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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from: _________________to ________________
Commission File No. 0-21341
OCWEN FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
FLORIDA 65-0039856
------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
THE FORUM, SUITE 1000
1675 PALM BEACH LAKES BOULEVARD
WEST PALM BEACH, FLORIDA 33401
------------------------ -----
(Address of principal executive office) (Zip Code)
(561) 682-8000
--------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE (NYSE)
(Title of each class) (Name of each exchange on
which registered)
Securities registered pursuant to Section 12 (g) of the Act: Not applicable.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Aggregate market value of the Common Stock, $.01 par value, held by
nonaffiliates of the registrant, computed by reference to the closing price as
reported on the NYSE as of the close of business on March 9, 1999: $262,679,977
million (for purposes of this calculation affiliates include only directors and
executive officers of the registrant).
Number of shares of Common Stock, $.01 par value, outstanding as of March 9,
1999: 60,800,357 shares
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Annual Report to
Shareholders for fiscal year ended December 31, 1998 are incorporated by
reference into Part II, Items 5-8.
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OCWEN FINANCIAL CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business..........................................................4
General.........................................................4
Segments........................................................5
Discount Loan Acquisition and Resolution Activities.............7
Investment in Unconsolidated Entities..........................12
Lending Activities.............................................13
Loan Servicing Activities......................................19
Asset Quality..................................................20
Investment Activities..........................................26
Sources of Funds...............................................35
Computer Systems and Use of Technology.........................39
Economic Conditions............................................40
Competition....................................................40
Subsidiaries...................................................40
Employees......................................................41
Regulation.....................................................41
The Company....................................................42
The Bank.......................................................43
Federal Taxation...............................................47
State Taxation.................................................47
Item 2. Properties.......................................................48
Offices........................................................48
Item 3. Legal Proceedings................................................48
Item 4. Submission of Matters to a Vote of Security Holders..............48
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters..................................48
Item 6. Selected Consolidated Financial Data.............................48
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................48
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.......49
Item 8. Financial Statements.............................................49
2
OCWEN FINANCIAL CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
(CONTINUED)
PAGE
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................49
PART III
Item 10. Directors and Executive Officers of Registrant....................49
Item 11. Executive Compensation............................................52
Item 12. Security Ownership of Certain Beneficial Owners and Management....55
Item 13. Certain Relationships and Related Transactions....................56
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K.......................................57
Signatures........................................................59
FORWARD-LOOKING STATEMENTS
IN THE NORMAL COURSE OF BUSINESS, THE COMPANY, IN AN EFFORT TO HELP
KEEP ITS SHAREHOLDERS AND THE PUBLIC INFORMED ABOUT THE COMPANY'S OPERATIONS,
MAY FROM TIME TO TIME ISSUE OR MAKE CERTAIN STATEMENTS, EITHER IN WRITING OR
ORALLY, THAT ARE OR CONTAIN FORWARD-LOOKING STATEMENTS, AS THAT TERM IS DEFINED
IN THE U.S. FEDERAL SECURITIES LAWS. GENERALLY, THESE STATEMENTS RELATE TO
BUSINESS PLANS OR STRATEGIES, PROJECTED OR ANTICIPATED BENEFITS FROM
ACQUISITIONS MADE BY OR TO BE MADE BY THE COMPANY, PROJECTIONS INVOLVING
ANTICIPATED REVENUES, EARNINGS, PROFITABILITY OR OTHER ASPECTS OF OPERATING
RESULTS OR OTHER FUTURE DEVELOPMENTS IN THE AFFAIRS OF THE COMPANY OR THE
INDUSTRY IN WHICH IT CONDUCTS BUSINESS. THESE FORWARD-LOOKING STATEMENTS, WHICH
ARE BASED ON VARIOUS ASSUMPTIONS (SOME OF WHICH ARE BEYOND THE COMPANY'S
CONTROL), MAY BE IDENTIFIED BY REFERENCE TO A FUTURE PERIOD OR PERIODS OR BY THE
USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "ANTICIPATE," "BELIEVE,"
"COMMITMENT," "CONSIDER," "CONTINUE," "COULD," "ENCOURAGE," "ESTIMATE,"
"EXPECT," "INTEND," "IN THE EVENT OF," "MAY," "PLAN," "PRESENT," "PROPOSE,"
"PROSPECT," "UPDATE," "WHETHER," "WILL," "WOULD," FUTURE OR CONDITIONAL VERB
TENSES, SIMILAR TERMS, VARIATIONS ON SUCH TERMS OR NEGATIVES OF SUCH TERMS.
