates and sells commercial, multi-
family and construction loans; (iii) the Retail Loan Division which concentrates
on offering loan products directly to the public primarily in the Bank's primary
market area; (iv) the Consumer Finance Group which provides financing for a
variety of private label and joint venture consumer products; (v) Asset
Management Division which services loans and REO for both the Bank and for Loan
Purchasers; and (vi) the Banking Division which offers depository services to
the public. These divisions do not necesarrily represent the operating segments
of the company.
On March 11, 1998, the Company entered into an agreement and plan of merger
("Merger Agreement") with FIRSTPLUS Financial Group, Inc. ("FIRSTPLUS"). The
Merger Agreement provided for the merger of the Company with and into FIRSTPLUS,
with FIRSTPLUS as the surviving corporation. On October 9, 1998, the Company
advised FIRSTPLUS that it was terminating the Merger Agreement based upon, among
other reasons, certain breaches of the Merger Agreement by FIRSTPLUS. On October
19, 1998, the Company filed a lawsuit against FIRSTPLUS arising out of the
Merger Agreement in the United States Federal District Court for Dallas, Texas.
Corporate Structure
The Company and the Bank consummated the Reorganization in June of 1997
whereby the Bank became a wholly owned subsidiary of the Company. Management
believes that the holding company form of organization provides the Company with
more flexibility and a greater ability to compete with other financial services
companies in the market place. In addition, due to regulatory capital
limitations, the Bank is limited in the amount of investments in residuals
resulting from securitizations that it can retain. The Company is not subject to
such limitations, and thus will reduce the restrictions on the Bank's regulatory
capital by acquiring loans and creating the residuals as part of a
securitization.
Core Lending Products
General. The Company originates, purchases, sell, securitizes and services
primarily non-conventional mortgage loans principally secured by first and
second mortgages on one- to four-family residences. The Company makes Liberator
Series loans, which are for the purchase or refinance of residential real
property by alternative borrowers, and Portfolio Series loans, which are debt
consolidation loans for Agency-Qualified Borrowers with loan-to-value ratios
generally up to 125%. The Company is currently emphasizing the origination of
Liberator Series loans and has eliminated the Portfolio Series loan product
effective October 1998. In addition, to a much lesser extent, the Company
originates multi-family residential, commercial real estate and construction
loans.
The Company purchases and originates mortgage loans and other real estate
secured loans primarily through a network of Originators on a nationwide basis.
Beginning in 1998, the Company began to originate a limited number of loans
specifically for retention in the Bank's portfolio as loans held for investment.
Loans originated or purchased since 1994 through the Company's regional lending
centers are generally originated for sale in the
7
secondary mortgage market and, since the fourth quarter of 1996, in asset
securitizations with servicing retained by the Company.
Adjustable-Rate Mortgages. The Company's adjustable rate mortgage ("ARM")
products consist of both first and second mortgages. The repayment and
amortization terms on first mortgage ARMs are 360 months. The repayment and
amortization terms on second mortgage ARMs may be 300, 240 or 180 months.
Interest rates adjust every six or twelve months, and are tied to the six-month
LIBOR or to the 1-Year U.S. Treasury Index, respectively. The periodic rate caps
vary between 1% and 3% on each rate change date. All ARM products are assumable,
subject to new borrower qualification, assumption agreements and fees. The
lifetime rate cap on ARMs is 6% to 7% above the initial rate. None of the ARM
products permit negative amortization. There are no fixed-rate conversion
options on any of the ARM products. Certain ARM products impose prepayment
penalties and others do not.
Marketing. The Company's primary means of marketing its products is direct
contact between its account executives and Originators. Each of the Company's 27
account executives is responsible for maintaining and expanding existing
Originator relationships within the account executive's assigned territory
through personal contact and promotional materials. Each account executive is
typically responsible for approximately 20 key Originators and is expected to
have weekly contact with each of these Originators. In addition, each account
executive is responsible for up to 30 additional Originators with whom the
account executive will have frequent contact. Each account executive also works
to develop Originator relationships through "cold calls" and following up on
inquiries made by Originators to the Company's toll-free number. Each account
executive works as part of a team with one of the Company's loan coordinators
and assistant coordinators. Each loan coordinator and assistant loan coordinator
works with three or four account executives. The loan coordinators and their
assistants are responsible for inputting the new loans into the Company's data
systems and for shepherding the loans from the point of origination through
funding. After origination, the whole loan coordinators and their assistants are
available to talk to Originators on a daily basis. Whole loan coordinators and
their assistants are located in each of the Company's regional lending centers.
The Company believes that the key element in developing, maintaining and
expanding its relationships with Originators is to provide the highest possible
level of product knowledge and customer service. Each account executive receives
comprehensive training prior to being assigned to a territory. In most cases,
training includes experience in the loan production department so that the
account executive will be familiar with all phases of loan origination and
production and will also become acquainted with the whole loan coordination
team. This training enables the account executive to quickly review a loan
application in order to identify the borrower's probable risk classification and
then assist the Originator in identifying the appropriate product for the
borrower, thereby enhancing the likelihood that the loan will be approved at the
rate and on the terms anticipated by the borrower. After a loan package is
submitted to the Company, the loan coordination team provides assistance to the
Originator throughout the process to complete the loan transaction. Account
executives and loan coordinators are compensated based on the number and the
dollar volume of loans funded. A significant portion of a regional manager's
compensation is tied to the profitability of his or her regional lending center
and includes a component based on loan performance.
Origination and Purchase of Loans. Loans are originated both through the
Company's wholesale network of Originators and on a retail basis through the
Company's Retail Lending Division. The Company has also made bulk purchases of
loans from time to time and hired a senior management employee experienced in
bulk purchases to expand the Company's loan purchases.
The Company's mortgage financing and servicing operations are conducted
primarily through regional lending centers located in Riverside, California,
Jacksonville, Florida, the Denver, Colorado metropolitan area, Boston
Massachuetts and San Jose, California. From its present locations, the Company
is able to originate or purchase its core products in the District of Columbia
and all 50 states with the exception of Alaska and Hawaii.
8
The following table sets forth for the periods shown the aggregate dollar
amounts and the percentage of core products originated or purchased by the
Company in each state where 5.0% or more of the loans were originated or
purchased during the years ended December 31, 1998 and 1997:
December 31, December 31,
------------ ------------
1998 1997
---- ----
$ % $ %
------ ------ ------- ------
(Dollars in thousands)
California............................ $ 200,964 18.5% $159,385 22.3%
Michigan.............................. 67,995 6.3 20,853 2.9
Virginia.............................. 65,202 6.0 42,722 6.0
Utah.................................. 61,844 5.7 35,735 5.0
Maryland.............................. 55,801 5.1 39,545 5.5
Florida............................... 53,532 4.9 37,009 5.2
North Carolina........................ 51,694 4.8 38,011 5.3
Other................................. 529,338 48.7 342,292 47.8
---------- ----- -------- -----
Total............................... $1,086,370 100.0% $715,552 100.0%
========== ===== ======== =====
The Company's geographic markets are currently divided into three regions,
with a completely self-contained mortgage banking team assigned to each region.
Each team is headed up by a regional manager and includes dedicated account
executives, loan coordinators and assistant coordinators, underwriters, and
other production personnel so that the team can originate and produce loans in
that region. This concept of regional processing teams, which the Company
believes is efficient but quite rare in the industry, enables the Company to
more effectively anticipate and respond to Originator and borrower needs in each
region. Management believes that the concept also appeals to independent brokers
who may be reluctant to deal with a larger, more remote lender. Each regional
team is connected to senior management in Riverside, California by a computer
link that enables senior management to monitor all regional functions on a real
time basis.
Management personnel staffing a regional lending center are trained in the
Company's Riverside office. For a period of six to twelve months after the
establishment of a regional lending center all loans originated through that
office are reunderwritten by staff at the Riverside office to assure quality
control. In addition, the quality control department and the Company's internal
auditor regularly visit the regional lending centers for quality control
purposes.
In recent years, the Company has focused on both Liberator Series loans and
Portfolio Series loans. The Company is currently emphasizing the origination of
Liberator Series loans, as the Portfolio Series loans were phased out as of
October 1998.
Liberator Series loans are loans for the purchase or refinance of one- to
four-family residential real property by alternative borrowers and loans which
otherwise do not conform to FHLMC or FNMA guidelines ("conforming loans").
Loans to alternative borrowers are perceived by management as being advantageous
to the Company because they generally have higher interest rates and origination
and servicing fees and generally lower loan-to-value ratios than conforming
loans. In addition, management believes the Company has the resources to
adequately service loans acquired pursuant to this program as well as the
experience to resolve loans that become non-performing. The Company has
established specific underwriting policies and procedures, invested in
facilities and systems and developed correspondent relationships with
Originators throughout the country enabling it to develop its niche as an
originator and purchaser of one-to four-family residential loans to alternative
borrowers. Since the beginning of 1997, the Company has widely advertised its
NINA loan product and in 1998 began the enhanced NINA, which is a limited
documentation, lower loan-to-value loan product within the Liberator Series loan
portfolio. The Company intends to continue to expand the volume of Liberator
Series loans which it originates to market areas throughout the country to
alternative borrowers who meet its niche lending criteria. Loans to alternative
borrowers present a higher level of risk of default than conforming loans
because of the increased potential for default by borrowers who may have had
previous credit problems or who do not have an adequate credit history. Loans to
alternative borrowers also involve additional liquidity risks, as these loans
generally have a
9
more limited secondary market than conventional loans. The actual rates of
delinquencies, foreclosures and losses on loans to alternative borrowers could
be higher under adverse economic conditions than those currently experienced in
the mortgage lending industry in general. While the Company believes that the
underwriting procedures and appraisal processes it employs enable it to somewhat
mitigate the higher risks inherent in loans made to these borrowers, no
assurance can be given that such procedures or processes will afford adequate
protection against such risks.
As of October 1998, the Portfolio Series loans were discontinued as a product
line. Portfolio Series loans, which are debt consolidation loans for Agency
Qualified Borrowers, were originated both on a wholesale basis through the
Company's Life Financial Services Division, and through its Retail Lending
Division. These loans are consumer-oriented loans secured by real estate,
primarily home equity lines of credit and second deeds of trust, generally for
up to 125% of the appraised value of the real estate underlying the aggregate
loans on the property. Although the loan-to-value ratio on Portfolio Series
loans is higher than that offered by other mortgage products, management
believes that the higher yield and the low level of credit risk of the borrowers
offsets the risks involved. In the event of a default on a Portfolio Series loan
by a borrower, there generally would be insufficient collateral to pay off the
balance of such loan and the Company, as holder of a second position on the
property, would likely lose a substantial portion, if not all, of its
investment. While the Company believes that the underwriting procedures it
employs enable it to somewhat mitigate the higher risks inherent in such loans,
no assurance can be given that such procedures will afford adequate protection
against such risks.
The following table sets forth the principal balance of each of the Company's
core loan products originated during the years ended December 31, 1998 and 1997:
December 31, December 31,
------------ ------------
1998 1997
---- ----
(Dollars in thousands)
Liberator Series (full documentation).............. $ 421,616 $186,964
Liberator Series (NINA)............................ 262,210 55,932
Portfolio Series................................... 402,544 472,656
---------- --------
Total............................................ $1,086,370 $715,552
========== ========
The following table sets forth selected information relating to originations
of Liberator Series loans during the years ended December 31, 1998 and 1997:
For the YearEnded For the Year Ended
--------------------------- --------------------------
December 31, 1998 December 31, 1997
--------------------------- --------------------------
Full Full
---- ----
Documentation NINA Documentation NINA
-------------- ---------- -------------- ---------
(Dollars in thousands)
Principal balance............................................. $421,616 $262,210 $186,964 $55,932
Average principal balance per loan 8.3 113 90 112
Combined weighted average initial loan-to-value ratio......... 78.2% 75.2% 76.6% 72.2%
Percent of first mortgage loans............................... 94.8 97.4 89.6 99.4
Property securing loans:
Owner occupied.............................................. 94.6 93.4 88.5 94.3
Non-owner occupied.......................................... 5.4 6.6 11.5 5.7
Percentage fixed-rate......................................... 66.9 51.5 38.5 24.6
Percentage ARMs............................................... 33.1 48.5 61.5 75.4
Weighted average interest rate:
Fixed-rate.................................................. 9.5 9.7 10.7 10.9
ARMs........................................................ 9.3 9.3 9.5 9.3
The following table sets forth selected information relating to originations
of Portfolio Series loans during the years ended December 31, 1998 and 1997:
10
For the For the
------- -------
Year Ended Year Ended
---------- ----------
December 31, December 31,
------------ ------------
1998 1997
---- ----
Principal balance.......................................................... $402,544 $472,656
Average principal balance per loan......................................... 33 33
Combined weighted average initial loan-to-value ratio...................... 111.0 109.0
Percent of first mortgage loans............................................ 0.0 0.2
Property securing loans:
Owner occupied........................................................... 100.0 100.0
Non-owner occupied....................................................... 0.0 0.0
Percentage fixed-rate...................................................... 95.6 95.4
Percentage ARMs............................................................ 4.4 4.6
Weighted average interest rate:
Fixed-rate............................................................... 13.4 14.0
ARMs..................................................................... 11.1 11.0
Use and Qualifications of Originators. The Company purchases loans from select
Originators throughout the country. Such Originators must be approved by the
Company prior to submitting loans to the Company. Pursuant to the Company's
approval process, each Originator is generally required to have a specified
minimum level of experience in originating non-conforming loans, and provide
representations, warranties, and buy-back provisions to the Company.
The Company provides clear and concise criteria regarding its well-defined
core products to Originators with whom it may do business. If, following a
period of training and relationship building, Originators consistently fail to
present a high level of loans meeting the Company's underwriting criteria, the
Company will cease to do business with them. As a result, the Company has
developed, since 1994, a core group of Originators who form its nationwide
network of Originators. The Company generally classifies the Originators with
which it does business into four classes with descending priority with regard to
the terms and the pricing of the loans the Company purchases from such
Originators.
Junior Third Party Mortgage
------ ----------- --------
Correspondents Correspondents Originators Brokers(1)
-------------- -------------- ----------- ----------
Net Worth(2)..................................... $250,000 $100,000 $50,000 N/A
Years in Business................................ 2 2 2 N/A
Warehouse Credit Facility........................ Yes Yes No No
Errors and Omissions Insurance................... $1.0 million No No No
Number Doing Business with the Company at
December 31, 1998............................... 129 53 72 1,118
(1) Mortgage brokers are those persons who do not meet the specific foregoing
criteria but have demonstrated to the Company, or have a reputation for, the
ability to originate real estate secured loans and have acceptable credit
and finance industry references.
(2) Correspondents provide audited financial statements prepared in accordance
with GAAP from which net worth is determined. Junior Correspondents and
Third Party Originators provide unaudited financial information from which
net worth is obtained.
The Company purchases substantially all loans on an individual basis from
qualified Originators. No single Originator accounted for more than 3.1% of
the loans originated by the Company for the year ended December 31,
11
1998. It is the Company's general policy to limit the percentage of loans closed
by any single Originator to approximately 5.0% of loans closed in any given
period.
Underwriting. The underwriting and quality control functions are managed
through the Company's administrative offices in Riverside, California. The
Company believes that its underwriting process begins with the experience of its
staff, the education of its network of Originators, the quality of its
correspondent relationships and its loan approval procedures. 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.
Personnel in the Company's regional lending centers review in its entirety
each loan application submitted by the Company, Originators or through bulk
purchases for approval. The Company conducts its own underwriting review of each
loan, including those loans originated for or purchased by it from its
Originators. Loan files are reviewed for completeness, accuracy and compliance
with the Company's underwriting criteria and applicable governmental
regulations. This underwriting process is intended to assess both the
prospective borrower's ability to repay the loan and the adequacy of the real
property security as collateral for the loan granted, tailored to the general
nature of the Portfolio Series and the Liberator Series loans, respectively.
Based on the initial review, the personnel in the regional lending center will
inform the Originators of additional requirements that must be fulfilled to
complete the loan file. The Company strives to process each loan application
received from its network of Originators as quickly as possible in accordance
with the Company's loan application approval procedures. Accordingly, most loan
applications receive decisions within 48 hours of receipt and generally are
funded within one day following satisfaction of all conditions for approval of
the loan which is typically seven business days after the initial approval.
Each prospective borrower is required to complete a mortgage loan application
that may include (depending on the program requirement) information detailing
the applicant's liabilities, income, credit history, employment history and
personal information. Since most of the loan applications are presented through
the Company's network of Originators, the Company completes an additional credit
report on all applications received. Such report typically contains information
relating to such matters as credit history with local and national merchants and
lenders, installment debt payments and any record of defaults, bankruptcies,
repossessions or judgments. This credit report is obtained through a
sophisticated computer program that accesses what management believes to be the
most appropriate credit bureau in a particular zip code and combines that
information with the Company's own credit risk score.
This application and review procedure is used by the Company to analyze the
applicant's creditworthiness (i.e., a determination of the applicant's ability
to repay the loan). Creditworthiness is assessed by examination of a number of
factors, including calculating a debt-to-income ratio obtained by dividing a
borrower's fixed monthly debt by the borrower's gross monthly income. Fixed
monthly debt generally includes (i) the monthly payment under any related senior
mortgages which will include calculations for insurance and real estate taxes,
(ii) the monthly payment on the loan applied for and (iii) other installment
debt, including, for revolving debt, the required monthly payment thereon, or,
if no such payment is specified, 3% of the balance as of the date of
calculation. Fixed monthly debt may not include any debt (other than revolving
credit debt) described above that matures within less than 10 months of the date
of calculation.
Prior to funding a loan, several procedures are used to verify information
obtained from an applicant. The applicant's outstanding balance and payment
history on any senior mortgage may be verified by calling the senior mortgage
lender. If the senior mortgage lender cannot be reached by telephone to verify
this information, the Originators may rely upon information provided by the
applicant, such as a recent statement from the senior lender and verification of
payment, such as canceled checks, or upon information provided by national
credit bureaus. In order to verify an applicant's employment status, the
Originators may obtain from the applicant recent tax returns or other tax forms
(e.g., W-2 forms) or current pay stubs or may telephone the applicant's employer
or obtain written verification from the employer. As in the case of the senior
mortgage lender verification procedures, if the employer will not verify
employment history over the telephone, the Company or other Originators may rely
solely on the
12
other information provided by the applicant. The Company does offer NINA loans
at reduced loan-to-value ratios in lieu of documenting cash flow and/or assets
of the borrower. See "--Liberator Series (NINA)" for further information on NINA
loans.
Debt to income ratios for Portfolio Series mortgage loans generally did not
exceed 45%, but in certain instances where deemed appropriate by the Company,
the ratio may have gone as high as 50%. For Liberator Series mortgage loans,
debt to income ratios may vary depending upon a number of other factors used to
ascertain the creditworthiness of the borrower.
The general criteria currently used by the Company in classifying prospective
borrowers of its core loan products are summarized in the charts below.
Liberator Series
"Ax" Risk "A-" Risk "B" Risk
---------------------- ---------------------- ------------------------
Maximum Loan-to-Value
Ratio:
Primary residence(1)........... 97% 95% 85%
Secondary residence............ 90% 90% 80%
Investor property.............. 90% 90% 80%
Home equity line of
credit........................ 90% 90% 80%
Debt Service to Income
Ratio......................... 50% 50% 50-55%
Mortgage Credit.................. No more than 30-days No more than 30-days No more than 30 days
late in the last 12 Late in the last 12 late in last 12 months
months months for Liberator Plus
and no more than
60-days late in last 12
months for Liberator.
Bankruptcy Filings............... No bankruptcy in last No bankruptcy in last No bankruptcy in last
24 months 24 months 18 months
Minimum Credit Score
Liberator 620/600 600/575 550/530
Liberator Plus 620 501 575
"C" Risk "Cx" Risk
------------------------- ----------------------
Maximum Loan-to-Value
Ratio:
Primary residence(1)........... 75% 65%
Secondary residence............ 70% 65%
Investor property.............. 70% 65%
Home equity line of
credit........................ -- --
Debt Service to Income
Ratio......................... 50-60% 60%
Mortgage Credit.................. No more than two 60 Currently delinquent
days late payments and
one 90 days late
payments in last 12
months
Bankruptcy Filings............... No bankruptcy in last Discharged within 12
12 months months preceding
application; current
Chapter 13 or
foreclosure
acceptable when paid
in full or cured from
loan proceeds
Minimum Credit Score
Liberator 450 less than 450
Liberator Plus
(1) The NINA product is exactly the same except Loan-to-Value is 90% on primary
residence.
13
Loan Production by Borrower Risk Classification. The Company classifies
borrowers according to credit risk from A+ to Cx; however, the predominant
amount of its lending is to borrowers in categories A- or higher. The following
table sets forth information concerning the Company's principal balance of fixed
rate and adjustable rate loan production by borrower risk classification for the
years ended December 31, 1998 and 1997:
For the Year Ended For the Year Ended
------------------ -------------------
December 31, 1998 December 31, 1997
----------------- -----------------
Weighted Weighted
-------- --------
Average Weighted Average Weighted
------- -------- ------- --------
Product/Risk % of Interest Average % of Interest Average
------------ ---- -------- ------- ---- -------- -------
Classifications Volume Total Rate(1) Margin(2) Volume Total Rate(1) Margin(2)
--------------- ------ ----- ------- --------- ------ ----- ------- ---------
(Dollars in thousands)
Liberator Series (Full documentation)
A+..................................... $ 4,450 1.1% 9.10% 5.32% $ 964 0.5% 9.31% 5.16%
Ax..................................... 264,782 62.8 9.10 5.34 81,706 43.7 9.46 4.48
A-..................................... 69,818 16.5 9.47 5.68 52,488 28.1 9.77 5.24
A...................................... 1,118 0.3 9.21 5.72 -- -- -- --
-------- ----- ------- -----
Total A- or better................... 340,168 80.7 -- -- 135,158 72.3 9.58 4.78
-------- ----- ------- -----
B+..................................... 5,409 1.3 9.75 6.17 143 0.1 10.42 --
B...................................... 54,833 13.0 10.47 6.36 25,423 13.6 10.11 4.95
C...................................... 14,018 3.3 11.18 7.00 11,229 6.0 11.00 5.64
Cx..................................... 7,188 1.7 11.87 7.22 15,011 8.0 12.32 6.83
-------- ----- ------ -----
Totals............................... $421,616 100.0% 9.46 5.63 $186,964 100.0% 9.96 5.02
======== ===== ======== =====
Liberator Series (NINA)
A+ $ 3,172 1.2% 9.47 5.65 -- -- -- --
Ax..................................... 197,930 75.5 9.39 5.25 $ 38,404 68.7% 9.20 5.47
A-..................................... 20,761 7.9 9.83 5.71 8,460 15.1 9.93 6.18
A...................................... 340 0.1 8.34 -- -- -- -- --
A1..................................... 5,795 2.2 7.70 -- -- -- -- --
A2..................................... 1,996 0.8 7.97 -- -- -- -- --
A3..................................... 2,921 1.1 8.41 -- -- -- -- --
A4..................................... 1,666 0.6 9.11 -- -- -- -- --
-------- ----- ------ ----
Total A- or better................... 234,581 89.4 -- -- 46,864 83.8 9.33 5.59
-------- ----- ------ ----
B+..................................... 294 0.1 10.27 6.14 -- -- -- --
B...................................... 15,935 6.1 10.60 6.43 4,325 7.7 10.74 6.26
C...................................... 7,298 2.8 10.91 6.19 1,909 3.4 11.35 6.92
Cx..................................... 4,102 1.6 12.09 7.50 2,834 5.1 12.56 6.83
-------- ----- ----- ---
Totals............................... $262,210 100.0% 9.52 5.43 $ 55,932 100.0% 9.67 5.75
======== ===== ======== =====
Portfolio Series
A+..................................... $116,139 28.9% 12.78 2.79 $101,777 21.5% 13.09 5.00
Ax..................................... 128,068 31.8 13.20 3.90 171,206 36.2 13.72 5.26
A-..................................... 149,992 37.3 13.75 4.58 161,112 34.1 14.23 6.20
A...................................... 134 0..0 13.17 -- -- -- -- --
-------- ----- -------- -----
Total A- or better................... 394,333 98.0 13.29 3.83 434,095 91.8 13.76 5.55
-------- ----- -------- -----
B+..................................... 8,112 2.0 14.09 6.97 38,167 8.1 14.32 6.40
B...................................... 29 0.0 16.99 -- 394 0.1 12.74 3.23
36 0.0 12.50 -- -- -- -- --
B...................................... 34 0.0 13.99 -- -- -- -- --
-------- ----- -------- -----
Total................................ $402,544 100.0% 13.30 3.90 $472,656 100.0% 13.81 5.62
======== ===== ======== =====
(1) Weighted average interest rate includes both ARM loan products and fixed
rate loan products.
(2) Weighted average margin is based solely on ARM products.
Appraisal. All mortgaged properties relating to mortgage loans where
collateral assessment is an integral part of the evaluation process are
appraised by state licensed or certified appraisers. All of the appraisals are
either performed or reviewed by appraisers or appraisal firms approved by the
Company's senior management. These appraisers are screened and actively reviewed
on a regular basis. Each approved appraiser must have a minimum of $1.0 million
of errors and omissions insurance. All appraisers are required to assess the
valuation of the property pursuant to U.S. Government Property Analysis
guidelines and conduct an economic analysis of the geographic region in which
the property is located. Once a loan application file is complete, the file is
reviewed to determine
14
whether the property securing the loan should undergo a desk or field review.
This determination is made based on the loan-to-value ratio of the underlying
property and the type of loan or loan program. If after the initial desk review,
the underwriter requires additional information with regard to the appraised
value of the property, a field review may also be conducted. The Company
requires the appraiser to address neighborhood conditions, site and zoning
status and the condition and valuation of improvements. Following each
appraisal, the appraiser prepares a report which (when appropriate) includes a
reproduction cost analysis based on the current cost of constructing a similar
building and a market value analysis based on recent sales of comparable homes
in the area. Title insurance policies are required on all first mortgage liens
and second liens $100,000 and over, with a limited judgment lien report required
on all second lien loans under $100,000.
For Liberator Series loans, because of the alternative creditworthiness of the
borrowers, the evaluation of the value of the property securing the loans and
the ratio of loans secured by such property to its value become of greater
importance in the underwriting process. The specific procedures and criteria
utilized in the appraisal process range from a desk review, a field review, to a
second appraisal, depending on the size of the loan and its loan-to-value ratio.
The value of the mortgaged property has lesser importance with respect to the
Portfolio Series loans in light of their high loan-to-value ratios. As a result,
Portfolio Series loans generally have little or no equity in the mortgaged
property available to repay the loan if it is in default. For Portfolio Series
loans, the Company accepted the homeowner/mortgagee's "as stated" value on
loans to $35,000. On loans in excess of $35,000 to a maximum of $50,000, the
Company required a current tax assessment, a statistical appraisal or a HUD-1
conformed closing statement where purchase of the subject property has occurred
within the previous 12 months. For loans in excess of $50,000, a drive-by
appraisal including comparable analysis on a FHLMC Form 704 was required.
Qualified property inspection firms are also utilized for annual property
inspections on all properties 45 days or more delinquent. Property inspections
are intended to provide updated information concerning occupancy, maintenance
and changes in market conditions.
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 the Loan Committee and specified officers of the Company. All
real estate loans must be approved by a quorum of the designated committee or by
the designated individual or individuals.
All loans underwritten by the Company require the approval and signature of
two underwriters. Where there are exceptions to the Company's underwriting
criteria, the loan must be unanimously approved by the underwriter, supervisory
underwriter and the Senior Vice President of the Company or, if not unanimously
approved, by the Company's President and Chief Executive Officer. It has been
the Bank's policy to adhere strictly to its underwriting standards with few
exceptions. Additionally, the following committees, groups of officers and
individual officers are granted the authority to approve and commit the Company
to the funding of the following categories of loans:
Level of Approval
--------------------------------------------------------------------
Loan Committee
One Staff Two Staff Loan --------------
--------- --------- ---- and Board of
Underwriter Underwriters Committee -----------
Type of Loan ----------- ------------ --------- Directors
----------------------- ---------
Mortgage loans held for sale........... -- $1.0 million -- More than $1.0
or less(1) million
Mortgage loans held for investment..... -- $250,000 or less More than $250,000 $550,000 or more
but less than
$550,000
Other loans............................ Personal loans All other loans All other loans more All other loans in
secured by Bank $25,000 or less than $25,000 but less excess of $50,000
deposits than $50,000
15
(1) Loans in excess of $500,000 require approval by an executive officer in
addition to approval by two underwriters.
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, 1998, the Bank's loans to one borrower limit equaled $4.5
million. See "--Regulation--Federal Savings Institution Regulation--Loans-to-
One Borrower."
Loan Sales and Asset Securitizations
Loans are sold by the Company through securitizations and whole loan sales.
With the exception of customary provisions relating to breaches of
representations and warranties, loans securitized or sold by the Company are
sold without recourse to the Company and generally are sold with servicing
retained. For the years ended December 31, 1998, 1997 and 1996, the Company sold
$610.5 million, $94.7 million, and $154.6 million in loans, respectively. For
the years ended December 31, 1998, 1997 and 1996, the Company securitized $462.1
million, $415.4 million and $51.9 million, respectively.
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. 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.
No assurance can be given that the residuals could in fact be sold at their
carrying value, if at all.
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
17
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.
The Company has completed five securitizations, one during the fourth quarter
of 1996, one during the first quarter of 1997, one during the third quarter of
1997, one during the fourth quarter of 1997 and one during the thrid quarter of
1998. The characteristics and results of these securitizations are as follows:
1996-1 1997-1A 1997-1B
-------------------------- --------------------------- ------------------------------
Type of loan securitized Fixed Rate Liberator Adjustable Rate Fixed Rate Liberator
Series and Portfolio Liberator Series Series and Portfolio Series
Series
Weighted average coupon....... 13.32% 9.45% 13.02%
Amount of certificates issued. $55.0 million $38.5 million $61.5 million
Pass-through rate............. 6.95% 1 month LIBOR plus 21 7.49%
21 bp
Amount of loans
securitized(1)............... $51.9 million $33.6 million $46.5 million
Credit enhancement............ MBIA Insurance MBIA Insurance MBIA Insurance
Corporation Corporation Corporation
Initial funding of reserve
Accounts..................... $1.6 million $941,000 $3.1 million
Required reserve level to be
Funded....................... 9.0% of original 5.5% of original 10.6% of original
outstanding balance of outstanding balance of outstanding balance of
loans loans loans
Gain on sale of loans......... $4.3 million $5.7 million(2) $5.7 million(2)
Gain on sale of loans as a
percent of loans sold........ 8.29% 7.12%(2) 7.12%(2)
Estimated prepayment speed.... 17.0% H.E.P.(3) 25.0% C.P.R.(3)(4) 17.0% H.E.P.
Discount factor............... 13.5% 13.5% 13.5%
Annual estimated loss
Assumption................... 1.5% 0.5% 0.5% of Liberator Series
loans; 1.5% of Portfolio
Series loans
Servicing fees................ 0.50% for the first six 0.65% for the first 1.00% on fixed rate loans sold
months and 1.00% twelve months and 1.00%
thereafter thereafter
Rating........................ AAA/Aaa (S&P/Moody's) AAA/Aaa (S&P/Moody's) AAA/Aaa (S&P/Moody's)
1997-2 1997-3
---------------------------- ----------------------
Type of loan securitized Fixed Rate Portfolio Fixed Rate
Series Portfolio Series
Weighted average coupon....... 13.64% 13.86%
Amount of certificates issued. $123.8 million $250.0 million
Pass-through rate............. 7.12%(5) 7.62%
Amount of loans
securitized(1)............... $100.9 million $187.4 million
Credit enhancement............ Loan Loan
overcollateralization overcollateralization
Initial funding of reserve
Accounts..................... $1.3 million None
Required reserve level to be
Funded....................... 7.0% of original 6.3% of original
outstanding outstanding
balance of loans balance of loans
Gain on sale of loans......... $9.4 million $10.7 million
Gain on sale of loans as a
percent of loans sold........ 9.33% 5.69%
Estimated prepayment speed.... 12.0% H.E.P. 14.0% H.E.P.
Discount factor............... 13.5% 13.5%
Annual estimated loss
Assumption................... 2.0% 2.5%
Servicing fees................ 1.00% 1.00%
Rating........................ (6) (7)
(1) For 1996-1, an additional $3.1 million was funded during quarter ended March
31, 1997 which created a gain on sale of loans of $ . For 1997-1A, $4.9
million was funded in April 1997. For 1997-1B, $15.0 million was funded in
April 1997. For 1998-1, $ was funded in November , 1998. All of these
prefunded amounts were sold under the same terms and conditions as set forth
in the table above.
(2) The combined gain on sales of loans for 1997-1A and 1997-1B was $ million.
The percentages are based on the combined 1997-1A and 1997-1B
securitizations.
(3) Home Equity Prepayment ("H.E.P.") and Constant Prepayment Rate ("C.P.R.")
are methods of estimating prepayment speeds.
(4) This prepayment assumption was revised during the third quarter of 1997
resulting in an unrealized loss to the Company of $ ,000.
(5) Weighted average rate.
(6) Each of the Senior Notes were rated AAA/Aaa (Fitch/Moody's), the Class M-1
Notes were rated AA/A2, the Class M-2 Notes were rated A/A2 and the Class B
notes were rated BBB/Baa3.
17
(7) Each of the Senior Notes were rated AAA/Aaa (Fitch/Moody's), the Class M-1
Notes were rated AA/Aa2, the Class M-2 Notes were rated A/A2 and the Class B
Notes were rated BBB/Baa2.
The following table presents the actual loss and prepayment history as of
December 31, 1998 and 1997 for the securitizations conducted by the Company.
The 1997 data does not reflect the 1997-3 securitization, which was completed
during December 1997 and for which meaningful data was not available as of that
date:
December 31, 1998 1996-1 1997-1A 1997-1B 1997-2 1997-3 1998-1A 1998-1B
------ ------- ------- ------ ------ ------- -------
Lifetime actual loss percentage................................ 4.969% 4.13% 2.609% 2.39% 1.54% -- % -- %
Lifetime prepayments as a percentage of loans securitized
annualized................................................... 24.59 46.32 19.36 15.07 11.75 20.45% 7.14%
December 31, 1997 1996-1 1997-1A 1997-1B 1997-2
------ ------- ------- ------
Lifetime actual loss percentage................................ 0.75% -- % 0.43% 0.08%
Lifetime prepayments as a percentage of loans securitized
annualized................................................... 14.45 43.72 8.18 5.53
The actual loss and prepayment history information provided above are not
necessarily indicative of loss and prepayment results that may be experienced
over the duration of the securitization.
As market conditions warrant, loans will be either sold as securitizations or
on a whole loan basis, whole loans will be sold pursuant to purchase, sale and
servicing agreements negotiated with Loan Purchasers to purchase loans meeting
the Company's underwriting criteria. At December 31, 1998 there were no
outstanding commitments to deliver mortgage loans. The Company retains the
servicing rights on the majority of loans sold. However, the Company also sells
loans on a servicing released basis and may continue to subservice the loans for
a fee for a period of time. The Company sells loans to a number of different
investors with which it does business. As such, management believes that no one
relationship with a Loan Purchaser constitutes the predominant source of sales
for the Company and the Company does not rely on any specific entities for sales
of its loans.
Commercial Real Estate and Multi-Family Real Estate Lending
Consistent with its strategy of developing niche lending markets, the Company
increased its efforts to originate and purchase multi-family and commercial real
estate loans both in its primary market area and throughout the United States.
Specifically, the Company has targeted the market for borrowers seeking loans in
the range of $50,000 to $2.0 million, subject to the Bank's loans-to-one
borrower limit, currently $4.5 million, which are secured by multi-family
properties or properties used for commercial business purposes such as small
office buildings, light industrial or retail facilities. Since the Company has
been able to acquire such loans at a discount and expects to be able to continue
to acquire such loans at a discount or low premium, management believes that the
origination and subsequent sale of commercial and multi-family real estate loans
will increase the Company's cash flow. The Company has streamlined and
standardized its processing of commercial and multi-family real estate loans
with a view to sale in the secondary market or securitization. Since 1994,
substantially all commercial and multi-family real estate loans originated by
the Company have been sold in the secondary market without recourse. Although
there can be no assurances in this regard, management intends to gradually
expand these operations, thereby adding a source of revenue for the Company as
well as providing loans for future securitizations. There can be no assurances,
however, that any such securitization will be completed in the future.
Securitization of commercial and multi-family real estate loans is significantly
less standardized and streamlined than securitization of one- to four-family
residential mortgage loans.
Management believes that it has the infrastructure in place to safely
diversify its product line into this niche market. Two of the Company's senior
executive officers, Daniel L. Perl and Joseph R. L. Passerino, have combined
experience of approximately 29 years in commercial and multi-family real estate
lending and have developed substantial relationships with commercial and multi-
family real estate originators throughout the United States. In addition, the
Company works primarily with a select group of approximately 100 mortgage
brokers nationwide with
18
specifically delineated credentials. The Company also works with eleven
correspondents and expects to expand that number of approved correspondents to
15 in the near future. Commercial and multi-family real estate loan
correspondents in the Company's network must have a net worth of at least $1.0
million, a two to three year history of funding and servicing multi-family and
commercial real estate loans and errors and omissions insurance of at least $1.0
million. Where loans are originated by other than this pre-approved group of
correspondents, the Company will underwrite the loan. The Company also works
with a contract appraiser with nationwide experience in appraising commercial
and multi-family real estate loans who appraises or reviews the appraisals on
all such properties.
The Company's policy is to not make commercial or multi-family real estate
loans to borrowers who are in bankruptcy, foreclosure, have loans more than 30
days delinquent or other combinations of credit weaknesses unacceptable to the
Company. The Company targets high to medium credit quality borrowers. The
Company's underwriting procedures provide that commercial real estate loans may
be made in amounts up to 75% of the appraised value of the property depending on
the borrower's creditworthiness. Multi-family real estate loans may be made in
amounts up to 80% of the appraised value of the property. Commercial real estate
loans and multi-family real estate loans may be either fixed rate or adjustable
rate loans. These loans include prepayment penalties if repaid within the first
three to five years. When evaluating a commercial or multi-family real estate
loan, the Company considers the net operating income of the property and the
borrower's expertise, credit history and personal cash flows. The Company has
generally required that the properties securing commercial real estate and
multi-family real estate loans have debt service coverage ratios (the ratio of
net operating income to debt service) of at least 120%. The largest commercial
real estate loan in the Company's held for sale portfolio at December 31, 1998
was $1.2 million and is secured by an eight-retail unit and a 38 office space
building in Great Falls, Montana while the largest multi-family real estate loan
in the Company's held for sale portfolio at December 31, 1998 was $1.6 million
secured by a 90 unit multi-family property located in Pompano Beach, Florida. At
December 31, 1998 the Company's commercial real estate portfolio was $14.2
million, or 4.21% of total gross loans, $9.2 million of which were held for
sale. The Company's multi-family real estate portfolio at that same date was
$17.4 million, or 5.15% of total gross loans, $15.4 million of which were held
for sale.
Repayment of multi-family and commercial real estate loans generally is
dependent, in large part, on sufficient income from the property to cover
operating expenses and debt service. The Company attempts to offset the risks
associated with multi-family and commercial real estate lending by primarily
lending to individuals who will be actively involved in the management of the
property and generally to individuals who have proven management experience, and
by making such loans with lower loan-to-value ratios than one- to four-family
loans.
Construction Lending
The Company orignates construction loans for owner occupied single-family
homes, single-family homes on a speculative basis, single family tract, retail,
industrial, apartment and office product. Those projects built on a speculative
basis are to builders and borrowers who have shown by past performance to be
able to construct and effectively market the completed product and where
management is comfortable with the underlying economic conditions. The
Company`s loan to value maximum policy on a speculative residental project or a
commerical 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 some
tangible form of equity in each construction project.
As of December 31, 1998, the cumulative loan to value of the construction
portfolio was below 70% and the portfolio was concentrated in residential
product. Presently, the Company lends construction funds only in California
with a concentration in Southern California due to its proximity and familiarity
to management.
Construction lending affords the Company the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does single family
permanent mortgage lending. However, construction loans involve risks different
from completed project lending because loan funds are advanced upon security of
the project under
19
construction, and if the loan goes into default, additional funds may have to be
advanced to complete the project before it can be sold. Moveover, construction
projects are subject to uncertainties inherent in estimating construction costs,
potential delays in construction time, market demand and accuracy of the
estimate of value upon completion. The Company requires the borrower's to carry,
among other things, liability insurance equal to certain prescribed minimum
amounts, and of course construction insurance. The Company disburses its own
funds internaly via bank checks issued to control the physical completion to
disbursed funds ratio along with on-site inspection for each draw.