ALTHOUGH THE COMPANY BELIEVES THE ANTICIPATED RESULTS OR OTHER EXPECTATIONS
REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON REASONABLE
ASSUMPTIONS, IT CAN GIVE NO ASSURANCE THAT THOSE RESULTS OR EXPECTATIONS WILL BE
ATTAINED. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE INDICATED IN SUCH
STATEMENTS DUE TO RISKS, UNCERTAINTIES AND CHANGES WITH RESPECT TO A VARIETY OF
FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED BELOW. THE COMPANY DOES
NOT UNDERTAKE, AND SPECIFICALLY DISCLAIMS ANY OBLIGATION, TO RELEASE PUBLICLY
THE RESULTS OF ANY REVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS
TO REFLECT THE OCCURRENCE OF ANTICIPATED OR UNANTICIPATED EVENTS OR
CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS.
3
PART I
ITEM 1. BUSINESS
General
Ocwen Financial Corporation ("OCN" or the "Company") is a specialty
financial services company which conducts business primarily through Ocwen
Federal Bank FSB (the "Bank"), a federally-chartered savings bank and a
wholly-owned subsidiary of the Company, and, to a lesser extent, through other
non-bank subsidiaries.
The Company is a Florida corporation which was organized in February
1988 in connection with its acquisition of the Bank. During the early 1990s, the
Company sought to take advantage of the general decline in asset quality of
financial institutions in many areas of the country and the large number of
failed savings institutions during this period by establishing its discounted
loan acquisition and resolution program. This program commenced with the
acquisition of discounted single-family residential loans for resolution in 1991
and was expanded to cover the acquisition and resolution of discounted
multi-family residential and commercial real estate loans in 1994.
During the early 1990s, the Company also acquired assets and
liabilities of three failed savings institutions and merged Berkeley Federal
Savings Bank ("Old Berkeley"), a troubled financial institution, into the Bank.
The Company subsequently sold substantially all of the assets and liabilities
acquired in connection with these acquisitions. The Company is a registered
savings and loan holding company subject to regulation by the Office of Thrift
Supervision (the "OTS"). The Bank is subject to regulation by the OTS, as its
chartering authority, and by the Federal Deposit Insurance Corporation ("FDIC"),
as a result of its membership in the Savings Association Insurance Fund
("SAIF"), which insures the Bank's deposits up to the maximum extent permitted
by law. The Bank is also subject to certain regulation by the Board of Governors
of the Federal Reserve System ("Federal Reserve Board") and currently is a
member of the Federal Home Loan Bank ("FHLB") of New York, one of the 12
regional banks which comprise the FHLB System.
The Company's strategy focuses on what it believes to be the current
trend toward the growth in the sale or outsourcing of servicing of nonperforming
and underperforming loans by financial institutions and government agencies,
particularly in the event that credit quality for a product line (such as
subprime mortgage loans) deteriorates. The Company's strategy also focuses on
leveraging its technology infrastructure and core expertise to expand its
activities into related business lines both for itself and on a fee basis for
others.