Consumer and Other Lending
The Company's consumer and other loans generally consist of overdraft lines of
credit, commercial business loans and unsecured personal loans. At December 31,
1998, the Company's consumer and other loan portfolio was $3.0 million or .87%
of total gross loans.
Loan Servicing
Through December 31, 1993, the Company's loan servicing portfolio consisted
solely of loans originated directly by the Company and retained for investment
or sold, primarily as participations, to others. Commencing in January of 1994
through June of 1995, the Company purchased mortgage servicing rights on FNMA
and FHLMC loans in order to expand the size of its loan servicing department and
to further develop its loan servicing capabilities. The entire FHLMC servicing
portfolio was resold in December 1995. During 1995, the Company began to retain
substantially all servicing rights on loans sold. In addition, the Company
intends to retain the servicing rights to the loans it securitizes. The pooling
and servicing agreements related to the securitizations completed to date
contain provisions with respect to the maximum permitted loan delinquency rates
and loan default rates which, if exceeded, could allow the termination of the
Company's right to service the related loans. At December 31, 1998, the
cumulative losses and/or annual default rate on two of the Company's
securitization transactions exceeded the permitted limit in the related pooling
and servicing agreements. Servicing rights were $13.1 million at December 31,
1998. At December 31, 1998, the Company serviced $1.3 billion of loans of which
$1.0 billion were serviced for others. There can be no assurance that the
Company's estimates used to determine the fair value of mortgage servicing
rights will remain appropriate for the life of the loans sold or the
securitizations. If actual loan prepayments or delinquencies exceed the
Company's estimates, the carrying value of the Company's mortgage servicing
rights may have to be written down through a charge against earnings. The
Company cannot write up such assets to reflect slower than expected prepayments,
although slower prepayments may increase future earnings as the Company will
receive cash flows in excess of those anticipated. Fluctuations in interest
rates may also result in a write-down of the Company's mortgage servicing rights
in subsequent periods. During 1998 and 1997, the Company recorded write-downs of
$1.2 million and $1.3 million, respectively, on mortgage servicing rights as a
result of higher than anticipated prepayment speeds on adjustable rate mortgage
loans.
The loan servicing and collections department has increased in size from four
persons at December 31, 1994 to 62 persons at December 31, 1998. Within this
department, personnel have experience in both alternative lending and also in
managing the Company's non-performing loans in its historical local lending
portfolio. This experience was gained in part during the economic downturn in
Southern California and resulted in a low loss experience for the Company. See
"--Lending Overview--Allowance for Loan Losses." The head of the servicing
department has more than 25 years of experience in loan servicing and
collections, including responsibility for a $10.0 billion portfolio of
approximately 255,000 loans and a staff of 70 people. During the second quarter
of 1998, substantial space in Riverside, California was leased for the loan
servicing and collections operations and the space was occupied during that same
quarter. The Company has enhanced its telephonic systems by purchasing a power
dialing system, which became operational in the first quarter of 1998. During
the second quarter of 1998, the Company enhanced its computer systems by adding
document imaging, which creates an image of each document in a loan file
accessible through the Company's wide area network.
20
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.
While most of the Company's servicing portfolio is generated through its
origination and purchase activities, when economically attractive, the Company
has, from time to time, made bulk purchases of mortgage servicing rights from
financial institutions. The Company does not intend to make significant bulk
purchases of servicing rights in the near future but may do so depending on
market opportunities. The mortgage loans underlying the servicing rights
retained by the Company have been historically underwritten by the Company.
These servicing rights were either originated by mortgage brokers or purchased
through various programs from correspondents or junior correspondents. The costs
to acquire servicing are based on the present value of the estimated future
servicing revenues, net of the expected servicing expenses, for each
acquisition. Major factors impacting the value of servicing rights include
contractual service fee rates, projected mortgage prepayment speed, projected
delinquencies and foreclosures, projected escrow, agency and fiduciary funds to
be held in connection with such servicing and the projected benefit to be
realized from such funds.
In addition to weekly loan delinquency meetings which are attended by members
of senior management, the loan committee of the Board of Directors generally
performs a monthly review of all delinquent loans 90 days or more past due. In
addition, management reviews on an ongoing basis all delinquent loans. The
procedures taken by the Company with respect to delinquencies vary depending on
the nature of the loan and period of delinquency. When a borrower fails to make
a required payment on a loan, the Company takes a number of steps to have the
borrower cure the delinquency and restore the loan to current status. The
Company generally sends the borrower a written notice of non-payment within ten
days after the loan is first past due. In the event payment is not then
received, additional letters and phone calls generally are made. If the loan is
still not brought current, the Company generally sends a notice of the intent to
foreclose 35 days after the loan is first past due. If a loan remains delinquent
on the 45th day, a property inspection will be made to verify occupancy,
determine the condition of the property and as an attempt to contact the
borrower in person. If the borrower does not cure the delinquency and it becomes
necessary for the Company to take legal action, which typically occurs after a
loan is delinquent at least 60 days or more, the Company will commence
foreclosure proceedings against any real property that secures the loan. If a
foreclosure action is instituted and the loan is not brought current, paid in
full, or refinanced before the foreclosure sale, the real property securing the
loan generally is sold at foreclosure. The Company's procedures for repossession
and sale of consumer collateral are subject to various requirements under state
consumer protection laws.
Regulation and practices in the United States regarding the liquidation of
properties (e.g., foreclosure) and the rights of the mortgagor in default vary
greatly from state to state. Loans originated or purchased by the Company are
secured by mortgages, deeds of trust, trust deeds, security deeds or deeds to
secure debt, depending upon the prevailing practice in the state in which the
property securing the loan is located. Depending on local law, foreclosure is
effected by judicial action and/or non-judicial sale, and is subject to various
notice and filing requirements. If foreclosure is effected by judicial action,
the foreclosure proceedings may take several months.
In general, the borrower, or any person having a junior encumbrance on the
real estate, may cure a monetary default by paying the entire amount in arrears
plus other designated costs and expenses incurred in enforcing the obligation
during a statutorily prescribed reinstatement period. Generally, state law
controls the amount of foreclosure expenses and costs, including attorneys'
fees, which may be recovered by a lender.
There are a number of restrictions that may limit the Company's ability to
foreclose on a property. A lender may not foreclose on the property securing a
junior mortgage loan unless it forecloses subject to each senior mortgage, in
which case the junior lender or purchaser at such a foreclosure sale will take
title to the property subject to the lien securing the amount due on the senior
mortgage. Moreover, if a borrower has filed for bankruptcy
21
protection, a lender may be stayed from exercising its foreclosure rights. Also,
certain states provide a homestead exemption that may restrict the ability of a
lender to foreclose on residential property.
Credit Quality of Servicing Portfolio. The following table illustrates the
Company's delinquency and default experience with respect to its loan servicing
portfolio:
22
At December 31,
------------------------------------------
1998 1997
-------------------- -----------------
Number Number
------ ------
of % of % of of % of
-- ---- ---- -- ----
Loans/ Loans Principal Servicing Loans/ Loans
----- ----- --------- --------- ------ -----
Properties Serviced Balance Portfolio Properties Serviced
---------- -------- ------- --------- ---------- --------
(Dollars in thousands)
Delinquency percentage(1)(2)
30-59 days..................... 292 1.19% $ 11,419 0.85% 282 1.46%
60-89 days..................... 126 0.51 3,795 0.28 148 0.76
90 days and over............... 263 1.07 9,847 0.74 333 1.72
------ ---- ---------- ---- ------ ----
Total delinquency.............. 681 2.77% $ 25,061 1.87% 763 3.94%
====== ==== ========== ==== ====== ====
Default percentage(3)
Foreclosure.................... 144 0.57% $ 12,489 0.93% 52 0.27%
Bankruptcy..................... 157 0.64 8,213 0.61 49 0.25
Real estate owned(4)........... 17 0.07 1,998 0.15 33 0.17
------ ---- ---------- ---- ------ ----
Total default.................. 318 1.28% $ 22,700 1.69% 134 0.69%
====== ==== ========== ==== ====== ====
Total servicing portfolio........ 24,634 $1,339,003 19,359
====== ========== ======
At December 31,
-----------------------------------------------------
1996
-----------------------
Number
------
% of of % of % of
---- -- ---- ----
Principal Servicing Loans/ Loans Principal Servicing
--------- --------- ------ ----- --------- ---------
Balance Portfolio Properties Serviced Balance Portfolio
------- --------- ---------- -------- ------- ---------
(Dollars in thousands)
Delinquency percentage(1)(2)
30-59 days..................... $ 9,356 1.12% 10 0.26% $ 860 0.36%
60-89 days..................... 3,664 0.44 -- -- -- --
90 days and over............... 3,128 0.38 3 0.08 143 0.06
-------- ---- ----- ---- -------- ----
Total delinquency.............. $ 16,148 1.94% 13 0.34% $ 1,003 0.42%
======== ==== ===== ==== ======== ====
Default percentage(3)
Foreclosure.................... $ 6,269 0.75% 56 1.48% $ 6,279 2.64%
Bankruptcy..................... 2,814 0.34 9 0.24 778 0.33
Real estate owned(4)........... 3,509 0.42 9 0.24 1,197 0.50
-------- ---- ----- ---- -------- ----
Total default.................. $ 12,592 1.51% 74 1.96% $ 8,254 3.47%
======== ==== ===== ==== ======== ====
Total servicing portfolio........ $832,393 3,781 $237,958
======== ===== ========
23
(1) The delinquency percentage represents the number and outstanding principal
balance of loans for which payments are contractually past due, exclusive
of loans in foreclosure, bankruptcy, real estate owned or forbearance.
(2) The past due period is based on the actual number of days that a payment is
contractually past due. A loan as to which a monthly payment was due 60-89
days prior to the reporting period is considered 60-89 days past due, etc.
(3) The default percentage represents the number and outstanding principal
balance of loans in foreclosure, bankruptcy or real estate owned.
(4) An "REO Property" is a property acquired and held as a result of
foreclosure or deed in lieu of foreclosure.
24
Lending Overview
Loan Portfolio Composition. At December 31, 1998, the Company's gross loans
outstanding totaled $337.6 million, of which $238.7 million, or 70.7%, were held
for sale and $98.9 million, or 29.3%, were held for investment. The types of
loans that the Company may originate are subject to federal and 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.
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,
--------------------------------------------------------------------
1998 1997 1996 1995
--------------------- ------------------ ---------------- -----------------
Percent Percent Percent Percent
------- ------- -------- --------
of of of of
-- -- -- --
Amount Total Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Real estate(1):
Residential:
One- to four-
Family.................... $294,033 87.11% $278,205 89.02% $54,275 78.67% $54,007 84.04%
Multi-family............... 17,380 5.15 10,653 3.41 4,752 6.89 2,412 3.75
Commercial.................. 14,225 4.21 16,763 5.36 9,659 14.00 7,522 11.71
Construction................ 8,571 2.54 -- -- -- -- -- --
Other loans:
Loans secured by
Deposit accounts........... 270 0.08 165 0.05 177 0.25 186 0.29
Unsecured commercial
Loans...................... 124 0.04 63 0.02 67 0.10 70 0.11
Unsecured consumer
Loans...................... 2,951 0.87 6,675 2.14 65 0.09 63 0.10
-------- ------ -------- ----- ------- ------ ------- ------
Total gross
337,554 100.00% 312,524 100.00% 68,995 100.00% 64,260 100.00%
loans................... -------- ====== -------- ===== ------- ====== ------- ======
Less (plus):
Undisbursed loan funds...... 6,399 -- -- --
Deferred loan
Origination (costs)
Fees and (premiums)
Discounts.................. (5,946) (8,393) (543) (298)
Allowance for
Estimated loan
Losses..................... 2,777 2,573 1,625 1,177
-------- -------- ------- -------
Loans
Receivable,
net..................... $334,324 $318,344 $67,913 $63,381
======== ======== ======= =======
1994
----------------
Percent
--------
Amount of
------ --
Total
-----
Real estate(1):
Residential:
One- to four-
Family.................... $53,755 82.62%
Multi-family............... 2,685 4.12
Commercial.................. 8,131 12.50
Construction -- --
Other loans:
Loans secured by
Deposit accounts........... 213 0.33
Unsecured commercial
Loans...................... 197 0.30
Unsecured consumer
84 0.13
Loans...................... ------- ------
Total gross
65,065 100.00%
loans................... ------- ======
Less (plus):
Undisbursed loan funds --
Deferred loan
Origination (costs)
Fees and (premiums)
Discounts.................. 56
Allowance for
Estimated loan
Losses..................... 832
-------
Loans
Receivable,
net..................... $64,177
=======
(1) Includes second trust deeds.
25
Loan Maturity. The following table shows the contractual maturity of the
Bank's gross loans at December 31, 1998. There were $237.9 million of loans held
for sale, gross, at December 31, 1998. The table does not reflect prepayment
assumptions.
At December 31, 1998
----------------------------------------
One- to Total
------- -----
Four- Multi- Other Loans
----- ------ ----- -----
Family Family Commercial Construction Loans Receivable
------ ------ ---------- ------------ ----- ----------
Amounts due:
One year or less............................ $ 895 $ -- $ -- $8,571 $ 720 $ 10,186
After one year:
More than one year to three years.......... 257 42 3,225 -- 1,025 4,549
More than three years to five years........ 305 -- 803 -- 1,600 2,708
More than five years to 10 years........... 1,322 8,136 5,919 -- -- 15,377
More than 10 years to 20 years............. 106,671 8,594 3,205 -- -- 118,470
More than 20 years......................... 184,583 608 1,073 -- -- 186,264
-------- ------- ------- ------ ------ --------
Total amount due........................ 294,033 17,380 14,225 8,571 3,345 337,554
-------- ------- ------- ------ ------ --------
Less (plus):
Undisbursed loan funds..................... -- -- -- 6,399 -- 6,399
Unamortized discounts (premiums), net...... (4,499) (4) -- -- -- (4,503)
Deferred loan origination fees (costs)..... (2,343) 168 173 84 -- (1,918)
Lower of Cost or Market.................... 475 475
Allowance for estimated loan losses........ 1,984 68 250 60 415 2,777
-------- ------- ------- ------ ------ --------
Total loans, net........................ 298,416 17,148 13,802 2,028 2,930 334,324
-------- ------- ------- ------ ------ --------
Loans held for sale, net................... 216,645 15,262 8,980 -- 2,610 243,497
-------- ------- ------- ------ ------ --------
Loans held for investment, net............. $ 81,771 $ 1,886 $ 4,822 $2,028 $ 320 $ 90,827
======== ======= ======= ====== ====== ========
The following table sets forth at December 31, 1998, the dollar amount of
gross loans receivable contractually due after December 31, 1998, 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, 1999
---------------------------------------
Fixed Adjustable Total
----------- ----------- -----------
(Dollars in thousands)
Real estate loans:
Residential:
One- to four-family..................... $190,765 $102,374 $293,139
Multi-family............................ 15,306 2,074 17,380
Commercial............................... 8,598 5,626 14,225
Other loans.............................. 2,625 -- 2,625
-------- -------- --------
Total gross loans receivable......... $217,294 $110,074 $327,369
======== ======== ========
26
The following tables set forth the Company's loan originations, purchases,
sales and principal repayments for the periods indicated:
For the Year Ended December 31,
------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(Dollars in thousands)
Gross loans(1):
Beginning balance.............................. $ 312,524 $ 68,995 $ 64,260
Loans originated:
One-to four-family(2)....................... 440,685 341,294 100,745
Multi-family................................ 34,596 18,019 2,976
Commercial.................................. 22,274 13,631 7,172
Construction................................ 8,571 -- --
Other loans................................. 309 837 126
---------- -------- --------
Total loans originated................... 506,435 373,781 111,019
Loans purchased(3)........................... 674,117 399,326 111,534
---------- -------- --------
Total loans originated and purchased........ 1,180,552 773,107 222,553
---------- -------- --------
Total.................................... 1,493,076 842,102 286,813
Less:
Principal repayments......................... 79,085 17,289 9,184
Sales of loans............................... 610,468 94,705 154,620
Securitizations of loans..................... 462,067 415,350 51,944
Transfer to REO.............................. 3,902 2,234 2,070
---------- -------- --------
Total loans.............................. 337,554 312,524 68,995
Loans held for sale.......................... 238,664 280,859 30,454
---------- -------- --------
Ending balance loans held for investment....... $ 98,890 $ 31,665 $ 38,541
========== ======== ========
- --------------
(1) Gross loans includes loans held for investment and loans held for sale.
(2) Includes second trust deeds.
(3) Loans purchased consist predominantly of one- to four-family residential
Liberator Series and Portfolio Series loans.
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
27
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
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.
As a result of the declines in local and regional real estate market values and
the significant losses experienced by many financial institutions in prior
years, there has been a greater level of scrutiny by regulatory authorities of
the loan portfolios of financial institutions undertaken as part of the
examination of institutions by the OTS and the FDIC. 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 loans, REO and total assets classified
as substandard at December 31, 1998. At December 31, 1998 the Bank had $1.8
million of assets classified as Special Mention, $11.5 million of assets
classified as Substandard, there were no assets classified as Doubtful and
$118,000 of assets classified as Loss. As of December 31, 1998, assets
classified as Special Mention include 81 loans totaling $1.8 million secured by
one- to four-family residential properties. At December 31, 1998, the largest
loan classified as Special Mention had a loan balance of $224,000 and is secured
by a one- to four-family residential property located in Encinitas, California.
As set forth below, as of December 31, 1998, assets classified as Substandard,
Doubtful and Loss include 169 loans totaling $9.3 million.
At December 31, 1998
----------------------------------------------------------------------------------------------------------------------
Total Substandard, Doubtful
---------------------------
Loans REO and Loss Assets
------------------------ ------------------------ ---------------
Gross Net Number of Gross Net Number of Gross Net Number of
------- ---------- --------- ------- ---------- ---------- -------- ----------- ---------
Balance Balance(1) Loans Balance Balance(1) Properties Balance Balance(1) Assets
------- ---------- --------- ------- ---------- ---------- -------- ----------- ---------
(Dollars in thousands)
Residential:
One- to four-
family............ $8,713 $8,029 106 $1,998 $1,998 17 $10,711 $10,627 123
Multi-family....... -- -- -- -- -- -- -- -- --
Commercial.......... 479 427 2 -- -- -- 479 427 2
Other loans......... 281 281 61 -- -- -- 281 281 61
------ ------ --- ------ ------ -- ------- ------- ---
Total loans....... $9,473 $9,337 169 $1,998 $1,998 17 $11,471 $11,335 186
====== ====== === ====== ====== == ======= ======= ===
- --------------
(1) Net balances are reduced for specific loss allowances established against
substandard loans and real estate.
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 loans held for investment. There was one troubled-debt
28
restructured loan within the meaning of SFAS 15, and 17 REO properties at
December 31, 1998. Until September 30, 1996 it was the policy of the Company to
cease accruing interest on loans at the time foreclosure proceedings commenced,
which typically occurred when a loan is 45 days past due or possibly longer
depending on the circumstances, which period will not exceed 90 days past due.
Subsequent to March 31, 1996, the Company adopted a policy to cease accruing
interest on loans 90 days or more past due. For the years ended December 31,
1998, 1997, 1996, 1995 and 1994, 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 $789,000, $424,000,
$179,000, $67,000, and $106,000, none of which was recognized. For the same
periods, the amount of interest income recognized on troubled debt
restructurings was zero, zero, $12,000, $11,000, and $10,000.
At December 31,
------------------------------------------------
1998 1997 1996 1995 1994
-------- ------- ------- ------- -------
(Dollars in thousands)
Non-accrual loans:
Residential real estate:
One- to four-family............................................. $ 7,134 $3,245 $2,361 $1,305 $1,766
Multi-family.................................................... -- --- 45 --- --
Commercial....................................................... 131 131 --- 82 78
Other loans...................................................... 279 1,750 10 10 45
------- ------ ------ ------ ------
Total........................................................... 7,544 5,126 2,416 1,397 1,889
REO, net(1)....................................................... 1,898 1,440 561 827 555
------- ------ ------ ------ ------
Total non-performing assets..................................... $ 9,442 $6,566 $2,977 $2,224 $2,444
======= ====== ====== ------ ======
Restructured loans................................................ $ 131 $ 131 $ 131 $ 131 $ 0
Classified assets, gross.......................................... 10,529 7,565 4,829 3,929 3,951
Allowance for estimated loan losses as a percent of gross loans
receivable(2) 0.82% 0.88% 2.36% 1.83% 1.28%
Allowance for estimated loan losses as a percent of total
non-performing loans(3).......................................... 36.81% 50.20% 67.26% 84.25% 44.04%
Non-performing loans as a percent of gross loans
receivable(2)(3)................................................. 2.23% 1.64% 3.50% 2.17% 2.90%
Non-performing assets as a percent of total assets(3)............. 2.21% 1.65% 2.93% 3.00% 3.42%
(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.