On November 6, 1997, the Company acquired AMOS, Inc. ("AMOS"), a
Connecticut-based company engaged primarily in the development of mortgage loan
servicing software. AMOS' products are Microsoft(R) Windows(R)-based, have
client/server architecture and feature real-time processing, are designed to be
year 2000 compliant, feature a scalable database platform and have strong
workflow capabilities. On January 20, 1998, the Company acquired DTS
Communications, Inc. ("DTS"), a real estate technology company located in San
Diego, California. DTS has developed technology tools to automate real estate
transactions. DTS has been recognized by Microsoft Corporation for the
Microsoft(R) component-based architecture to facilitate electronic data
interchange. Both AMOS and DTS are wholly-owned subsidiaries of Ocwen Technology
Xchange, Inc. ("OTX").
OTX's principal products are REALTrans(SM) and OTX(TM) Mortgage
Software Suite. REALTrans(SM) is a web-based application that facilitates the
electronics purchase of real estate products and services via the Internet.
Products currently supported include title insurance, appraisals, escrow, field
services, inspections, warranty, broker price opinions, and real property data.
This application allows users remote access to send, receive, and track
information from any location. The user is able to track the status of orders,
and send and receive messages, as well as documents. In addition, the
REALTrans(SM) application includes several forms that can be completed online,
thereby facilitating the sending of actual data, not just images of documents,
REALTrans(SM) provides data integrity because all data are backed up and stored
at a secure off-site facility. The Company is making its advanced loan
resolution technology, the OTX(TM) Mortgage Software Suite, available to third
parties through the marketing of software licenses. OTX also provides consulting
services related to its software and Internet products.
The Company entered the United Kingdom ("UK") subprime residential
mortgage market in 1998 through the acquisition of 36.07% of the total
outstanding common stock of Norland Capital Group plc, doing business as
Kensington Mortgage Company ("Kensington"), on February 25, 1998. Kensington is
a leading originator of subprime residential mortgages in the U.K. On April 24,
1998, the Company, through its wholly-owned subsidiary Ocwen UK plc ("Ocwen
UK"), acquired substantially all of the assets, and certain liabilities, of the
U.K. operations of Cityscape Financial Corp. ("Cityscape UK"). As consummated,
the Company acquired Cityscape UK's mortgage loan portfolio and its residential
subprime mortgage loan origination and servicing businesses.
4
The Company's domestic subprime residential lending activities are
conducted primarily through Ocwen Financial Services, Inc. ("OFS"), a 97.8%
owned subsidiary. OFS acquired both the subprime residential lending operations
previously conducted by the Bank and substantially all of the assets of Admiral
Home Loan ("Admiral"), the Company's primary correspondent mortgage banking firm
for subprime single-family residential loans, in a transaction which closed on
May 1, 1997.
On May 5, 1998, the Company, through its wholly-owned subsidiary,
Investor's Mortgage Insurance Holding Company ("IMI"), acquired 1,473,733
partnership units of Ocwen Partnership L.P. ("OPLP"), the operating subsidiary
partnerships of Ocwen Asset Investment Corp. ("OAC"). This purchase was in
addition to the 160,000 units owned at December 31, 1997, and the 175,000 units
acquired on February 17, 1998, for which the Company exchanged shares of OAC
stock, increasing the total number of units owned by IMI to 1,808,733 or 8.71%
of the total partnership units outstanding at December 31, 1998. OAC specializes
in the acquisition and management of real estate and mortgage assets and is
managed by Ocwen Capital Corporation ("OCC"), a wholly-owned subsidiary of OCN
formed in 1997. At December 31, 1998, the Company owned 1,540,000 or 8.12% of
the outstanding common stock of OAC.
SEGMENTS
The Company's primary business is the acquisition, servicing and
resolution of subperforming and nonperforming mortgage loans and the related
development of loan servicing technology and software for the mortgage and real
estate industries. Within its business, The Company's primary activities consist
of its single family residential and multi-family residential, small commercial
and large commercial discount loan acquisition and resolution activities,
servicing of residential and commercial mortgage loans for others, lending,
investments in a wide variety of mortgage-related securities and investments in
low-income housing tax credit interests.