29
The following table sets forth delinquencies in the Company's loan
portfolio as of the dates indicated:
At December 31, 1998 At December 31, 1997
----------------------------------------- -----------------------------------------
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...................... 6 $ 326 68 $7,134 27 $2,328 33 $3,245
Multi-family............................ -- -- -- -- -- -- -- ---
Commercial.............................. -- -- 1 131 -- -- 1 131
Other loans............................. 36 160 61 279 115 583 321 1,750
---- ----- ---- ------ ------ --------- ------ ------
Total................................. 42 $ 486 130 $7,544 142 $2,911 355 $5,126
==== ===== ==== ====== ====== ========= ====== ======
Delinquent loans to total gross loans... 0.14% 2.23% 0.93% 1.64%
===== ====== ========= ======
At December 31, 1996
------------------------------
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...................... 3 $ 354 21 $2,361
Multi-family............................ -- -- 1 45
Commercial.............................. -- -- -- --
Other loans............................. -- -- 1 10
---- ----- ---- ------
Total................................... 3 $ 354 23 $2,416
==== ===== ==== ======
Delinquent loans to total gross loans... 0.51% 3.50%
===== ======
Allowance for Loan Losses. The Company maintains an allowance for loan
losses to absorb losses inherent in the loan portfolios. 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 a 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 sale and 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: (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.
30
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, 1998, the Company's allowance for loan losses was $2.8
million or 0.82% of total gross loans, and 36.81% of non-performing loans
compared to an allowance for loan losses of $2.6 million at December 31, 1997 or
0.88% of gross loans and 50.20% of non-performing loans. At December 31, 1998,
the Company's allowance for loan losses was $2.8 million, consisting of a $2.3
million formula allowance, a $118,000 specific allowance and a $420,000
unallocated allowance.
31
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,
------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- -------- -------- --------
(Dollars in thousands)
Balance at beginning of period..................... $ 2,573 $ 1,625 $ 1,177 $ 832 $ 436
Provision for loan losses.......................... 4,166 1,850 963 1,194 1,306
Charge-offs:
Real estate:
One- to four-family........................... 1,023 901 668 736 771
Multi-family.................................. -- --- 45 -- --
Commercial.................................... -- --- 11 111 47
Other loans...................................... 3,048 8 10 67 95
-------- -------- ------- ------- -------
Total...................................... 4,071 909 734 914 913
Recoveries......................................... 109 7 219 65 3
-------- -------- ------- ------- -------
Balance at end of period........................... $ 2,777 $ 2,573 $ 1,625 $ 1,177 $ 832
======== ======== ======= ======= =======
Average net loans outstanding...................... $329,699 $191,140 $72,650 $65,521 $65,566
======== ======== ======= ======= =======
Net charge-offs to average net loans outstanding... 1.20% 0.47% 0.71% 1.30% 1.39%
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.
1998 1997 1996
-------------------------------- --------------------------------- -----------------------
Percent of Percent of
---------- ----------
Gross Gross
----- -----
Loans in Loans in
-------- --------
Each Each
---- ----
Percent of Category Percent of Category Percent of
---------- -------- ---------- -------- ----------
Allowance to Total Allowance to Total Allowance
--------- -------- --------- -------- ---------
to Total Gross to Total Gross to Total
--------- ----- -------- ----- --------
Amount Allowance Loans Amount Allowance Loans Amount Allowance
------ --------- ----- ------ --------- ----- ------ ---------
One- to four- family $1,984 71.45% 64.54% $1,206 46.87% 89.02% $1,462 89.97%
Multi-family........ 68 2.46 5.16 66 2.57 3.41 20 1.23
Commercial.......... 250 8.99 4.22 150 5.83 5.36 124 7.63
Construction 60 2.16 2.54 -- -- -- -- --
Other............... 415 14.93 23.44 1,151 44.73 2.21 19 1.17
------ ------ ------ ------ ------ ------ ------ ------
Total allowance for
loan losses........ $2,777 100.00% 100.00% $2,573 100.00% 100.00% $1,625 100.00%
====== ====== ====== ====== ====== ====== ====== ======
1995
---------------------------
Percent of Percent of
---------- ----------
Gross Gross
----- -----
Loans in Loans in
-------- --------
Each Each
---- ----
Category Percent of Category
-------- --------- --------
to Total Allowance to Total
-------- --------- --------
Gross to Total Gross
----- ------- -----
Loans Amount Allowance Loans
----- ------ --------- -----
One- to four- family 78.67% $1,001 85.05% 84.04%
Multi-family........ 6.89 14 1.19 3.75
Commercial.......... 14.00 143 12.15 11.71
Construction -- -- -- --
Other............... 0.44 19 1.61 0.50
------ ------ ------ ------
Total allowance for
loan losses........ 100.00% $1,177 100.00% 100.00%
====== ====== ====== ======
REO
At December 31, 1998, the Company had $1.9 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 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.
32
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 equity securities meeting the Company's
guidelines and in mortgage-backed securities guaranteed by the U.S. government
and agencies thereof and other financial institutions.
At December 31, 1998 the Company had $8,000 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.
At December 31, 1998, the residual assets, which resulted from the
Company's asset securitizations, of $50.3 million were classified as trading
securities. For regulatory reasons, the residual assets are held by the Company.
Future residuals and related assets generated by asset securitizations will be
held by the Bank only until they can be sold to the Company or disposed of in
some other transaction. The residual assets and any future residuals generated
by future asset securitizations and held by the Company will be marked to market
on a quarterly basis with unrealized gains and losses recorded in operations.
See "--Loan Sales and Asset Securitizations."
The following table sets forth certain information regarding the carrying
and fair values of the Company's securities (excluding residual assets) at the
dates indicated. There were no securities available-for-sale at the dates
indicated:
At December 31,
---------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
Carrying Fair Carrying Fair Carrying Fair
-------- -------- -------- -------- -------- --------
Value Value Value Value Value Value
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
Securities:
Held-to-maturity:
U.S. Treasury and other agency securities........ $4,463 $4,475 $6,070 $6,088 $8,827 $8,785
Mortgage-backed securities....................... 8 8 9 9 10 10
------ ------ ------ ------ ------ ------
Total securities held-to-maturity............. $4,471 $4,483 $6,079 $6,097 $8,837 $8,795
====== ====== ====== ====== ====== ======
33
The table below sets forth certain information regarding the carrying
value, weighted average yields and contractual maturities of the Company's
securities (excluding residual assets) as of December 31, 1998. There were no
securities available-for-sale at December 31, 1998.
At December 31, 1998
----------------------------------------------------------------------------
More than One More than Five More than Ten
------------- ------------------- ----------------
One Year or Less Year to Five Years Years to Ten Years Years
---------------- -------------------- ------------------- -----
Weighted Weighted Weighted
--------- -------- --------
Carrying Average Carrying Average Carrying Average Carrying
-------- --------- -------- ------ -------- ------- --------
Value Yield Value Yield Value Yield Value
-------- --------- ----- ----- -------- ----- -----
(Dollars in thousands)
Securities:
Held-to-maturity:
U.S. Treasury and
other agency securities............. $2,000 6.13% $ -- -- % $ -- -- --
Mortgage-backed securities............ -- -- -- -- 8
------ ------ ------- ---
Total held-to-maturity.............. 2,000 6.13 -- -- -- -- 8
FHLB stock................................. 2,463 5.44 -- -- -- -- --
------ ------ ---
Total securities held-to-maturity... $4,463 5.74 $ -- -- $ -- -- $ 8
------ ====== ======= ===
Total
--------------------
Weighted Weighted
--------- --------
Average Carrying Average
-------- ------- --------
Yield Value Yield
-------- ------- -----
Securities:
Held-to-maturity:
U.S. Treasury and
other agency securities............. -- % $2,000 6.13%
Mortgage-backed securities............ 7.25 8 7.25
------
Total held-to-maturity.............. 7.25 2,008 6.13
FHLB stock................................. -- 2,463 5.44
------
Total securities held-to-maturity... 7.25 $4,471 5.75
======
35
Sources of Funds
General. Deposits, lines of credit, loan repayments and prepayments,
proceeds from sales and securitization of loans, 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, 1998, certificates of deposit constituted 90.8%
of total average deposits. The term of the fixed-rate certificates of deposit
offered by the Company vary from 30 days to eighteen years and the offering
rates are established by the Company on a weekly basis. 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, 1998, the Company had $291.1 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. In
addition, the Company seeks to attract deposits from outside of its market area
by using nationwide advertising. In order to meet its liquidity needs for the
purchase of loans, from time to time the Company offers above market interest
rates on short term certificate accounts and may utilize brokered deposits. At
December 31, 1998, 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.
The following table presents the deposit activity of the Company for the
periods indicated:
For the Year Ended December 31,
------------------------------------
1998 1997 1996
----------- --------- ----------
(Dollars in Thousands)
Net deposits (withdrawals)............. $ 97,638 $118,078 $15,700
Interest credited on deposit accounts.. 14,030 7,976 2,476
-------- -------- -------
Total increase (decrease)
in deposit accounts................ $111,668 $126,054 $18,176
======== ======== =======
36
At December 31, 1998, the Company had $82.0 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................ $22,072 5.52%
Over three through 12 months........ 57,977 5.49
Over 12 months...................... 1,981 5.58
-------
Total............................ $82,030 5.50
=======
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 Ended December 31,
---------------------------------------------------------------------------------------------
1998 1997 1996
--------------------------------- -------------------------------- ----------------------
Percent Percent Percent
-------- ------- --------
of Total Weighted of Total Weighted of Total
-------- -------- -------- -------- --------
Average Average Average Average Average Average Average Average
------- -------- ------- ------- ------- ------- ------- --------
Balance Deposits Rate Balance Deposits Rate Balance Deposits
------- -------- ---- ------- -------- ----- ------- --------
(Dollars in thousands)
Passbook accounts.................. $ 4,324 1.69% 2.36% $ 4,003 2.73% 2.10% $ 4,401 6.03%
Money market accounts.............. 4,779 1.87 4.79 2,971 2.02 2.96 4,233 5.80
Checking accounts.................. 17,966 7.01 1.72 11,756 8.00 2.37 7,048 9.65
-------- ------ -------- ------ ------- ------
Total............................ 27,069 10.57 2.36 18,730 12.75 2.41 15,682 21.48
Certificate accounts:
Three months or less............. 9,148 3.57 5.52 15,887 10.81 5.54 3,994 5.47
Four through 12
months.......................... 192,871 75.28 5.85 88,129 59.97 6.01 36,519 50.01
13 through 36 months............. 22,105 8.63 5.84 18,467 12.57 5.71 10,204 13.98
37 months or greater............. 4,997 1.95 6.55 5,730 3.90 6.28 6,616 9.06
-------- ------ -------- ------ ------- ------
Total certificate
accounts........................ 229,121 89.43 5.85 128,213 87.25 5.92 57,333 78.52
-------- ------ -------- ------ ------- ------
Total average deposits........... $256,190 100.00% 5.48% $146,943 100.00% 5.47% $73,015 100.00%
======== ====== ======== ====== ======= ======
Weighted
--------
Average
-------
Rate
----
Passbook accounts.................. 2.09%
Money market accounts.............. 2.79
Checking accounts.................. 1.59
Total............................ 2.05
Certificate accounts:
Three months or less............. 5.66
Four through 12
months.......................... 5.23
13 through 36 months............. 6.25
37 months or greater............. 6.36
Total certificate
accounts........................ 5.57
Total average deposits........... 4.81%
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at December 31, 1998.
Period to Maturity from December 31, 1998 At December 31,
---------------------------------------------------------------------------- ------------------
Over One Over Over Over
--------- ----------- ---------- ----------
One Year to Two to Three to Four to More than
-------- --------- ----------- ---------- ---------- ----------
Or Less Two years Three years Four years Five years Five years Total 1997 1996
-------- --------- ----------- ---------- ---------- ---------- --------- -------- --------
(Dollars in thousands)
Certificate accounts:
0 to 4.00%.......... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ --
4.01 to 5.00%......... 16,436 16,436 2,344 3,504
5.01 to 6.00%......... 261,996 3,222 465 310 108 222 266,323 102,920 60,145
6.01 to 7.00%......... 12,087 441 20 16 6 78 12,648 87,009 3,891
7.01 to 8.00%......... 599 385 223 58 25 278 1,568 1,572 1,890
-------- ------ ---- ---- ---- ---- -------- -------- -------
Total.............. $291,118 $4,048 $708 $384 $139 $578 $296,974 $193,845 $69,430
======== ====== ==== ==== ==== ==== ======== ======== =======
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
37
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, 1998, 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 mortgage originations and purchases or for other corporate
purposes. At December 31, 1998, the Bank's warehouse lines of credit consisted
of two separate lines of credit aggregating $375.0 million, of which $13.6
million has been drawn at December 31, 1998. The lines of credit are secured by
loans originated or purchased by the Company and range in 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 $50.0 million secured by
residual assets created by the Company's securitizations and stock of the Bank
of which $26.3 million has been drawn at December 31, 1998. All of the lines of
credit are uncommitted and may be terminated by the lenders at will. These lines
of credit contain affirmative, negative and financial covenants, with which the
Company was in compliance at December 31, 1998.
On March 14, 1997, the Bank issued subordinated debentures (the
"Debentures") in the aggregate principal amount of $10.0 million through the
Debenture Offering. 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 the risk-based capital requirements in an amount up to
100% of the Bank's core capital. See "Regulation--Federal Savings Institution
Regulation-- Capital Requirements." By enhancing the Bank's capital position
the Debentures provided support for the Bank's operations. The Debentures were
until March, 1998 direct, unconditional obligations of the Bank ranking with all
other existing and future unsecured and subordinated indebtedness of the Bank.
They are subordinated on liquidation, as to principal and interest, and premium,
if any, to all claims against the Bank having the same priority as savings
account holders or any higher priority.
At any time prior to maturity of the Debentures, the Bank was allowed to
substitute in its place as obligor on the Debentures and as a party to the
Debenture Purchase Agreement. 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.
Due to the Substitution, holders of the Debentures had the option, at September
15, 1998 or at such later time as the Substitution occurs, 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. As of September 30, 1998, holders exercised their
option to have the company purchase $8.5 million of Debentures. The Debentures
were redeemed on December 14, 1998. The Company met this obligation by drawing
$7.3 million from a new $10 million line of credit.
38
The following table sets forth certain information regarding the Company's
borrowed funds at or for the periods ended on the dates indicated:
At or For the Year
-----------------------------------------------
Ended December 31,
-----------------------------------------------
1998 1997 1996
------------- ---------------- ------------
(Dollars in Thousands)
FHLB advances:
Average balance outstanding............................................. $ 1,154 $ 8,284 $ 4,259
Maximum amount outstanding at any month-end during the period........... 17,062 17,800 13,900
Balance outstanding at end of period.................................... -- 9,000 --
Weighted average interest rate during the period........................ 5.02% 5.82% 5.93%
Debentures:
Average balance outstanding............................................. $ 9,526 $ 7,997 --
Maximum amount outstanding at any month-end during the period........... 10,000 10,000 --
Balance outstanding at end of period.................................... 1,500 10,000 --
Weighted average interest rate during the period........................ 14.03% 14.09% --
Lines of credit:
Average balance outstanding............................................. $112,886 $ 48,765 --
Maximum amount outstanding at any month-end during the period........... 345,848 226,846 --
Balance outstanding at end of period.................................... 39,977 100,170 --
Weighted average interest rate during the period........................ 6.62% 6.53% --
Total borrowings:
Average balance outstanding............................................. $123,566 $ 65,046 $ 4,259
Maximum amount outstanding at any month-end during the period........... 372,910 254,646 13,900
Balance outstanding at end of period.................................... 41,477 119,170 --
Weighted average interest rate during the period........................ 7.18% 7.37% 5.93%
Asset Securitizations. The Company has completed five asset
securitizations, one during the fourth quarter of 1996, one during the first
quarter of 1997, one during the third quarter of 1997, one during the fourth
quarter of 1997 and one during the third quarter of 1998. Net cash proceeds to
the Company from these asset securitizations aggregated $877.9 million. As the
Company anticipates that it will conduct regular asset securitizations in the
future, it is expected that gain on sale of loans securitized will constitute a
substantial source of cash flow for the Company's future loan originations,
although there can be no assurance in this regard.
Competition
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 have
announced their intention to adapt their conforming origination programs and
allocate resources to the origination of non-conforming loans. In addition,
certain of these larger mortgage companies and commercial banks have begun to
offer products similar to those offered by the 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
39
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 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.
Subsidiaries
As of December 31, 1998, the Company had two subsidiaries: the Bank and
Life Investment Holdings, Inc. 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, 1998.
Personnel
As of December 31, 1998, the Company had 335 full-time employees and 11
part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees to
be good.
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 is preparing 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
syste ms as part of the program. The IT dependent portion of the
40
program is approximately 80% complete, while the non-IT dependent portion of the
program is substantially complete.
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 phase is substantially complete, with minor patches and upgrades to
internal non-critical IT systems to be complete by June 30, 1999. The validation
and implementation phases have been completed for the Company's mission critical
business financial systems. Other third party systems are in process of being
validated and implemented, and these phases are estimated to be complete by June
30, 1999.
To complete the five program phases, the Company is primarily using
internal resources. The service bureau responsible for the Company's mission
critical business financial systems is providing 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 process and anticipated to be
completed by the first quarter of 1999, with Y2k issues incorporated. The
contingency plan is intended to enable the Company to continue to operate, to
the extent that it can do so safely, including performing certain processes
manually, repairing or obtaining replacement systems, and changing vendors. To
date, no systems or vendors have had to be replaced and it is anticipated that
none will be. The Company believes, however, that due to the widespread nature
of the potential Y2k issues, the contingency planning process is an ongoing one,
which will require further modifications as the Company obtains additional
information regarding: (i) the Company's internal systems and equipment during
the validation phase of its Y2k program, and (ii) the status of third party Y2k
readiness.
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 December, and further training sessions are scheduled for June and
September 1999. In addition, the company provides informational brochures 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.
41
Costs
Through 1998, the amount of approximately $60,000 incurred and expensed for
developing and implementing the Y2k program has not had a material effect on the
Company's operations. The total remaining cost for addressing Y2k compliance is
not expected to be material to the Company's operations. All remaining costs
will be funded through operating cash flows and will be funded by reallocating
existing resources rather than incurring incremental costs. 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 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").
42
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 the Congress, could have a material
adverse impact on the Company, the Bank 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
43
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.
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,
withinspecified 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,
1998, the Bank met each of its capital requirements.
The following table presents the Bank's capital position at December 31,
1998.
Capital Ratios
------------------------
Actual Required Excess Actual Required
--------- ------------- --------- ---------- -----------
(Dollars in thousands)
Tangible.............. $27,311 $ 5,678 $21,633 7.21% 1.50%
Core (Leverage)....... 27,311 15,143 12,168 7.21 4.00
Risk-based............ 29,952 21,978 7,974 10.90 8.00
44
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 thant 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 their
capitalization and one of three subcategories based on examination ratings and
other supervisory infromation. 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 merged.
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,
1998, the Bank's
45
limit on loans to one borrower was $4.5 million. At December 31, 1998, the
Bank's largest aggregate outstanding balance of loans to one borrower was $2.0
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, 1998, the Bank
maintained 99.96% 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 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, 1998, 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, 1998 was 7.07%, which exceeded the applicable requirements. The Bank
has never been subject to monetary penalties for failure to meet its liquidity
requirements.
Assessments. Savings institutions are required to pay assessments to the OTS
to fund the agency's operations. The general assessments, paid on a semi-annual
basis, are computed upon the savings institution's total assets, including
consolidated subsidiaries, as reported in the Bank's latest quarterly thrift
financial report. The assessments paid by the Bank for the fiscal year ended
December 31, 1998 totaled $77,000.
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
46
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 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
appropirate 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 1998 that reserves be maintained against aggregate transaction
accounts as follows: for accounts aggregating $47.8 million or less (subject to
adjustment by the Federal Reserve Board) the reserve requirement was 3%; and for
accounts aggregating greater than $47.8 million, the reserve requirement was
$1.48 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 $47.8 million. The first $4.7 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
47
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
1997 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, 1995,
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.
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.
48
SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee on
every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
Additional Item. Executive Officers of the Registrant.