Net Interest Net (Loss) Total
DECEMBER 31, 1998 Income Income Assets
----------- ----------- -----------
Discount loans: (Dollars in thousands)
Single family residential loans...................... $ 21,568 $ 14,394 $ 613,769
Large commercial real estate loans................... 35,220 28,103 591,612
Small commercial real estate loans................... 23,149 8,195 259,609
----------- ----------- -----------
79,937 50,692 1,464,990
----------- ----------- -----------
Mortgage loan servicing:
Domestic............................................. 6,604 8,066 56,302
Foreign (U.K.)....................................... 147 4,771 11,974
----------- ----------- -----------
6,751 12,837 68,276
----------- ----------- -----------
Investment in low-income housing tax credits............ (8,246) 9,119 220,234
Commercial real estate lending.......................... 16,066 13,588 74,439
OTX 5 (9,623) 21,659
Subprime single family residential lending:
Domestic............................................. 14,080 (20,524) 156,997
Foreign (U.K.)....................................... 11,898 7,475 286,224
----------- ----------- -----------
25,978 (13,049) 443,221
----------- ----------- -----------
Investment securities................................... (214) (59,186) 382,201
Equity investment in OAC................................ -- (8,701) 39,088
Other................................................... 2,524 3,123 593,971
----------- ----------- -----------
$ 122,801 $ (1,200) $ 3,308,079
=========== =========== ===========
5
Net Interest Net (Loss) Total
DECEMBER 31, 1997 Income Income Assets
---------- ---------- ----------
Discount loans: (Dollars in thousands)
Single family residential loans................ $ 24,870 $ 23,349 $ 844,146
Large commercial real estate loans............. 33,142 24,474 585,035
Small commercial real estate loans............. 19,257 5,349 308,543
---------- ---------- ----------
77,269 53,172 1,737,724
---------- ---------- ----------
Mortgage loan servicing:
Domestic....................................... 2,629 3,972 11,160
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
2,629 3,972 11,160
---------- ---------- ----------
Investment in low income housing tax credits..... (5,080) 9,087 168,748
Commercial real estate lending................... 25,794 12,405 230,682
OTX ............................................. (33) -- 5,116
Subprime single family residential lending:
Domestic....................................... 5,205 (2,166) 225,814
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
5,205 (2,166) 225,814
---------- ---------- ----------
Investment securities............................ 2,698 3,587 344,231
Equity investment in OAC......................... -- -- --
Other............................................ 7,760 (1,125) 345,690
------------- -------------- -------------
$ 116,242 $ 78,932 $ 3,069,165
============= ============= =============
6
Net Interest Net (Loss) Total
DECEMBER 31, 1996 Income Income Assets
---------- ---------- ----------
Discount loans: (Dollars in thousands)
Single family residential loans................ $ 12,122 $ 16,827 $ 650,261
Large commercial real estate loans............. 17,565 15,480 516,622
Small commercial real estate loans............. 14,851 1,398 283,466
---------- ---------- ----------
44,538 33,705 1,450,349
---------- ---------- ----------
Mortgage loan servicing:
Domestic....................................... 1,685 (2,558) 5,020
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
1,685 (2,558) 5,020
---------- ---------- ----------
Investment in low-income housing tax credits..... (4,962) 11,577 93,309
Commercial real estate lending................... 12,305 3,617 402,582
Subprime single family residential lending:
Domestic....................................... 4,486 3,131 128,878
Foreign (U.K.)................................. -- -- --
---------- ---------- ----------
4,486 3,131 128,878
---------- ---------- ----------
Investment securities............................ 8,632 987 342,801
Other............................................ 11,050 (317) 60,746
------------- ------------- -------------
$ 77,734 $ 50,142 $ 2,483,685
============= ============= =============
DISCOUNT LOAN ACQUISITION AND RESOLUTION ACTIVITIES
The Company believes that, under appropriate circumstances, the
acquisition of nonperforming and underperforming mortgage loans at discounts
offers significant opportunities to the Company. Discount loans generally have
collateral coverage which is sufficiently in excess of the purchase price of the
loan, such that successful resolutions can produce total returns which are in
excess of an equivalent investment in performing mortgage loans.
The Company began its discount loan operations in 1991 and initially
focused on the acquisition of single family residential loans. In 1994 the
Company expanded this business to include the acquisition and resolution of
discount multi-family residential and commercial real estate loans (together,
unless the context otherwise requires, "commercial real estate loans"). Prior to
entering the discount loan business, management of the Company had substantial
loan resolution experience through former subsidiaries of the Company which had
been engaged in the business of providing private mortgage insurance for
residential loans. This experience assisted the Company in developing the
procedures, facilities and systems to evaluate and acquire discount loans and to
resolve such loans in a timely and profitable manner. Management of the Company
believes that the resources utilized by the Company in connection with the
acquisition, servicing and resolution of discount real estate loans, which
include proprietary technology and software, allow the Company to effectively
manage an extremely data-intensive business and that, as discussed below, these
resources have applications in other areas. See "Business-Computer Systems and
Use of Technology."
COMPOSITION OF THE DISCOUNT LOAN PORTFOLIO. At December 31, 1998, the
Company's net discount loan portfolio amounted to $1.03 billion or 31% of the
Company's total assets. Substantially all of the Company's discount loan
portfolio is secured by first mortgage liens on real estate.
7
The following table sets forth the composition of the Company's
discount loan portfolio by type of loan at the dates indicated:
December 31,
----------------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------- ------------
(Dollars in Thousands)
Single family residential loans $ 597,100 $ 900,817 $ 504,049 $ 376,501 $ 382,165
Multi-family residential loans 244,172 191,302 341,796 176,259 300,220
Commercial real estate loans(1) 449,010 701,035 465,801 388,566 102,138
Other loans................... 10,144 1,865 2,753 2,203 911
------------ ------------ ------------ ------------- ------------
Total discount loans........ 1,300,426 1,795,019 1,314,399 943,529 785,434
Unaccreted discount (2)....... (252,513) (337,350) (241,908) (273,758) (255,974)
Allowance for loan losses..... (21,402) (23,493) (11,538) -- --
------------ ------------ ------------ ------------ ------------
Discount loans, net........... $ 1,026,511 $ 1,434,176 $ 1,060,953 $ 669,771 $ 529,460
============ ============ ============ ============ ============
(1) The balance at December 31, 1998 consisted of $154.1 million of loans
secured by office buildings, $100.4 million of loans secured by hotels,
$21.2 million of loans secured by retail properties or shopping centers
and $173.3 million of loans secured by other properties. The balance at
December 31, 1997 consisted of $363.7 million of loans secured by
office buildings, $98.9 million of loans secured by hotels, $106.8
million of loans secured by retail properties or shopping centers and
$131.6 million of loans secured by other properties. The balance at
December 31, 1996 consisted of $202.1 million of loans secured by
office buildings, $46.0 million of loans secured by hotels, $138.6
million of loans secured by retail properties or shopping centers and
$79.1 million of loans secured by other properties.
(2) The balance at December 31, 1998 consisted of $161.6 million on single
family residential loans, $20.8 million on multi family residential
loans, $69.8 million on commercial real estate loans and $0.3 million
on other loans respectively. The balance at December 31, 1997 consisted
of $170.7 million on single family residential loans, $46.0 million on
multi-family residential loans, $120.5 million on commercial real
estate loans and $0.2 million on other loans, respectively. The balance
at December 31, 1996 consisted of $92.2 million on single family
residential loans, $71.8 million on multi-family residential loans,
$77.6 million on commercial real estate loans and $0.3 million on other
loans, respectively.