The following table sets forth certain information regarding the executive
officers of the Company and the Bank who are not also directors.
Position with the Company and Bank
----------------------------------
Name Age at 12/31/98 and Past Five Years Experience
---------- --------------- ------------------------------
Jeffrey L. Blake....... 39 Corporate Secretary and Chief Financial Officer
Mary E. Darter......... 38 Executive Vice President. Joined the Bank in 1994. Previously in
charge of warehouse line of credit division and bulk acquisitions
at Imperial Credit Industries/Southern Pacific Thrift and Loan
Joseph R.L. Passerino.. 44 Senior Vice President. Joined the Bank in February 1994.
Previously in charge of loan production for St. Thomas Capital
Corporation.
49
Item 2. Properties
As of December 31, 1998, the Company conducted its business through ten
offices.
Net Book Value
--------------
Original of Property or
-------- --------------
Year Leasehold
---- ---------
Leased Leased Date of Improvements at
------ ------ ------- ---------------
or or Lease December 31,
--- -- ----- ------------
Location Owned Acquired Expiration 1997
---------------------------------- ----- -------- ---------- ----
Corporate Headquarters and
Regional Lending Center:(1)
10540 Magnolia Avenue, Suites B & C
Riverside, CA Leased 1997 2003 $1,382,000
Regional Lending Center:
2600 South Parker Road, Suite 6-300
Aurora, CO Leased 1997 2000 39,000
Regional Lending Center:
8031 Philips Highway
Jacksonville, FL Leased 1997 2002 1,000
Regional Lending Office:
4990 Speak Lane Suite 270.
San Jose, CA Leased 1998 1999 --
Regional Lending Office
19 Park Street
Attleboro, MA Leased 1998 2003 25,000
Branch Office:
1598 E. Highland Avenue
San Bernardino, CA Leased 1986 2001 219,000
Branch Office:
10530 Magnolia Avenue, Suite A
Riverside, CA Leased 1997 2002 11,000
Branch Office:
1526 Barton Road
Redlands, CA Leased 1998 2003 98,000
Branch Office
9971 Adams Avenue
Huntington Beach, CA Leased 1998 2006 72,000
Consumer Finance:
4110 Tigris Way
Riverside, CA Owned 1996 ---- 528,000
50
The Company opened five low-cost retail lending offices and closed these
offices plus two additional offices during the year ended December 31, 1998.
Subsequent to that date, the Company had opened three retail lending offices.
One retail lending office remains open at Corporate Headquarters.
Item 3. Legal Proceedings
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.
Item 4. Submission of Matters to a Vote of Security Holders
None.
51
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
1 , 1999, there were approximately 271 holders of record of the Common Stock.
The following table summarizes the range of the high and low closing sale prices
per share of Common Stock as quoted by Nasdaq for the periods indicated.
52
High Low
-------- --------
Quarter Ended
March 31, 1997 N/A N/A
June 30, 1997.......... $13.50 $13.38
September 30, 1997..... 19.25 13.63
December 31, 1997...... 21.87 11.75
High Low
-------- --------
Quarter Ended
March 31, 1998 $20.19 $10.75
June 30, 1998.......... 25.38 17.25
September 30, 1998..... 20.56 5.00
December 31, 1998...... 6.06 2.25
Item 6. Selected Financial Data
At December 31,
-------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------- ------------- -------------- ------------- -------------
(In thousands, except per share and share data)
Selected Balance Sheet Data:
Total assets............................. $ 428,078 $ 397,071 $ 101,763 $ 74,136 $ 71,402
Securities held-to-maturity and FHLB
Stock................................. 4,471 6,079 8,837 2,700 2,860
Loans held for sale...................... 243,497 289,268 31,018 21,688 17,070
Loans held for investment................ 93,604 31,649 38,520 42,870 47,939
Allowance for estimated loan losses...... 2,777 2,573 1,625 1,177 832
Residual assets at fair value............ 50,296 45,352 4,691 -- --
Mortgage servicing rights................ 13,119 8,526 2,645 683 --
Deposit accounts......................... 323,433 211,765 85,711 67,535 65,689
Borrowings............................... 41,477 119,170 3,278 -- 1,250
Stockholders' equity..................... 51,998 50,886 7,716 4,268 3,748
Book value per share(1).................. $ 7.92 $ 7.77 $ 2.40 $ 2.29 $ 2.01
Shares outstanding(1).................... 6,562,396 6,546,716 3,211,716 1,866,216 1,866,216
(Continued on the next page)
53
For the Year Ended December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(In thousands, except per share and share data)
Selected Operating Data:
Interest income.............................................. $ 41,104 $ 21,146 $ 6,928 $ 5,825 $ 4,824
Interest expense............................................. 22,915 12,830 3,766 3,448 2,721
---------- ---------- ---------- ---------- ----------
Net interest income......................................... 18,189 8,316 3,162 2,377 2,103
Provision for estimated loan losses.......................... 4,166 1,850 963 1,194 1,306
---------- ---------- ---------- ---------- ----------
Net interest income after provision for estimated loan
Losses 14,023 6,466 2,199 1,183 797
Net gains from mortgage financing operations................. 7,664 25,730 5,708 3,575 1,428
Other non-interest income.................................... 6,519 1,500 760 445 260
Non-interest expense:
Compensation and benefits................................... 11,570 9,210 5,233 2,544 1,575
Net loss on foreclosed real estate.......................... 211 126 158 53 280
SAIF special assessment..................................... -- -- 448 -- --
Other expense............................................... 14,638 6,654 2,842 1,792 1,601
---------- ---------- ---------- ---------- ----------
Total non-interest expense.................................. 26,419 15,990 8,681 4,389 3,456
---------- ---------- ---------- ---------- ----------
Income (loss) before income tax provision (benefit).......... 1,787 17,706 (14) 814 (971)
Income tax provision (benefit)............................... 728 7,382 38 294 (300)
---------- ---------- ---------- ---------- ----------
Net income (loss)............................................ $ 1,059 $ 10,324 $ (52) $ 520 $ (671)
========== ========== ========== ========== ==========
Basic earnings (loss) per share(2)........................... $ 0.16 $ 2.11 $ 0.02 $ 0.28 $ (0.36)
========== ========== ========== ========== ==========
Diluted earnings (loss) per share(2)......................... $ 0.16 $ 2.02 $ 0.02 $ 0.28 $ (0.36)
========== ========== ========== ========== ==========
Basic weighted average shares outstanding(2)................. 6,554,743 4,884,993 2,370,779 1,866,216 1,866,216
========== ========== ========== ========== ==========
Diluted weighted average shares outstanding(2)............... 6,805,827 5,107,951 2,370,779 1,866,216 1,866,216
========== ========== ========== ========== ==========
At or For the Year Ended December 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
----- ----- ----- ----- -----
(Dollars in thousands)
Selected Financial Ratios and Other Data(3):
Performance Ratios:
Return on average assets................................... 0.23% 4.19% (0.06)% 0.69% (0.89)%
Return on average equity................................... 1.92 40.45 (0.90)% 13.64 (17.01)
Average equity to average assets........................... 12.14 10.35 6.77 5.04 5.22
Equity to total assets at end of period.................... 12.15 12.82 7.58 5.76 5.25
Average interest rate spread(4)............................ 3.83 3.30 3.78 3.09 2.79
Net interest margin(5)..................................... 4.36 3.68 3.95 3.25 2.88
Average interest-earning assets to
average interest-bearing liabilities..................... 109.81 106.65 103.64 103.50 102.27
Efficiency Ratio(6)........................................ 80.96 44.63 88.50 67.78 83.78
Loan Originations and Purchases.............................. $1,180,552 $ 773,107 $ 222,553 $ 134,772 $ 72,815
Bank Regulatory Capital Ratios(7):
Tangible capital........................................... 7.21% 5.38% 7.57% 5.68% 5.25%
Core capital............................................... 7.21 5.38 7.57 5.68 5.25
Risk-based capital......................................... 10.90 10.52 8.09 10.17 10.00
Asset Quality Ratios:
Non-performing assets as a percent of total
assets(8)................................................ 2.21% 1.65% 2.93% 3.00% 3.42%
Allowance for estimated loan losses as a percent of
non-performing loans..................................... 36.81 50.20 67.26 84.25 44.04
(footnotes on next page)
54
(1) Book value per share is based upon the shares outstanding at the end of each
period, adjusted 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.
(2) Earnings per share is based upon the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred during
1996. Earnings 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.
(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 Company originates, purchases, sell, securitizes and services primarily
non-conventional mortgage loans principally secured by first and second
mortgages on one- to four-family residences. The Company makes Liberator Series
loans, which are for the purchase or refinance of residential real property by
alternative borrowers and , through October 1998, Portfolio Series loans, which
are debt consolidation loans for Agency-Qualified Borrowers, generally with
loan-to-value ratios of up to 125%. In addition, to a much lesser extent, the
Company originates multi-family residential commercial real estate and
construction loans. The Company purchases and originates mortgage loans and
other real estate secured loans through a network of Originators throughout the
country. The Company funds substantially all of the loans which it originates or
purchases through deposits, other borrowings, internally generated funds and
FHLB advances. In the immediate and foreseeable future, the Company will also
fund loans from the cash proceeds, if any, received from securitizations.
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 relationships and the willingness of investors to purchase the
loans at an acceptable price to the Company. Due to substantial activity in the
purchase and sale of loans in recent years, the net gains from mortgage
financing operations have been significant. 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."
55
Average Balance Sheets
The following tables set forth certain information relating to the Company at
December 31, 1998 and for the years ended December 31, 1998, 1997 and 1996. 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.
At December 31, Year Ended December 31,
--------------- ------------------------------------------
1998 1997
------------------- -----------------------
Average
Yield/ Average Yield/ Average
ASSETS Balance Cost Balance Interest Cost Balance Interest
- ----------------------------------------------------- ------- ----- -------- -------- ------ -------- --------
(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits and short-term investments. $ 2,967 3.70 $ 29,268 $ 1,499 5.12% $ 9,709 $ 635
Investment securities(1)............................. 4,463 5.75 6,258 374 5.98 8,685 495
Loans receivable, net(2)............................. 334,324 10.38 329,699 32,247 9.78 191,140 17,746
Mortgage-backed securities(1)........................ 8 7.25 9 0 0.00 9 1
Residual assets...................................... 50,296 13.50 51,789 6,984 13.49 16,549 2,269
-------- -------- ------- -------- -------
Total interest-earning assets........................ 392,058 10.59 417,023 41,104 9.86 226,092 21,146
------- -------
Non-interest-earning assets(3)....................... 36,020 37,708 20,471
-------- -------- --------
Total assets(3)...................................... $428,078 $454,731 $246,563
======== ======== ========
LIABILITIES AND EQUITY
- -----------------------------------------------------
Interest-bearing liabilities:
Passbook accounts.................................... $ 4,642 2.35 $ 4,324 102 2.36 $ 4,003 84
Money market accounts................................ 7,729 4.84 4,779 229 4.79 2,971 88
Checking accounts.................................... 14,088 1.72 17,966 309 1.72 11,756 279
Certificate accounts................................. 296,974 5.85 229,121 13,408 5.85 128,213 7,587
-------- -------- ------- -------- -------
Total deposit accounts............................... 323,433 5.60 256,190 14,048 5.48 146,943 8,038
Borrowings........................................... 41,477 7.77 123,566 8,867 7.18 65,046 4,792
-------- -------- ------- -------- -------
Total interest-bearing liabilities................... 364,910 5.84 379,756 22,915 6.03 211,989 12,830
Non-interest-bearing liabilities(3).................. 11,170 19,760 9,052
-------- -------- --------
Total liabilities(3)................................. 376,080 399,516 221,041
Equity(3)............................................ 51,998 55,215 25,522
-------- -------- --------
Total liabilities and equity(3)...................... $428,078 $454,731 $246,563
======== ======== ========
Net interest income before provision for estimated $18,189 $ 8,316
loan losses......................................... ======= =======
Net interest rate spread(4).......................... 4.84 3.83
Net interest margin(5)............................... 4.64 4.36
Ratio of interest-earning assets to interest-bearing 107.44 109.81
liabilities.........................................
Year Ended December 31,
----------------------------------------------
1996
-------------------
Average Average
Yield/ Average Yield/
ASSETS Cost Balance Interest Cost
- ----------------------------------------------------- ------ -------- -------- ------
(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits and short-term investments. 6.54% $ 5,358 $ 286 5.34%
Investment securities(1)............................. 5.70 1,912 100 5.23
Loans receivable, net(2)............................. 9.28 72,650 6,513 8.96
Mortgage-backed securities(1)........................ 11.11 11 1 9.09
Residual assets...................................... 13.71 166 28 16.87
-------- -------
Total interest-earning assets........................ 9.35 80,097 6,928 8.65
-------
Non-interest-earning assets(3)....................... 5,123
--------
Total assets(3)...................................... $ 85,220
========
LIABILITIES AND EQUITY
- -----------------------------------------------------
Interest-bearing liabilities:
Passbook accounts.................................... 2.10 $ 4,401 92 2.09
Money market accounts................................ 2.96 4,233 118 2.79
Checking accounts.................................... 2.37 7,048 112 1.59
Certificate accounts................................. 5.92 57,333 3,192 5.57
-------- -------
Total deposit accounts............................... 5.47 73,015 3,514 4.81
Borrowings........................................... 7.37 4,268 252 5.90
--------
Total interest-bearing liabilities................... 6.05 77,283 3,766 4.87
Non-interest-bearing liabilities(3).................. 2,170
--------
Total liabilities(3)................................. 79,453
Equity(3)............................................ 5,767
--------
Total liabilities and equity(3)...................... $ 85,220
========
Net interest income before provision for estimated
loan losses......................................... $ 3,162
=======
Net interest rate spread(4).......................... 3.30 3.78
Net interest margin(5)............................... 3.68 3.95
Ratio of interest-earning assets to interest-bearing 106.65 103.64
liabilities.........................................
(footnotes on next page)
56
- --------------
(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.
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, 1998 December 31, 1997
----------------- -----------------
Compared to Compared to
----------- ------------
Year Ended Year Ended
---------- ----------
December 31, 1997 December 31, 1996
------------------------------ ------------------------------
Increase Increase
-------- --------
(Decrease) (Decrease)
---------- ----------
Due to Due to
------- -------
Volume Rate Net Volume Rate Net
---------- --------- ------------ ----------- ---------- ------------
(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits and short-term
investments................................ $ 1,029 $ (165) $ 864 $ 274 $ 75 $ 349
Investment securities, net................... (144) 23 (121) 385 10 395
Loans receivable, net(1)..................... 13,497 1,004 14,501 10,992 241 11,233
Residual assets.............................. 4,753 (38) 4,715 2247 (6) 2,241
Mortgage-backed securities................... -- (1) (1) -- -- --
------- ------ ------- ------- ---- -------
Total interest-earning assets............. 19,135 823 19,958 13,898 320 14,218
Interest-bearing liabilities:
Money market accounts........................ 70 71 141 (37) 7 (30)
Passbook accounts............................ 7 11 18 (8) (8)
Checking accounts............................ 120 (90) 30 96 71 167
Certificate accounts......................... 5,912 (91) 5,821 4,182 213 4,395
Borrowings................................... 4,202 (127) 4,075 4,462 78 4,540
------- ------ ------- ------- ---- -------
Total interest-bearing liabilities........ 10,311 (226) 10,085 8,695 369 9,064
------- ------ ------- ------- ---- -------
Change in net interest income.................. $ 8,824 $1,049 $ 9,873 $ 5,203 $(49) $ 5,154
======= ====== ======= ======= ==== =======
- --------------
(1) Includes interest on loans held for sale.
57
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 assets 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 the continued growth of
the Company's mortgage financing operation.
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
58
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 were $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 provisions 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-loan Sales and Asset Securitizations." There was an overall
increase in the level of mortgage financing operations, with loans sold or
securitized 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
59
addition of the regional operating centers in the Boston, Massachusettes 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 comparable 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.
As a result of the Company's loan securitization activities, residual assets
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 $193.8million as
of December
60
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.
Comparison of Operating Results for the Years Ended December 31, 1997 and
December 31, 1996
General
For the year ended December 31, 1997 the Company recorded net income of
$10.3 million compared to a net loss of $52,000 for the year ended December 31,
1996. The basic and diluted earnings (loss) per share for the year ended
December 31, 1997 were $2.11 and $2.02, respectively, compared to $(0.02) and
$(0.02), respectively, for the year ended December 31, 1996. The increase in net
income was due to the expansion of the mortgage financing operations, the
increase in gains with respect to such operations, increases in net interest
income and the absence of a special SAIF assessment.
Interest Income
Interest income for the year ended December 31, 1997 was $21.1 million,
compared to $6.9 million for the year ended December 31, 1996, 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 $226.1 million for the year ended December 31, 1997 compared to $80.1 million
for the year ended December 31, 1996. The yield on interest earning assets
increased to 9.35% for the year ended December 31, 1997 compared to 8.65% for
the year ended December 31, 1996. The largest single component of interest
earning assets was average loans receivable, net, which were $191.1 million with
a yield of 9.28% for the year ended December 31, 1997 compared to $72.7 million
with a yield of 8.96% for the year ended December 31, 1996. The increase in the
average balance of loans receivable was attributable to the continued growth of
the Company's mortgage financing operation.
Interest Expense
For the year ended December 31, 1997, interest expense was $12.8 million,
compared to $3.8 million for the year ended December 31, 1996 due to an increase
in the average balance of interest bearing liabilities combined
61
with an increase in the cost of those liabilities. At the end of the quarter
ended March 31, 1997, the Company issued subordinated debentures with an
interest rate of 13.5%. This issuance of debentures, combined with an increased
use of borrowed funds as well as a heavier reliance on certificate accounts,
resulted in an increase in the average cost of interest bearing liabilities to
6.05% for the year ended December 31, 1997 compared to 4.87% for the year ended
December 31, 1996. Average interest bearing liabilities were $212.0 million for
the year ended December 31, 1997 compared to $77.3 million for the year ended
December 31, 1996.
The largest component of average interest bearing liabilities was certificate
accounts, which averaged $128.2 million with an average cost of 5.92% compared
to $57.3 million with an average cost of 5.57% for the year ended December 31,
1996. The second largest component of interest bearing liabilities is
borrowings, which increased to an average balance of $65.0 million with an
average cost of 7.37% for the year ended December 31, 1997 compared to $4.3
million with an average cost of 5.90% for the year ended December 31, 1996.
During 1997, increased borrowings include the issuance of the subordinated
debentures, as well as two warehouse lines of credit in the amount of $250.0
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.
Net Interest Income Before Provision for Estimated Loan Losses
Net interest income before provision for estimated loan losses for the year
ended December 31, 1997 was $8.3 million compared to $3.2 million for the year
ended December 31, 1996. 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 $226.1 million for the
year ended December 31, 1997 compared to $80.1 million for the year ended
December 31, 1996. Average interest bearing liabilities increased to $212.0
million with an average cost of 6.05% for the year ended December 31, 1997
compared to $77.3 million with an average cost of 4.87% for the year ended
December 31, 1996. The ratio of interest earning assets to interest bearing
liabilities was 106.65% for the year ended December 31, 1997 compared to 103.64%
for the year ended December 31, 1996.
Provision for Estimated Loan Losses
Provision for estimated loan losses were $1.9 million for the year ended
December 31, 1997 compared to $963,000 for the year ended December 31, 1996. The
increase in provisions was based on an evaluation of the composition of the
Company's loan portfolio and an increase in non-performing consumer loans.
Charge offs net of recoveries for the year ended December 31, 1997 were $902,000
compared to $515,000 for the year ended December 31, 1996. The Company had non-
accrual loans at December 31, 1997 of $5.1 million, compared to $2.4 million at
December 31, 1996. The increase in non-accrual loans was largely due to an
increase in non-performing consumer loans, which were $1.7 million as of
December 31, 1997 compared to $10,000 as of December 31, 1996. The increase in
non-performing consumer loans relates directly to a bulk purchase of $7.4
million in consumer loans during 1997. Management believes that the allowance
for loan losses at December 31, 1997 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
62
For the year ended December 31, 1997, net gains from mortgage financing
operations totaled $25.7 million compared to $5.7 million for the year ended
December 31, 1996. The 1997 net gain includes a pre-tax unrealized loss of
$966,000, due to an adjustment to the valuation of the residual assets related
to the 1997-1 securitization, as a result of the higher-than-estimated
prepayment speeds. See "Item 1--Business-loan Sales and Asset
Securitizations." The increase in net gains from mortgage financing operations
was attributable to the increase in the level of mortgage financing operations,
with loans sold or securitized totaling $510.1 million for the year ended
December 31, 1997 compared to $206.6 million for the year ended December 31,
1996. Net gains from mortgage financing operations as a percent of loans sold or
securitized was 5.04% for the year ended December 31, 1997 compared to 2.76% for
the year ended December 31, 1996. This increase in percentage reflected the
effects of the securitization of loans compared to whole loan sales. During the
year ended December 31, 1997, loans securitized represented 81.5% of loan sales
and securitizations, while during the year ended December 31, 1996, loans
securitized represented 25.1% of loan sales and securitizations. Loans
originated and purchased totaled $773.1 million for the year ended December 31,
1997 compared to $222.6 million for the year ended December 31, 1996.