The properties which secure the Company's discount loans are located
throughout the United States. At December 31, 1998, the five states with the
greatest concentration of properties securing the Company's discount loans were
California, New York, Illinois, Michigan and New Jersey, which had $211.5
million, $144.0 million, $111.2 million, $104.8 million and $84.4 million
principal amount of discount loans (before unaccreted discount), respectively.
The Company believes that the relatively dispersed geographic distribution of
its discount loan portfolio can reduce the risks associated with concentrating
such loans in limited geographic areas, and that, due to its expertise,
technology and software, and procedures, the geographic distribution of its
discount loan portfolio does not place significantly greater burdens on the
Company's ability to resolve such loans.
Discount loans may have net book values up to the Bank's
loan-to-one-borrower limitation. See "Business Regulation-The Bank-Loan-to-One-
Borrower."
ACQUISITION OF DISCOUNT LOANS. In early years, the Company acquired
discount loans from the FDIC and the Resolution Trust Corporation ("RTC")
primarily in auctions of pools of loans acquired by them from the large number
of financial institutions which failed during the late 1980s and early 1990s.
Although the RTC no longer is in existence and the banking and thrift industries
have recovered from the problems experienced in the late 1980s and early 1990s,
governmental agencies, particularly the Department of Housing and Urban
Development ("HUD"), continue to be potential sources of discount loans. The
Company obtains a substantial amount of discount loans from various private
sector sellers, such as banks, savings institutions, mortgage companies,
subprime lenders and insurance companies. At December 31, 1998, approximately
74% of the loans in the Company's discount loan portfolio had been acquired from
the private sector, as compared to 58% at December 31, 1997, 77% at December 31,
1996, and 90% at December 31, 1995.
Overall, the percentage of discount loans in the Company's discount
loan portfolio acquired from private sector sellers has decreased since 1995 as
a result of the Company's acquisition of a substantial amount of discount loans
from HUD. During the year ended December 31, 1997, the Company and a co-investor
were the successful bidder to purchase from HUD 24,773 single family residential
loans with an aggregate unpaid principal balance of $1.55 billion and a purchase
price of $1.34 billion. The Company acquired $771.6 million of these loans and
the right to service all of such loans. In 1996, the Company and a co-investor
were the successful bidder to purchase from HUD 4,591 single family residential
loans with an aggregate unpaid principal balance of $258.1 million and a
purchase price of $204.0 million. The Company acquired $112.2 million of these
loans and the right to service all of such loans. In 1996, the Company also
acquired from HUD discount multi-family residential loans with an unpaid
principal balance of
8
$225.0 million. The foregoing acquisitions were in addition to the acquisition
of $741.2 million gross principal amount of single family residential loans from
HUD by BCBF, LLC (the "LLC"), a limited liability company formed in March 1996
by the Bank and BlackRock Capital Finance L.P. ("BlackRock"). See "Investment in
Unconsolidated Entities - Investment in Joint Ventures."
Since 1996, the Company has acquired over $2.04 billion of single
family residential loans and $1.96 billion of distressed commercial and
multi-family residential loans from the private sector and government agencies,
making it the largest purchaser of such assets in the United States. In 1998,
the Company acquired $1.1 billion of unpaid principal balance of discount loans,
of which $0.6 billion were residential loans with the balance being commercial.
HUD loans are acquired by HUD pursuant to various assignment programs
of the Federal Housing Administration ("FHA"). Under programs of the FHA, a
lending institution may assign an FHA-insured loan to HUD because of an economic
hardship on the part of the borrower which precludes the borrower from making
the scheduled principal and interest payment on the loan. FHA-insured loans also
are automatically assigned to HUD upon the 20th anniversary of the mortgage
loan. In most cases, loans assigned to HUD after this 20-year period are
performing under the original terms of the loan. Once a loan is assigned to HUD,
the FHA insurance has been paid and the loan is no longer insured. As a result,
none of the HUD loans are insured by the FHA.