Non-Interest Expense
For the year ended December 31, 1997, non-interest expense was $16.0 million
compared to $8.7 million for the year ended December 31, 1996. 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 $773.1 million for the year ended
December 31, 1997 compared to $222.6 million for the year ended December 31,
1996.
For the year ended December 31, 1997, compensation and benefits were $9.2
million compared to $5.2 million for the year ended December 31, 1996. These
costs are directly related to the expansion of the mortgage financing operations
and the corresponding increase in personnel, to an average of 230 for the year
ended December 31, 1997 compared to 97 for the year ended December 31, 1996.
Premises and occupancy expenses were $1.4 million for the year ended December
31, 1997 compared to $746,000 for the year ended December 31, 1996 due to the
expansion of the mortgage financing operation and the addition of the regional
operating center in the Denver, Colorado metropolitan area, the new corporate
headquarters and regional lending center located in Riverside, California during
1997, the relocation of the Florida regional office, the addition of five low
cost retail lending offices in California, and the opening of one new retail
Bank branch in Riverside, California. The Company anticipates that premises and
occupancy expense will continue to increase as the Company adds new retail
lending and retail banking offices, as well as additional office space for
expansion of the loan servicing operations.
As a result of the expansion of the mortgage financing operations, other
operating expenses increased as well. Data processing increased to $809,000 for
the year ended December 31, 1997 compared to $390,000 for the year ended
December 31, 1996. The increase in non-interest expense was partially offset by
a reduction in FDIC insurance premiums in the 1997 period. During the quarter
ended September 30, 1996, the Bank paid a one time assessment to the FDIC of
$448,000 for the recapitalization of the SAIF. Marketing, telephone,
professional services and other expenses were $301,000, $650,000, $467,000 and
$3.0 million, respectively, for the year ended December 31, 1997 compared to
$189,000, $246,000, $218,000 and $879,000 for the year ended December 31, 1996.
Other expense for the year ended December 31, 1997 included a write down of the
servicing asset in the amount of $1.3 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, 1997.
Income Taxes
63
The provision for income taxes increased to $7.4 million for the year ended
December 31, 1997 compared to $38,000 for the year ended December 31, 1996.
Income before income tax provision increased to $17.7 million for the year ended
December 31, 1997 compared to a loss of $14,000 for the year ended December 31,
1996. The effective tax rate was 41.7% for the year ended December 31, 1997.
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
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. Since
this policy was implemented after March 31, 1997, the Company has engaged in
only a limited amount of hedging activities. Management is continuing to
evaluate and refine its hedging policies. No hedging positions were outstanding
at December 31, 1998.
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 400 basis point increase to a
400 basis point decrease in market interest rates. The interest rate risk policy
of the Bank provides that the maximum permissible change in NPV for a 400 basis
point increase or decrease in market interest rates is a 45% change in the net
portfolio value. 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, 1998, 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
64
interest rates was 202 basis points and would result in a $9.2 million reduction
in the NPV of the Bank. As of December 31, 1998, the Bank's Sensitivity Measure
is 2 basis points above the threshold at which the Bank could be required to
hold additional risk-based capital under OTS regulations. 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."
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
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. In particular, the Bank's core products do not behave in a manner
which the OTS model projects. Borrowers of Portfolio Series loans are less
likely to refinance or prepay such loans because of the high cost of obtaining a
high loan to value loan. In addition, management believes that borrowers of
Liberator Series loans are less likely to refinance or prepay such loans because
of their lack of an adequate credit rating or possible prior credit problems.
Accordingly, 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. The results of this modeling are monitored by management and
presented to the Board of Directors, quarterly.
The following table shows the NPV and projected change in the NPV of the Bank
at December 31, 1998 assuming an instantaneous and sustained change in market
interest rates of 100, 200, 300 and 400 basis points ("bp").
Interest Rate Sensitivity of Net Portfolio Value (NPV)
Net Portfolio Value NPV as % of Portfolio
----------------------------- ---------------------
Value of Assets
---------------
% Change
-----------
Change in Rates $ Amount $ Change % Change NPV Ratio (bp)
- ------------------------ --------- ------------ ------------- ------------- -----------
(Dollars in thousands)
+ 400 bp $15,531 $(23,008) (60)% 4.04% (529)
+ 300 bp 22,965 (15,574) (40) 5.85 (349)
+ 200 bp 29,312 (9,227) (24) 7.32 (202)
+ 100 bp 34,287 (4,252) (11) 8.42 (91)
Static 38,539 -- -- 9.34 --
- 100 bp 43,552 5,013 13 10.39 105
- 200 bp 49,730 11,191 29 11.64 231
- 300 bp 56,860 18,321 48 13.05 371
- 400 bp 62,630 24,091 63 14.14 480
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 securitizations, and to a lesser extent, interest payments on
investment securities and proceeds from the maturation of investment securities.
While maturities and
65
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 7.04%, 10.4%, and 8.5% for the years ended
December 31, 1998, 1997 and 1996, respectively. Management currently attempts to
maintain a minimum liquidity ratio of 5.0%.
The Company's cash flows are comprised of three primary classifications: cash
flows from operating activities, investing activities and financing activities.
Cash flows used in operating activities were $112.4 million, $292.2 million and
$14.8 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Such cash flows primarily consisted of loans originated and
purchased for sale (net of loan fees) of $1.2 billion, $773.1 million and $222.6
million, net of proceeds from the sale and securitization of loans held for sale
of $1.1 billion, $489.5 million and $210.6 million for the years ended December
31, 1998, 1997 and 1996, respectively. Net cash provided by (used in) investing
activities were $83.0 million, $8.6 million and $(1.6) million for the years
ended December 31, 1998, 1997, and 1996 respectively, and consisted primarily of
principal collections on loans and proceeds from maturation of investments,
offset by investment purchases. Proceeds from the maturation of investment
securities were $3.0 million, $5.0 million and $2.0 million for the years ended
December 31, 1998, 1997 and 1996, respectively. Net cash provided by financing
activities consisted primarily of net activity in deposit accounts and
borrowings. The net increase in deposits and borrowings was $34.0 million,
$241.6 million and $21.5 million for the years ended December 31, 1998, 1997 and
1996, respectively. The Company received net proceeds from the IPO of the
Company's Common Stock of $32.8 million during the year ended December 31, 1997.
The Bank also received proceeds from the issuance of common stock in the Private
Placement of $3.5 million in August 1996 and $9.6 million from the sale of the
Debentures in March 1997, $8.5 million of which were redeemed in December 1998.
At December 31, 1998, the Bank exceeded all of its regulatory capital
requirements with a tangible capital level of $27.3 million, or 7.2% of total
adjusted assets, which is above the required level of $5.7 million, or 1.50%;
core capital of $27.3 million, or 7.2% of total adjusted assets, which is above
the required level of $15.1 million, or 4.0%, and risk-based capital of $30.0
million, or 10.9% of risk-weighted assets, which is above the required level of
$22.0 million, or 8.0%. See "Item 1--Regulation--Federal Savings Institution
Regulation--Capital Requirements."
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, 1998,
cash and short-term investments totalled $8.2 million. The Company has other
sources of liquidity if a need for additional funds arises, including the
utilization of FHLB advances. At December 31, 1998, the Bank had no advances
outstanding from the FHLB. Other sources of liquidity include investment
securities maturing within one year. The Bank also has two warehouse lines of
credit available in the amount of $375.0 million of which $13.6 million had been
drawn upon at December 31, 1998. The Company has a residual financing line of
credit in the amount of $40.0 million, of which $19.0 million has been drawn
upon at December 31, 1998 and a $10 million revolving line of credit of which
$7.3 million has been drawn upon at December 31, 1998.
The Company had no material contractual obligations or commitments for capital
expenditures at December 31, 1998. At December 31, 1998 the Company had
outstanding commitments to originate or purchase mortgage loans of $11.0 million
compared to $29.2 million at December 31, 1997. 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, 1998, totalled $291.1 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
66
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.
Impact of New Accounting Standards
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and hedging Activities, which is effective for fiscal years
beginning after June 15, 1999. This statement establishes accounting and
reporting for derivative instruments, including certain deriative instruments
embedded in other contracts, and for hedging activities. The Company does not
currently enter into hedging transactions, therefore, the adoption of the
standard is not expected to have a material effect on the Company's financial
condition, results of operations and cash flows.
In October 1998, FASB issued SFAS No. 134, Accounting for Mortgage-Backed
Securities Retained After the Securitization of Mortgage Loans Held for Sale by
a Mortgage-Banking Enterprise, which is effective for the first fiscal quarter
beginning after December 15, 1998. This statement amends SFAS No. 65,
Accounting for Certain Mortgage-Backed Activities, to require that after
securitization of the mortgage loans held for sale, an entity engaged in
mortgage-banking activities classify the resulting mortgage-backed securities or
retained interest based on its ability and intent to sell or hold those
investments. Management has not yet completed its analysis of the effect this
standard will have on the Company's financial condition, results of operations
and cash flows.
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, 1998 and 1997. 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.
67
At December 31, 1998 Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
--------- -------- -------- -------- -------- -----------
(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 Assets....................... $ 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%
68
At December 31, 1997 Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
--------- -------- --------- --------- --------- -----------
(Dollars in thousands)
Selected Assets:
Investments and Fed Funds............. $ 4,071 $ 1,999 $ -- $ -- $ -- $ --
Average interest rate................. 5.75% 6.12% 0.00% 0.00% 0.00% 0.00%
Mortgage-backed securities
Adjustable rate............ $ 9 $ -- $ -- $ -- $ -- $ --
Average interest rate................. 7.50% 0.00% 0.00% 0.00% 0.00% 0.00%
Loans--fixed rate..................... $ 685 $ 495 $ 662 $ 1,449 $ 4,351 $122,528
Average interest rate................. 13.02% 9.37% 13.36% 15.82% 12.27% 12.00%
Loans--adjustable rate................ $125,892 $45,892 $10,495 $ 75 $ -- $ --
Average interest rate................. 9.05% 9.95% 9.74% 10.13% 0.00% 0.00%
Residual Assets....................... $ 2,954 $ 4,066 $11,656 $10,449 $10,793 $ 5,434
Average Interest Rate................. 13.50% 13.50% 13.50% 13.50% 13.50% 13.50%
Mortgage Servicing Rights............. $ 3,576 $ 2,892 $ 2,058 $ -- $ -- $ --
Average Interest Rate................. 16.00% 16.00% 16.00% 0.00% 0.00% 0.00%
Selected Liabilities:
Interest-bearing NOW passbook
and MMDA's.......................... $ 3,585 $ 2,867 $ 2,293 $ 1,835 $ 1,468 $ 5,872
Average interest rate................. 2.80% 2.80% 2.80% 2.80% 2.80% 2.80%
Certificates of deposit................. $187,501 $ 3,631 $ 1,179 $ 589 $ 421 $ 524
Average interest rate................... 5.93% 6.07% 6.56% 6.40% 6.02% 6.83%
FHLB Advances......................... $ 9,000
Average interest rate................. 7.07% 0.00% 0.00% 0.00% 0.00% 0.00%
Warehousing lines of credit and
subordinated debentures............. $100,170 $ -- $ -- $ -- $ -- $ 10,000
Average interest rate................. 7.19% 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.
69
Item 8. Financial Statements and Supplementary Data
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
LIFE Financial Corporation
Riverside, California
We have audited the accompanying consolidated statements of financial
condition of LIFE Financial Corporation and subsidiaries (the Company) as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
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 1997, and the results of their
operations and their cash flows for each of the three 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
70
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
As of December 31, 1998 and 1997
(dollars in thousands)
1998 1997
--------- ------------
ASSETS
- -----------------------------------------------------------------------------------------
Cash and cash equivalents................................................................ $ 8,152 $ 3,467
Securities held to maturity, estimated fair value of $2,020 (1998) and $5,030 (1997)..... 2,008 5,012
Residual assets, at fair value........................................................... 50,296 45,352
Loans held for sale...................................................................... 243,497 289,268
Loans held for investment, net of allowance for estimated loan losses of $2,777 (1998)
and $2,573 (1997)....................................................................... 90,827 29,076
Mortgage servicing rights................................................................ 13,119 8,526
Accrued interest receivable.............................................................. 2,762 2,638
Foreclosed real estate, net.............................................................. 1,898 1,440
Premises and equipment, net.............................................................. 7,145 4,764
Federal Home Loan Bank stock............................................................. 2,463 1,067
Other assets............................................................................. 5,911 6,461
-------- --------
TOTAL ASSETS............................................................................. $428,078 $397,071
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------
LIABILITIES:
Deposit accounts....................................................................... $323,433 $211,765
Federal Home Loan Bank advances........................................................ 9,000
Other borrowings....................................................................... 39,977 100,170
Subordinated debentures................................................................ 1,500 10,000
Accounts payable and other liabilities................................................. 11,170 15,250
-------- --------
Total liabilities.................................................................... 376,080 346,185
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; 6,562,396 (1998)
and 6,546,716 (1997) shares issued and outstanding.................................... 66 65
Additional paid-in capital............................................................. 42,223 42,171
Retained earnings, partially restricted................................................ 9,709 8,650
-------- --------
Total stockholders' equity........................................................... 51,998 50,886
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................................... $428,078 $397,071
======== ========
See notes to consolidated financial statements.
71
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For Each of the Three Years in the Period Ended December 31, 1998
(in thousands, except per share data)
1998 1997 1996
---------- ---------- -----------
INTEREST INCOME:
Loans..................................................................... $ 32,247 $ 17,746 $ 6,513
Residual assets........................................................... 6,984 2,269 28
Securities held to maturity............................................... 254 435 56
Other interest-earning assets............................................. 1,619 696 331
---------- ---------- ----------
Total interest income.................................................. 41,104 21,146 6,928
---------- ---------- ----------
INTEREST EXPENSE:
Deposit accounts.......................................................... 14,048 8,038 3,514
Federal Home Loan Bank advances and other borrowings...................... 7,531 3,665 252
Subordinated debentures................................................... 1,336 1,127
---------- ---------- ----------
Total interest expense................................................. 22,915 12,830 3,766
---------- ---------- ----------
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN
LOSSES..................................................................... 18,189 8,316 3,162
PROVISION FOR ESTIMATED LOAN LOSSES......................................... 4,166 1,850 963
---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR ESTIMATED LOAN
LOSSES..................................................................... 14,023 6,466 2,199
NONINTEREST INCOME:
Loan servicing and other fees............................................. 5,340 959 496
Service charges on deposit accounts....................................... 179 130 128
Net gains from mortgage financing operations.............................. 7,664 25,730 5,708
Other income.............................................................. 1,000 411 136
---------- ---------- ----------
Total noninterest income............................................... 14,183 27,230 6,468
NONINTEREST EXPENSE:
Compensation and benefits.................................................. 11,570 9,210 5,233
Premises and occupancy..................................................... 3,419 1,360 746
Data processing............................................................ 1,495 809 390
Net loss on foreclosed real estate......................................... 211 126 158
FDIC insurance premiums.................................................... 141 102 174
SAIF special assessment.................................................... 448
Marketing.................................................................. 2,415 301 189
Telephone.................................................................. 1,404 650 246
Professional services...................................................... 1,579 467 218
Other expense.............................................................. 4,185 2,965 879
---------- ---------- ----------
Total noninterest expense................................................. 26,419 15,990 8,681
---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAX PROVISION................................... 1,787 17,706 (14)
INCOME TAX PROVISION........................................................ 728 7,382 38
---------- ---------- ----------
NET INCOME (LOSS)........................................................... $ 1,059 $ 10,324 $ (52)
========== ========== ==========
EARNINGS (LOSS) PER SHARE:
Basic earnings (loss) per share............................................ $0.16 $2.11 $(0.02)
========== ========== ==========
Diluted earnings (loss) per share.......................................... $0.16 $2.02 $(0.02)
========== ========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic earnings per share................................................... 6,554,743 4,884,993 2,370,779
========== ========== ==========
Diluted earnings per share................................................. 6,805,827 5,107,951 2,370,779
========== ========== ==========
See notes to consolidated financial statements.
72
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For Each of the Three Years in the Period Ended December 31, 1998
(dollars in thousands)
Additional Retained Total
---------- -------- -----
Common stock Paid-in earnings Stockholders'
------------ ------- -------- --------------
Shares Amount Capital (deficit) equity
------ ------ ------- -------- ------
BALANCE, January 1, 1996........................ 933,108 $ 9 $ 3,393 $ 866 $ 4,268
Stock split effected in the form of a dividend.. 933,108 9 2,479 (2,488)
Net proceeds from issuance of common stock...... 1,345,500 14 3,486 3,500
Net loss........................................ (52) (52)
--------- --- ------- ------- -------
BALANCE, December 31, 1996...................... 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
========= === ======= ======= =======
See notes to consolidated financial statements.
73
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Each of the Three Years in the Period Ended December 31, 1998
(dollars in thousands)
1998 1997 1996
----------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)...................................................... $ 1,059 $ 10,324 $ (52)
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation and amortization....................................... 1,931 683 301
Provision for estimated loan losses................................. 4,166 1,850 963
Accretion of deferred fees.......................................... (31) (26) (41)
Provision for estimated losses on foreclosed real estate............ 24 108 145
Loss (gain) on sale of foreclosed real estate, net.................. 46 (74) (41)
Gain on sale and securitization of loans held for sale.............. (24,214) (24,210) (5,385)
Net unrealized loss (gain) on residual assets...........,........... 16,550 (1,520) (323)
Net accretion of residual assets.................................... (6,984) (2,269) (28)
Change in valuation allowance on mortgage servicing rights.......... 1,168 (12)
Direct writedown of mortgage servicing rights....................... 1,281
Amortization of mortgage servicing rights........................... 2,689 958 320
Purchase and origination of loans held for sale, net of loan fees... (1,180,552) (773,107) (222,553)
Proceeds from sales and securitization of loans held for sale....... 1,075,862 489,540 210,590
Increase in accrued interest receivable............................. (124) (2,101) (30)
Deferred income taxes............................................... (7,961) 8,125 (1,347)
Increase in accounts payable and other liabilities.................. 3,853 9,423 2,725
Federal Home Loan Bank stock dividend............................... (99) (58) (34)
Decrease (increase) in other assets................................. 262 (11,082) 52
----------- --------- ---------
Net cash used in operating activities............................ (112,355) (292,155) (14,750)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in loans.................................................. 82,728 8,586 3,975
Proceeds from sale of foreclosed real estate........................... 2,601 1,034 1,471
Purchase of securities held to maturity................................ (2,000) (8,013)
Proceeds from maturities of securities held to maturity................ 3,000 5,000 1,975
Additions to premises and equipment, net............................... (4,020) (3,814) (904)
Purchase of Federal Home Loan Bank stock............................... (1,297) (195) (65)
----------- --------- ---------
Net cash provided by (used in) investing activities.............. 83,012 8,611 (1,561)
74
1998 1997 1996
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposit accounts........................................ $111,668 $126,054 $18,176
(Decrease) increase in Federal Home Loan Bank advances.................. (9,000) 9,000
Net (repayments) proceeds from other borrowings......................... (60,193) 96,892 3,278
Net proceeds from issuance of common stock.............................. 53 32,846 3,500
Net proceeds from issuance of subordinated debentures................... 9,644
Repurchase of subordinated debentures................................... (8,500) -- --
-------- -------- -------
Net cash provided by financing activities........................... 34,028 274,436 24,954
-------- -------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS..................... 4,685 (9,108) 8,643
CASH AND CASH EQUIVALENTS, beginning of year............................. 3,467 12,575 3,932
-------- -------- -------
CASH AND CASH EQUIVALENTS, end of year................................... $ 8,152 $ 3,467 $12,575
======== ======== =======
SUPPLEMENTAL CASH FLOW DISCLOSURES--
Cash paid during the year for:
Interest............................................................... $ 23,826 $ 11,298 $ 3,773
======== ======== =======
Income taxes........................................................... $ 3,328 $ 3,616 $ 267
======== ======== =======
NONCASH INVESTING ACTIVITIES DURING THE YEAR:
Transfers from loans held for sale to loans held for investment........ $ 76,135 $ -- $ 856
======== ======== =======
Transfers from loans to foreclosed real estate......................... $ 3,129 $ 2,234 $ 2,070
======== ======== =======
Loans to facilitate sales of foreclosed real estate.................... $ 394 $ 287 $ 761
======== ======== =======
NONCASH FINANCING ACTIVITIES DURING THE YEAR--
Stock dividends paid.................................................... $ -- $ -- $ 2,488
======== ======== =======
See notes to consolidated financial statements.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Each of the Three Years in Period Ended December 31, 1998
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) and Life Investment Holdings, Inc. (Life Investment)
(collectively, the Company). All significant intercompany accounts and
transactions have been eliminated in consolidation.
LIFE is a savings and loan holding company, incorporated in the State of
Delaware, that was initially organized for the purpose of acquiring all of the
capital stock of the Bank through the holding company reorganization (the
Reorganization) of the Bank, which was consummated on June 27, 1997. Pursuant to
the Reorganization, LIFE issued 3,211,716 shares of common stock in exchange for
the 1,070,572 shares of the Bank's outstanding common stock and, accordingly,
the Bank became a wholly-owned subsidiary of LIFE. Such business combination was
75
accounted for at historical cost in a manner similar to a pooling of interests.
On June 30, 1997, the Company completed its sale of 2,900,000 additional shares
of its common stock through an initial public offering. On July 2, 1997, the
Company issued 435,000 shares of common stock to the public through the exercise
of the underwriter's overallotment option. The consolidated financial condition
and results of operations of the Company for periods prior to the date of the
Reorganization consist of those of the Bank.
The Company originates, purchases, sells and services nonconventional mortgage
loans principally secured by first and second mortgages on one- to four-family
residences. The Company focuses on loans for the purchase or refinance of
residential real property by borrowers who, because of prior credit problems or
the absence of a credit history, are considered ''alternative borrowers.''
Through October 1998, the Company also originated debt consolidation loans up to
125% of the loan-to-value ratio of such loans for borrowers whose credit history
qualifies for loans under federal agency programs. The Company purchases and
originates mortgage loans and other real estate secured loans through a network
of approved correspondents and mortgage brokers on a nationwide basis, as well
as through the Company's retail lending division. Beginning in 1998, the Company
began to originate a limited number of loans specifically for retention in the
Bank's portfolio as loans held for investment. Loans originated or purchased
since 1994 through the Company's regional lending centers are generally
originated for sale in the secondary mortgage market and, since the fourth
quarter of 1996, in asset securitizations with servicing retained by the
Company. The Company generally retains the majority of the servicing rights to
the loans sold or securitized and may sell servicing rights at a later date,
depending on market opportunities. In addition, the Company purchases and
originates for resale in the secondary market, smaller commercial real estate
and multi-family loans. The Company began originating construction loans for the
loan portfolio during the fourth quarter of 1998. These loans are primarily
secured by single family and tract homes. The Company funds substantially all of
the loans which it purchases or originates through deposits from customers
concentrated in the communities surrounding the Bank's home office in San
Bernardino County, internally generated funds, advances from the Federal Home
Loan Bank and other borrowings.
The Company has continued to focus efforts on the origination of multi-family
and commercial real estate as well as consumer-oriented loans secured by real
estate, primarily home equity lines of credit and second trust deeds.
Specifically, the Company has targeted borrowers seeking loans secured by multi-
family properties or properties used for commercial business purposes such as
small office buildings or light industrial or retail facilities. Such loans are
generally originated for sale.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
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--The Company's real estate loan portfolio consists primarily of long-
term loans secured by first and second trust deeds on single-family residences.
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 and include 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.
76
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, 1998 and 1997, the principal balance of loans held for sale consists of
$211,478,000 and $255,137,000, respectively, in single-family residential
mortgage loans; $15,426,000 and $8,634,000, respectively, in multi-family
residential mortgage loans; $9,150,000 and $10,749,000, respectively, in
commercial mortgage loans; and $2,610,000 and $6,339,000, respectively, in other
loans.
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.
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
and all loans that have a specific loss allowance applied to adjust the loan to
fair value. The accrual of interest on impaired loans is
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
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. The Company uses the fair value of
collateral method for measuring impaired loans. The Company applies such
measurement provision to all loans in its portfolio except for one- to four-
family residential mortgage loans and unsecured consumer loans, which are
collectively evaluated for impairment.
Allowances for Estimated Loan and Real Estate Losses--It is the policy of the
Company to maintain separate allowances for estimated loan and real estate
losses at levels 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, general valuation allowances
for loan and real estate losses have been established. Management's
determination of the adequacy of the loan and real estate 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, which 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.
77
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 Financing Operations--The Company sells and/or securitizes the
majority of loans held for sale with servicing retained. 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.
Effective January 1, 1997, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities", which was amended by SFAS
No. 127. This statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities
based on consistent application of a financial-components approach that focuses
on control. It distinguished transfers of financial assets that are sales from
transfers that are secured borrowings. Under the financial-components approach,
after a transfer of financial assets, an entity recognizes all financial and
servicing assets it controls and liabilities it has incurred and derecognizes
financial assets it no longer controls and liabilities that have been
extinguished. The financial-components approach focuses on the assets that
exist after the transfer.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
Many of these assets and liabilities are components of financial assets that
existed prior to the transfer. If a transfer does not meet criteria for a sale,
the transfer is accounted for as a secured borrowing with pledge of collateral.
The statement is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996.
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, 1998 and 1997, the Company utilized a
weighted average prepayment assumption of 26.1% and 21.1%, respectively, and a
weighted average discount rate of 13.5% and 16.0%, respectively. The discount
rate was changed at December 31, 1998 to conform with the discount rate used to
estimate the fair value of residual assets. This change did not have a material
impact on the Company's impairment analysis at December 31, 1998. The cost
allocated to servicing rights is amortized in proportion to, and over the period
of, estimated net future servicing fee income.
Residual Assets--In 1998, 1997, and 1996, the Company completed the
securitization and sale of approximately $462.1 million, $415.4 million, and
$51.9 million, respectively, in loans in the form of mortgage pass-through
certificates and recognized gains of approximately $9.3 million, $22.5 million,
and $1.4 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 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
78
years ended December 31, 1998, 1997, and 1996, net unrealized gains (losses) of
($16.6 million), $1.5 million, and $323,000, 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 residual assets. At December 31, 1997, the Company utilized prepayment
assumptions ranging from 12% to 60%, an estimated annual loss factor assumption
ranging from 0.5% to 2.5% and a discount rate of 13.5% to value residual assets.
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 residual assets. 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 residual assets.
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
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
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 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 and 1997 is $12.9 million and $12.3
million, respectively, and is included in residual assets in the accompanying
consolidated statements of financial condition at its fair value.
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.
79
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.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
Earnings Per Share--Earnings per share has been adjusted retroactively to
reflect the three-for-one stock exchange effected pursuant to the Reorganization
and the stock split effected in the form of a dividend during 1996. The per
share amounts and weighted average shares outstanding included in the
accompanying consolidated financial statements have been restated to reflect the
Reorganization and stock split.
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, 1997, federal funds sold
approximated $550,000. There were no federal funds sold as of 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 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--Beginning with the first quarter of 1998, the
Company adopted SFAS No. 130, "Reporting Comprehensive Income". This statement
requires that all items that are required to be recognized under accounting
standards as comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. There were no
items of other comprehensive income arising during 1998, 1997 and 1996.
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information",
which is effective for annual periods beginning after December 15, 1997. This
statement established standards for the method that public entities use to
report information about
80
operating segments in annual financial statements, and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographical areas, and major
customers.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which is effective for fiscal years
beginning after June 15, 1999. This statement establishes accounting and
reporting for derivative instruments, including certain deriative instruments
embedded in other contracts, and for hedging activities. The Company does not
currently enter into hedging transactions; therefore, the adoption of the
standard is not expected to have a material effect on the Company's financial
condition, results of operations, and cash flows.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise", which will become effective for
the first fiscal quarter beginning after December 15, 1998. This statement
requires that after the securitization of mortgage loans held for sale, an
entity engaged in mortgage banking activities classify the resulting mortgage-
backed securities based on its ability and intent to sell or hold those
investments. The Company has not yet completed its analysis of the effect this
standard will have on the Company's financial condition, results of operations,
or cash flows.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
Reclassifications--Certain reclassifications have been made to the 1997 and
1996 consolidated financial statements to conform to the 1998 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, 1998 and 1997, that
the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1998 and 1997, 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,
1998 that management believes have changed the Bank's category.
81
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
The Bank's actual capital amounts and ratios are also presented in the table.
To be well-
-----------
capitalized under
------------------
For capital prompt corrective
----------- ------------------
Actual adequacy purposes action provisions
---------------- ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ -------- ------- -------- -------
(dollars in thousands)
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 I Capital (to Risk-Weighted Assets)......... 27,311 9.94% N/A N/A 16,484 6.00%
As of December 31, 1997:
Total Capital (to Risk-Weighted Assets).......... $33,947 10.52% 25,813 8.00% $32,265 10.00%
Core Capital (to Adjusted Tangible Assets)....... 21,545 5.38% 16,022 4.00% 20,028 5.00%
Tangible Capital (to Tangible Assets)............ 21,545 5.38% 6,008 1.50% N/A N/A
Tier I Capital (to Risk-Weighted Assets)......... 21,545 6.68% N/A N/A 19,359 6.00%
The Bank has been required by the Office of Thrift Supervision (OTS) since the
Bank's examination completed August 9, 1996 to compute its regulatory capital
ratios based upon the higher of (1) the average of total assets based on month-
end results,or (2) total assets as of the quarter-end.
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. Examination
results have been reflected in the financial statements presented herein. Future
examinations by the OTS or FDIC could include a review of certain transactions
or other amounts reported in the 1998 financial statements. Adjustments, if any,
cannot presently be determined.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the Funds Act), which, among other things, imposed a special
one-time assessment on Savings Association Insurance Fund (SAIF) member
institutions, including the Bank, to recapitalize the SAIF. As required by the
Funds Act, the FDIC
82
imposed a special assessment of 65.7 basis points on SAIF-assessable deposits
held as of March 31, 1995, payable November 27, 1996. The special assessment was
recognized as an expense in the third quarter of 1996 and is tax deductible. The
Bank took a pretax charge of $448,000 as a result of the SAIF special
assessment.
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.
3. Securities Held to Maturity
The amortized cost and estimated fair value of securities held to maturity
were as follows at December 31 (in thousands):
1998
-----------------------------------------
Amortized Gross unrealized Estimated
--------- ---------------- ---------
Cost Gains Losses fair value
---- ----- ------ ----------
U.S. Treasury and other agency securities...... $2,000 $ 12 $ -- $2,012
Mortgage-backed securities..................... 8 -- -- 8
------ ----- ------ ------
$2,008 $ 12 $ -- $2,020
====== ===== ====== ======
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
1997
-------------------------------------------
Amortized Gross unrealized Estimated
--------- ---------------- ---------
Cost Gains Losses fair value
---- ----- ------ ----------
U.S. Treasury and other agency securities...... $5,003 $ 18 $ -- $5,021
Mortgage-backed securities..................... 9 -- -- 9
------ ----- ------ ------
$5,012 $ 18 $ -- $5,030
====== ===== ====== ======
The maturity distribution of securities held to maturity at December 31, 1998
is as follows (in thousands):
Amortized Estimated
--------- ---------
Cost fair value
---- ----------
Due in one year or less.......... $2,000 $2,012
Mortgage-backed securities....... 8 8
------ ------
$2,008 $2,020
====== ======
The weighted average yield on securities held to maturity was 6.13% and 5.88%
at December 31, 1998 and 1997, respectively.
83
4. Loans Held for Investment
Loans held for investment consisted of the following at December 31 (in
thousands):
1998 1997
------------ ------------
Mortgage loans:
Residential:
One- to four family................................ $82,555 $23,068
Multi-family....................................... 1,954 2,019
Commercial and land................................ 5,075 6,014
Construction....................................... 8,571
------- -------
98,155 31,101
Other loans:
Loans secured by deposit accounts.................. 270 165
Unsecured commercial loans......................... 124 63
Unsecured consumer loans........................... 341 336
------- -------
735 564
------- -------
98,890 31,665
Less:
Undisbursed loan funds............................. 6,399
Deferred loan origination fees (costs)............. (1,588) 16
Discounts on loans................................. 475
Allowance for estimated loan losses................ 2,777 2,573
------- -------
8,063 2,589
------- -------
$90,827 $29,076
======= =======
Weighted average interest rate at end of period........ 9.23% 8.06%
======= =======
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
The Company grants residential and commercial loans held for investment to
customers located primarily in Southern California. Consequently, a borrower's
ability to repay may be impacted by economic factors in the region.
At December 31, 1998 and 1997, included in loans held for investment and loans
held for sale are adjustable rate loans with principal balances of $109,487,000
and $169,063,000, respectively. Adjustable rate loans are indexed primarily to
LIBOR.
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 following summarizes activity in the allowance for estimated loan losses
for the years ended December 31 (in thousands):
1998 1997 1996
------- ------- -------
Balance, beginning of year............... $ 2,573 $1,625 $1,177
Provision for estimated loan losses...... 4,166 1,850 963
Recoveries............................... 109 7 219
84
Charge-offs.............................. (4,071) (909) (734)
------- ------ ------
Balance, end of year..................... $ 2,777 $2,573 $1,625
======= ====== ======
The Company had nonaccrual loans at December 31, 1998, 1997, and 1996 of
$7,544,000, $5,126,000, and $2,416,000, respectively. If nonaccrual loans had
been performing in accordance with their original terms, the Company would have
recorded interest income of $33,036,000, $18,170,000, and $6,692,000,
respectively, instead of interest income actually recognized of $32,247,000,
$17,746,000, and $6,513,000, respectively, for the years ended December 31,
1998, 1997, and 1996.
At December 31, 1998 and 1997, the Company had impaired loans totaling
$8,239,000 and $5,518,000, respectively, with related reserves of $1,320,000 and
$1,017,000, respectively. During the years ended December 31, 1998, 1997, and
1996, the average recorded investment in impaired loans was $7,875,000,
$3,413,000, and $2,300,000, respectively. Total cash collected on impaired loans
during the years ended December 31, 1998, 1997, and 1996 was $4,595,000,
$1,498,000, and $1,339,000, respectively, of which $3,771,000, $1,329,000, and
$1,249,000, respectively, was credited to principal. Interest income of
$824,000, $169,000 and $90,000 on impaired loans was recognized for cash
payments received during the years ended December 31, 1998, 1997, and 1996,
respectively.
At December 31, 1998 and 1997, troubled debt restructured loans amounted to
$131,000. There were no troubled debt restructurings effected during the years
ended December 31, 1998 and 1997.
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 $4,493,000 at
December 31, 1998.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
Activity in loans to directors and executive officers during the year ended
December 31 are as follows (in thousands):
1998 1997 1996
------ ------ ------
Balance, beginning of year......... $ 413 $ -- $ --
Originations....................... -- 778 154
Loans sold servicing released...... (163) (365) (154)
----- ----- -----
Balance, end of year............... $ 250 $ 413 $ --
===== ===== =====
5. Mortgage Financing Operations
Loans serviced for others at December 31, 1998, 1997, and 1996 totaled
$1,001,699,000, $536,726,000, and $168,963,000, respectively.
In connection with mortgage servicing activities, the Company held funds in
trust for others totaling approximately $22,133,000 and $8,068,000 at December
31, 1998 and 1997, respectively. At December 31, 1998 and 1997, $1,326,000 and
$32,000, 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.
85
For the years ended December 31, 1998 and 1997, respectively, 20.9% and 22.7%
of the properties securing loans funded by the Company were located in
California, 5.5% and 4.8% were located in Utah, 3.3% and 3.0% were located in
Colorado, 5.0% and 5.2% were located in Florida, 5.7% and 5.9% were located in
Virginia, 4.9% and 5.4% were located in Maryland, 4.5% and 5.1% were located in
North Carolina, 5.9% and 2.7% were located in Michigan and the remainder were
dispersed throughout the country. At December 31, 1998 and 1997, respectively,
25.3% and 35.0% of the loan servicing portfolio was collateralized by real
estate properties located in California. At December 31, 1998 and 1997, no other
state accounted for more than 6.0%.
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 securitizations, the Company is required to repurchase
or substitute loans in the event of a breach of a representation or warranty
made by the Company. While the Company may have recourse to the sellers of loans
it purchased, there can be no assurance of the sellers' abilities to honor their
respective obligations to the Company. Likewise, in connection with its whole
loan sales, the Company enters 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 against the Company, 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.
At December 31, 1998, the cumulative losses and/or annual default rate on two
of the Company's securitization transactions exceeded the permitted limit in the
related pooling and servicing agreements. Although to date no servicing rights
have been terminated, this condition could allow for the termination of the
Company's rights to service the related loans.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
In addition, borrowers, loan purchasers, monoline insurance carriers, and
trustees in the Company's securitizations may make claims against the Company
arising from alleged breaches of fiduciary obligations, misrepresentations,
errors and omissions of employees, officers and agents of the Company, including
appraisers; incomplete documentation; and failure by the Company to comply with
various laws and regulations applicable to its business. Any claims asserted in
the future may result in liabilities or legal expenses that could have a
material adverse effect on the Company's results of operations, financial
condition, cash flows and business prospects.
The following is a summary of activity in mortgage servicing rights for the
years ended December 31 (in thousands):
1998 1997 1996
---------- ----------- --------
Balance, beginning of year.......................... $ 8,526 $ 2,645 $ 683
Additions through originations...................... 8,450 8,120 2,270
Amortization........................................ (2,689) (958) (320)
Change in valuation allowance....................... (1,168) 12
86
Direct writedowns................................... (1,281)
------- ------- ------
Balance, end of year................................ $13,119 $ 8,526 $2,645
======= ======= ======
The following is a summary of activity in the valuation allowance for mortgage
servicing rights for the years ended December 31 (in thousands):
1998 1997 1996
---------- ------- -----------
Balance, beginning of year................................. $ 1 $ 1 $ 13
Additions (reductions) charged (credited) to operations.... 1,168 (12)
------ ----- -----
Balance, end of year....................................... $1,169 $ 1 $ 1
====== ===== =====
Net gains from mortgage financing operations for the years ended December 31
consisted of the following (in thousands):
1998 1997 1996
------------ ---------- --------
Gains on sale and securitization of loans held for sale.... $ 24,214 $24,210 $5,385
Net unrealized gain (loss) on residual assets.............. (16,550) 1,520 323
-------- ------- ------
$ 7,664 $25,730 $5,708
======== ======= ======
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
6. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in
thousands):
1998 1997
--------------- ---------------
Premises............................................. $ 635 $ 569
Leasehold improvements............................... 2,753 1,930
Furniture, fixtures and equipment.................... 7,191 4,116
Automobiles.......................................... 24 ---
------- -------
10,603 6,615
Less accumulated depreciation and amortization....... (3,458) (1,851)
------- -------
$ 7,145 $ 4,764
======= =======
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):
1998 1997 1996
----------- ------------- -------------
Balance, beginning of year................... $ 79 $ 65 $ 44
Provision for estimated real estate losses... 24 108 145
Recoveries................................... -- 2 2
Charge offs.................................. (3) (96) (126)
----- ----- -----
Balance, end of year......................... $ 100 $ 79 $ 65
===== ===== =====
Net loss on foreclosed real estate is summarized as follows for the years
ended December 31 (in thousands):
87
1998 1997 1996
-------- ----------- ------------
Net (gain) loss on sales of foreclosed real estate........ $ 46 $ (74) $ (41)
Net real estate operating costs........................... 141 92 54
Provision for estimated real estate losses................ 24 108 145
----- ----- -----
Net loss on foreclosed real estate........................ $ 211 $ 126 $ 158
===== ===== =====
8. Deposit Accounts
Deposit accounts consisted of the following at December 31 (in thousands):
1998 1997
----------------------- -------------
Weighted Weighted
-------- --------
Average Average
------- -------
Balance Interest Rate Balance Interest rate
------- ------------- ------- -------------
Checking accounts........................................ $ 14,088 1.72% $ 11,353 2.99%
Passbook accounts........................................ 4,642 2.35 3,838 2.10
Money market accounts.................................... 7,729 4.84 2,729 2.98
Certificate accounts:
Under $100,000......................................... 214,943 5.98 141,036 5.93
$100,000 and over...................................... 82,031 5.50 52,809 5.98
-------- --------
$323,433 5.48% $211,765 5.68%
======== ========
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
The aggregate annual maturities of certificate accounts at December 31 are
approximately as follows (in thousands):
1998 1997
----------- ---------
Within one year $291,118 $187,501
One to two years 4,048 3,631
Two to three years 708 1,179
Three to four years 383 589
Four to five years 139 421
Thereafter 578 524
-------- --------
$296,974 $193,845
======== ========
Interest expense on deposit accounts for the years ended December 31 is
summarized as follows (in thousands):
1998 1997 1996
--------- -------- --------
Checking accounts............... $ 309 $ 279 $ 112
Passbook accounts............... 102 84 92
Money market accounts........... 229 88 118
Certificate accounts............ 13,408 7,587 3,192
------- ------ ------
$14,048 $8,038 $3,514
======= ====== ======
88
9. Advances from Federal Home Loan Bank and Other Borrowings
As of December 31, 1998 and 1997, the Company had an available line of credit
with the Federal Home Loan Bank of San Francisco (FHLB) of $7,635,000 and
$17,471,000, 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 $6,946,000 and $21,777,000 at December 31, 1998 and 1997,
respectively.