A majority of the $771.6 million of loans acquired by the Company from
HUD during the year ended December 31, 1997 are subject to forbearance
agreements after the servicing transfer date. During the forbearance period,
borrowers are required to make a monthly payment which is based on their ability
to pay and which may be less than the contractual monthly payment. Once the
forbearance period is over, the borrower is required to make at least the
contractual payment regardless of ability to pay. Virtually all of the foregoing
loans acquired from HUD reached the end of the forbearance period by the end of
1998. Prior purchases of loans from HUD by the Company (and the LLC) primarily
included loans that were beyond the forbearance period.
Discount real estate loans generally are acquired in pools, although
discount commercial real estate loans may be acquired individually. These pools
generally are acquired in auctions or competitive bid circumstances in which the
Company faces substantial competition. Although many of the Company's
competitors have access to greater capital and have other advantages, the
Company believes that it has a competitive advantage relative to many of its
competitors as a result of its experience in managing and resolving discount
loans, its large investment in the computer systems, technology and other
resources which are necessary to conduct its business, its national reputation
and the strategic relationships and contacts which it has developed in
connection with these activities.
The Company generally acquires discount loans solely for its own
portfolio. From time to time, however, the Company and one or more co-investors
may submit a joint bid to acquire a pool of discount loans in order to enhance
the prospects of submitting a successful bid. If successful, the Company and the
co-investors generally allocate ownership of the acquired loans in an agreed
upon manner, although in certain instances the Company and the co-investor may
continue to have a joint interest in the acquired loans. In addition, from time
to time the Company and a co-investor may acquire discount loans through a joint
venture. See "Investment in Unconsolidated Entities - Investment in Joint
Ventures."
Prior to making an offer to purchase a portfolio of discount loans, the
Company conducts an extensive investigation and evaluation of the loans in the
portfolio. Evaluations of potential discount loans are conducted primarily by
the Company's employees who specialize in the analysis of nonperforming loans,
often with further specialization based on geographic or collateral-specific
factors. The Company's employees regularly use third parties, such as brokers,
who are familiar with a property's type and location, to assist them in
conducting an evaluation of the value of a collateral property, and depending on
the circumstances, particularly in the case of commercial real estate loans, may
use subcontractors, such as local counsel and engineering and environmental
experts, to assist in the evaluation and verification of information and the
gathering of other information not previously made available by a potential
seller.
The Company determines the amount to be offered to acquire potential
discount loans by using a proprietary modeling system and loan information
database which focuses on the anticipated recovery amount and the timing and
cost of the resolution of the loans. The amount offered by the Company generally
is at a discount from both the stated value of the loan and the value of the
underlying collateral which the Company estimates is sufficient to generate an
acceptable return on its investment.
RESOLUTION OF DISCOUNT LOANS. After a discount loan is acquired, the
Company utilizes its information technology software systems to resolve the loan
as expeditiously as possible in accordance with specified procedures. The
various resolution alternatives generally include the following: (i) the
borrower brings the loan current in accordance with original or modified terms,
(ii) the borrower repays the loan or a negotiated amount of the loan, (iii) the
borrower
9
agrees to deed the property to the Company in lieu of foreclosure, in which case
it is classified as real estate owned and held for sale by the Company, or (iv)
the Company forecloses on the loan and the property is acquired at the
foreclosure sale either by a third party or by the Company, in which case it is
classified as real estate owned and held for sale by the Company. In addition,
in the case of single family residential loans, assistance is provided to
borrowers in the form of forbearance agreements under which the borrower either
makes a monthly payment less than or equal to the original monthly payment or
makes a monthly payment more than the contractual monthly payment to make up for
arrearages.