At December 31, 1998, there were no outstanding FHLB advances. At December 31,
1997, outstanding FHLB advances totaled $9,000,000 at a weighted average
interest rate of 7.07%.
The following summarizes activities in advances from the FHLB for the years
ended December 31 (dollars in thousands):
1998 1997 1996
--------------- ---------------- -----------------
Average balance outstanding........................................ $ 1,154 $ 8,284 $ 4,259
Maximum amount outstanding at any month-end during the year........ 17,062 17,800 13,900
Weighted average interest rate during the year..................... 5.02% 5.82% 5.93%
At December 31, 1998, the Company had four warehousing lines of credit
available to it from national investment banking firms. The first line allows
the Company to draw up to $75,000,000 and expires on June 30, 1999. The second
line allows the Company to draw up to $300,000,000 and expires August 20, 1999.
The third line allows the Company to draw up to $40,000,000 and maintains a
revolving maturity date. The fourth line allows the
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
Company to draw up to $10,000,000 and expires on December 14, 1999. An aggregate
balance of $39,977,000 and $100,170,000 was drawn on these lines as of December
31, 1998 and 1997, respectively, at a weighted average interest rate of 7.56%
and 7.19%, respectively. These lines of credit, which were obtained during 1997
and 1998, bear interest at a variable rate based on LIBOR. Outstanding
borrowings under these lines of credit at the Bank are collateralized by loans
held for sale. Outstanding borrowings under these lines of credit at LIFE
Financial are collateralized by the residual assets and the stock of the Bank.
These lines of credit contain certain affirmative, negative and financial
covenants, with which the Company was in compliance at December 31, 1998.
The following summarizes activities in the lines of credit for the year ended
December 31, 1998 (dollars in thousands):
1998 1997
------------------ -------------------
Average balance outstanding......................................... $112,886 $ 48,765
Maximum amount outstanding at any month-end during year............. 345,848 226,846
Weighted average interest rate during the year...................... 6.62% 6.53%
10. Subordinated Debentures
89
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 LIFE in its place as obligors 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.
The Debentures are redeemable at the option of LIFE, 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 LIFE 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
options to have LIFE 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.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
11. Income Taxes
Income taxes for the years ended December 31 consisted of the following (in
thousands):
1998 1997 1996
-------- -------- --------
Current provision (benefit):
Federal.................................................................. $ 7,050 $ (317) $ 1,073
State.................................................................... 1,639 (426) 312
------- ------ -------
8,689 (743) 1,385
------- ------ -------
Deferred (benefit) provision:
Federal.................................................................. (5,287) 5,685 (1,036)
State.................................................................... (2,674) 2,440 (311)
------- ------ -------
(7,961) 8,125 (1,347)
------- ------ -------
Total income tax provision (benefit)................................... $ 728 $7,382 $ 38
======= ====== =======
A reconciliation from statutory federal income taxes to the Company's
effective income taxes for the years ended December 31 are as follows:
1998 1997 1996
------- ------ -------
Statutory federal taxes................................................... $ 625 $6,199 $ (5)
State taxes, net of federal income tax benefit............................ 128 1,315 1
Other..................................................................... (25) (132) 42
------- ------ -------
$ 728 $7,382 38
======= ====== =======
Deferred tax assets (liabilities) were comprised of the following at December
31 (in thousands):
90
1998 1997
--------------- ---------------
Deferred tax assets:
Depreciation........................... $ 83 $ 119
Accrued expenses....................... 297 1,276
Net operating loss..................... 3,423
Allowance for loan losses.............. 915 910
Capital loss carryforward.............. 36 60
Loans held for sale.................... 1,586 1,391
Other.................................. 649 1,245
------- --------
3,566 8,424
------- --------
Deferred tax liabilities:
Gain on sale of loans.................. (3,604) (15,166)
Originated servicing rights............ (1,149) (818)
Federal Home Loan Bank stock........... (168) (132)
------- --------
(4,921) (16,116)
------- --------
(1,355) (7,692)
Less valuation allowance.................. (36) (36)
------- --------
Net deferred tax liability................ $(1,391) $ (7,728)
======= ========
At December 31, 1998 and 1997, the net deferred tax liability is included in
other liabilities in the accompanying consolidated statements of financial
condition. Included in other assets at December 31, 1997 are refundable income
taxes of $2,428,000.
At December 31, 1998 and 1997, a valuation allowance has been recorded against
the deferred tax asset related to the capital loss carryforward, as it is more
likely than not that such benefit will not be realized.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
The Bank's financial statement 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 Bank is partially redeemed, this tax bad debt reserve, which
approximates $330,000 at December 31, 1998, 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 Bank
will make any disqualifying distributions that would result in the recapture of
these reserves.
12. Commitments, Contingencies and Concentrations of Risk
The Company is involved in various legal proceedings associated with normal
operations. In the opinion of management, based on the advice of legal counsel,
such litigation and claims are expected to be resolved without material effect
on the financial position of the Company.
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:
1999................. $1,233
91
2000.................... 1,148
2001.................... 1,022
2002.................... 748
2003.................... 187
Thereafter.............. 253
-----
$4,591
======
Rental expense under all operating leases totaled $1,095,000, $424,000, and
$232,000 for the years ended December 31, 1998, 1997, and 1996, respectively.
The Company and the Bank have negotiated employment agreements with their
Chief Executive Officer. 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--Loans to alternative borrowers present a higher level of
risk of default than conforming loans because of the increased potential for
default by borrowers who may have had previous credit problems or who do not
have any credit history. Loans to alternative borrowers also involve additional
liquidity risks, as these loans generally have a more limited secondary market
than conventional loans. The actual rates of delinquencies, foreclosures and
losses on loans to alternative borrowers could be higher under adverse economic
conditions than those currently experienced in the mortgage lending industry in
general. While the Company believes that the underwriting procedures and
appraisal processes it employs enable it to somewhat mitigate the higher risks
inherent in loans made to these borrowers, no assurance can be given that such
procedures or processes will afford adequate protection against such risks.
The debt consolidation loans the Company originated through October 1998 for
agency-qualified borrowers are primarily home equity lines of credit and second
deeds of trust generally up to 125% of the appraised value of the real estate
underlying the loans. In the event of a default on such a loan by a borrower,
there generally would be insufficient collateral to pay off the balance of such
loan and the Company, as holder of a second position on the property, would
likely lose a substantial portion, if not all, of its investment. While the
Company believes that the underwriting procedures it employs enable it to
somewhat mitigate the higher risks inherent in such loans, no assurance can be
given that such procedures will afford adequate protection against such risks.
At December 31, 1998, approximately 48% of the loans in the Company's
securitizations consisted of this type of loan.
The Company has been actively involved in the origination, purchase and sale
to institutional investors of real estate secured loans and, more recently, in
asset securitizations. Generally, the profitability of such mortgage financing
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 or sold through asset securitizations. 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 financing 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 or
asset securitizations are completed, the Company is exposed to downward
movements in the market price of such loans due to upward movements in interest
rates.
92
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 or pools of loans in
asset securitizations 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.
Dependence on Securitizations--Since December 1996, the Company has completed
five loan securitization transactions. The Company derived a significant portion
of its income in 1998, 1997, and 1996 by recognizing such gains on sale. The
Company's ability to complete securitizations is affected by several factors,
including conditions in the securities markets, generally; and in the asset-
backed securities markets, specifically; the credit quality of the Company's
loan portfolio, and the Company's ability to obtain credit enhancements.
Although the Company obtained credit enhancements in its securitizations, which
facilitated an investment-grade rating for the securitization interests, there
can be no assurance that the Company will be able to obtain future credit
enhancements on acceptable terms or that future securitizations will be
similarly rated.
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, 1998,
1997 and 1996.
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. Approximately
$1,480,000 and $100,000 in expense was recorded pursuant to the Bonus Plan
during the years ended December 31, 1997 and 1996, respectively. There was no
cash bonus recorded during 1998.
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. 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.
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
The components of the 1996 Option Plan as of December 31, 1998, 1997, and
1996, and changes during the years then ended (as adjusted for the
Reorganization), consist of the following:
1998 1997 1996
------------------- ------------------------------ --------
Weighted Weighted Weighted
-------- -------- --------
average average Average
-------- -------- --------
exercise exercise Exercise
-------- -------- --------
Shares price Shares price Shares price
-------- -------- -------- -------- -------- --------
Options outstanding at the beginning of the year.............. 316,200 $3.33 321,600 $3.33 ---
Granted.................................................... 321,600 $3.33
Exercised.................................................. (15,680) 3.33
Forfeited.................................................. (18,360) 3.33 (5,400) 3.33
------- ------- --------
Options outstanding at the end of the year.................... 282,160 3.33 316,200 3.33 321,600 3.33
======= ======= ========
Options exercisable at the end of the year.................... 6,040 3.33 27,540 3.33 ---
Weighted average remaining contractual life of options ======= =======
outstanding at end of year................................... 8 years 9 years 10 years
Weighted average information for options granted during
the year:
Fair value N/A N/A $1.66
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 public offering,
including Company options that were exchanged for Bank options pursuant to the
1996 Option Plan for issuance under the Option Plans.
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 1998 and
1997:
94
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
1998 1997
---------
Weighted Weighted
--------- ---------
Average Average
--------- ---------
Exercise Exercise
--------- ---------
Shares Price Shares Price
------------ --------- ----------- ---------
Options outstanding at the beginning of the year.... 193,000 $11.14 ---
Granted....................................... 8,000 $11.62 194,000 $11.14
Forfeited..................................... (27,500) $11.16 (1,000) $11.00
-------- --------
Options outstanding at end of the year.............. 173,500 $11.15 193,000 $11.14
======== ========
Options exercisable at the end of the year.......... 15,000 17,500
======== ========
Weighted average information on options
granted during the year--fair value............... $7.60 $ 8.37
Options exerciable 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 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 either year, volatility rate of 45.72% and 55.92%, respectively, risk-free
interest rate of 5.59% and 6.45% , respectively and expected lives of 10 years
for both years.
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, 1998, 1997 and
1996 would have been reduced to the pro forma amounts indicated below (dollars
in thousands, except per share data):
1998 1997 1996
--------- --------- ----------
Net income (loss) to common stockholders:
As reported................................... $1,059 $10,324 $ (52)
Pro forma..................................... $ 619 $ 9,778 $ (68)
Basic earnings (loss) per share:
As reported................................... $ 0.16 $ 2.11 $(0.02)
Pro forma..................................... $ 0.09 $ 2.00 $(0.03)
Diluted earnings (loss) per share:
As reported................................... $ 0.16 $ 2.02 $(0.02)
Pro forma..................................... $ 0.09 $ 1.91 $(0.03)
95
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
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, 1998 and 1997 totaled $10,969,000 and
$29,173,000, 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, 1998. At December 31,
1997, the Company had outstanding commitments to sell loans of $62,649,000.
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.
96
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in Period Ended December 31, 1998
1998
---------------------
Carrying Estimated
--------- ---------
amount Fair value
--------- ----------
(in thousands)
Assets:
Cash and cash equivalents............................. $ 8,152 $ 8,152
Securities held to maturity........................... 2,008 2,020
Residual assets....................................... 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
FHLB stock............................................ 2,463 2,463
Accrued interest payable.............................. 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
1997
---------------------
Carrying Estimated
--------- ---------
Amount Fair value
--------- ----------
(in thousands)
Assets:
Cash and cash equivalents............................. $ 3,467 $ 3,467
Securities held to maturity........................... 5,012 5,030
Residual asset........................................ 45,352 45,352
Loans held for sale................................... 289,268 295,346
Loans held for investment, net........................ 29,076 28,493
Mortgage servicing rights............................. 8,526 9,816
FHLB stock............................................ 1,067 1,067
Accrued Interest Receivable 2,638 2,638
Liabilities:
Deposit accounts...................................... 211,765 211,877
FHLB advances......................................... 9,000 9,000
Other borrowings...................................... 100,170 100,170
Subordinated debentures............................... 10,000 10,000
Accrued interest payable.............................. 1,493 1,493
Off-balance sheet unrealized gain on commitments........ ---- 2,702
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
97
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in the Period Ended December 31, 1998
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 Assets and Mortgage Servicing Rights--Fair values are estimated
using discounted cash flows based on current market values.
FHLB Stock--The fair value is based on its redemption value.
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.
FHLB Advances, 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, 1998
and 1997, 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, 1998 and 1997. 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.
98
16. Segment Information
The Company's operations within the financial services industry principally
focus on banking and mortgage financing activities. Information about these
segments as of or for the years ended December 31, 1998, 1997 and 1996 is as
follows (dollars in thousands):
1998
----------------------------------
Mortgage Mortgage Mortgage
---------- ---------- ----------
Financing Financing Financing
---------- ---------- ----------
Banking 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
1997
-------
Mortgage Mortgage Mortgage
--------- --------- ---------
Financing Financing Financing
--------- --------- ---------
Banking 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
1996
-------
Mortgage Mortgage Mortgage
--------- --------- ---------
Financing Financing Financing
--------- --------- ---------
Banking Portfolio Liberator Other Total
------- --------- --------- --------- --------
Revenue for the year........................................ $ 3,898 $ 1,728 $ 5,437 $ 2,333 $ 13,396
Interest income............................................. 3,049 706 2,220 953 6,928
Interest expense............................................ 863 528 1,662 712 3,766
Net income (loss) for the year.............................. 577 (187) (589) 147 (52)
Assets employed at year-end................................. 59,943 8,860 26,049 6,911 101,763
99
17. Earnings Per Share
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in the Period Ended December 31, 1998
A reconciliation of the numerators and denominators used in basic and diluted
EPS computations is as follows (in thousands, except per share data):
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
======= ===== ======
Per
---------
Income Shares 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
======= ===== ======
Per
---------
Income Shares share
---------- ------------ ---------
(numerator) (denominator) amount
---------- ------------ ---------
Year ended December 31, 1996
Net earnings (loss) applicable to earnings (loss) per share..... $ (52)
-------
Basic and diluted earnings (loss) per share--
Earnings (loss) available to common stockholders................ $ (52) 2,371 $(0.02)
======= ===== ======
100
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in the Period Ended December 31, 1998
18. Parent Company Financial Information
The following presents the unconsolidated financial statements of the parent
company only, LIFE Financial Corporation (Note 1) as of December 31 (in
thousands):
LIFE FINANCIAL CORPORATION (Parent company only)
1998 1997
--------- ---------
STATEMENTS OF FINANCIAL CONDITION
ASSETS:
Cash and cash equivalents........................................ $ 566 $ 933
Residual assets.................................................. 50,296 45,352
Investment in subsidiaries....................................... 27,315 21,552
Other assets..................................................... 4,109 1,938
------- -------
TOTAL ASSETS.................................................. $82,286 $69,775
======= =======
LIABILITIES:
Other borrowings................................................. $27,832 $15,537
Accounts payable and other liabilities........................... 2,456 3,352
------- -------
TOTAL LIABILITIES................................................ 30,288 18,889
------- -------
TOTAL STOCKHOLDERS' EQUITY....................................... 51,998 50,886
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY....................... $82,286 $69,775
======= =======
LIFE FINANCIAL CORPORATION (Parent company only)
1998 1997 1996
------------- --------- -----------
STATEMENTS OF OPERATIONS
INTEREST INCOME.............................................. $ 6,461 $ 185 $ --
INTEREST EXPENSE............................................. 2,440 80
-------- -------
Net interest income........................................ 4,021 105
NONINTEREST INCOME (LOSS).................................... (10,233) 14,088
NONINTEREST EXPENSE.......................................... 1,903 1,308
EQUITY IN NET EARNINGS (LOSS) OF SUBSIDIARIES................ 5,763 2,760 (52)
-------- ------- -----
EARNINGS (LOSS) BEFORE INCOME TAX EXPENSE.................... (2,352) 15,645 (52)
INCOME TAX EXPENSE (BENEFIT)................................. (3,411) 5,321
-------- -------
101
NET EARNINGS (LOSS).......................................... $ 1,059 $10,324 $ (52)
======== ======= =====
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in the Period Ended December 31, 1998
LIFE FINANCIAL CORPORATION (Parent company only)
SUMMARY STATEMENT OF CASH FLOWS
1998 1997 1996
-------------- -------------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)............................................................. $ 1,059 $ 10,324 $ (52)
Adjustments to reconcile net earnings (loss) to cash used in operating
activities:
Gain (loss) on sale and securitization of loans held for sale................. 10,616 (13,631)
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 assets.............................................. (6,984) (1,622)
Net unrealized loss (gain) on residual assets................................. 16,550 (448)
Increase in accounts payable and other liabilities............................ (896) 3,352
Increase in other assets...................................................... (2,171) (3,493)
Equity in net (earnings) loss of subsidiaries................................. (5,763) (2,760) 52
--------- --------- ----------
Net cash used in operating activities...................................... (12,715) (13,132)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of residual assets from the Bank....................................... (23,243)
Capital contributions to subsidiaries........................................... (11,075)
---------
Net cash used in investing activities...................................... (34,318)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from other borrowings.............................................. 12,295 15,537
Net proceeds from issuance of common stock...................................... 53 32,846
--------- ---------
Net cash provided by financing activities.................................. 12,348 48,383
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS....................................... 367 933
CASH AND CASH EQUIVALENTS, beginning of year.................................... 933
--------- --------- ----------
CASH AND CASH EQUIVALENTS, end of year.......................................... $ 566 $ 933 $ --
========= ========= ==========
102
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For Each of the Three Years in the Period Ended December 31, 1998
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)
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)
1997:
Interest income.......................... $2,282 $ 4,159 $ 5,663 $ 9,042
Interest expense......................... 1,561 2,460 3,080 5,729
Provision for estimated loan losses...... 500 - 400 950
Noninterest income....................... 1,975 2,363 8,651 14,241
Net earnings (loss)...................... (190) 917 3,880 5,717
Earnings (loss) per share:
Basic................................. (0.06) 0.28 0.59 0.87
Diluted............................... (0.06) 0.28 0.57 0.83
During the quarter ended December 31, 1998, the Company recorded net unrealized
losses on residual assets of $9.9 million.
Item 9. Change In and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
103
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 May , 1999, 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 May 1999, 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 May , 1999,
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 May , 1999, which will be filed
within 120 days after the end of the Registrant's fiscal year.
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*
104
21.0 Subsidiary information is incorporated herein by reference
to "Part I--Subsidiaries"
23.1 Consent of Deloitte & Touche LLP
27.0 Financial Data Schedule
(b) Reports on Form 8-K
None.
- --------------
* 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.
105
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/ Daniel L. Perl
By: Daniel L. Perl
President and Chief Executive Officer
DATED: APRIL 15, 1999
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/ Daniel L. Perl President and Chief Executive APRIL 15, 1999
- --------------------------- Officer (principal executive
Daniel L. Perl officer)
/s/ Jeffrey L. Blake Vice President and APRIL 15, 1999
- --------------------------- Chief Financial Officer
Jeffrey L. Blake (principal financial and
accounting officer)
/s/ Ronald G. Skipper Chairman of the Board APRIL 15, 1999
- ---------------------------
Ronald G. Skipper
/s/ John D. Goddard Director APRIL 15, 1999
- ---------------------------
John D. Goddard
/s/ Milton E. Johnson Director APRIL 15, 1999
- ---------------------------
Milton E. Johnson
/s/ Robert K. Riley Director APRIL 15, 1999
- ---------------------------
Robert K. Riley