In appropriate cases, the Company works with borrowers to resolve the
loan in advance of foreclosure. One method is through forbearance agreements,
which generally allow the borrower to pay the contractual monthly payment plus a
portion of the arrearage each month, and other means. Although this strategy may
result in an initial reduction in the yield on a discounted loan, the Company
believes that it is advantageous because it (i) generally results in a higher
resolution value than foreclosure; (ii) reduces the amount of real estate owned
acquired by foreclosure or by deed-in-lieu thereof and related risks, costs and
expenses; (iii) enhances the ability of the Company to sell the loan in the
secondary market, either on a whole loan basis or through securitizations (in
which case the Company may continue to earn fee income from servicing such
loans); and (iv) permits the borrower to retain ownership of the home and, thus,
enhances relations between the Company and the borrower. As a result of the
Company's current loan resolution strategy of emphasizing forbearance agreements
and other resolutions in advance of foreclosure, the Company has been able to
resolve 72% of its residential discount loans before foreclosure, as compared to
a 23% industry average.
The general goal of the Company's asset resolution process is to
maximize, in a timely manner, cash recovery on each loan in the discount loan
portfolio. The Company generally anticipates a longer period (approximately 12
to 30 months) to resolve discount commercial real estate loans than discount
single family residential loans because of their complexity and the wide variety
of issues that may occur in connection with the resolution of such loans.
The Credit Committee of the Board of Directors of the Bank actively
monitors the asset resolution process to identify discount loans which have
exceeded their expected foreclosure period and real estate owned which has been
held longer than anticipated. Plans of action are developed for each of these
assets to remedy the cause for delay and are reviewed by the Credit Committee.
SALE OF DISCOUNT LOANS. From time to time the Company sells performing
discount loans either on a whole loan basis or indirectly through the
securitization of such loans and sale of the mortgage-related securities backed
by them. During the years ended December 31, 1998, 1997 and 1996, the Company
sold $696.1 million, $518.9 million and $230.2 million of discount loans,
respectively, which resulted in gains of $63.5 million, $60.4 million and $15.3
million, respectively, including net securitization gains of $48.1 million,
$53.1 million and $7.9, respectively. Also, during 1997 the LLC, as part of
larger transactions involving the Company and an affiliate of Black Rock,
completed the securitizations of 1,730 discount single family residential loans
acquired from HUD in 1996 and 1995, with an unpaid principal balance of $78.4
million and past due interest of $22.5 million, which resulted in the Company
recognizing indirect gains of $14.0 million as a result of the Company's pro
rata interest in the LLC.
The following table sets forth certain information related to the
Company's securitization of discount loans during 1998, 1997 and 1996.
Loan Securitized
- - --------------------------------------------------------------------------- Book Value of
Types of Loans Principal No. of Loans Securities Retained(1) Net Gain
- - ---------------------------------- -------------- ------------- --------------------- -------------
1998: (Dollars in thousands)
Single family discount............ $ 498,798 7,638 $ 32,261 $ 48,085
============== ============= ================ =============
1997:
Single family discount............ $ 418,795 6,295 $ 20,635 $ 51,137
Small commercial discount......... 62,733 302 4,134 1,994
-------------- ------------- ---------------- -------------
$ 481,528 6,597 $ 24,769 $ 53,131
============== ============= ================ =============
1996:
Large commercial discount......... $ 164,417 25 $ 8,384 $ 7,929
============== ============= ================ =============
(1) Consists of subordinated and/or residual securities resulting from the
Company's securitization activities, which had a fair value of $71.5
million at December 31, 1998.
10
ACTIVITY IN THE DISCOUNT LOAN PORTFOLIO. The following table sets forth
the activity in the Company's gross discount loan portfolio during the periods
indicated:
Year Ended December 31,
--------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------- -------------------- -------------------- -------------------- --------------------
No. of No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
----------- -------- ----------- -------- ----------- -------- ----------- -------- ----------- --------
(Dollars in Thousands)
Balance at beginning
of period ........... $ 1,795,019 12,980 $ 1,314,399 5,460 $ 943,529 4,543 $ 785,434 3,894 $ 433,516 5,160
Acquisitions(1) ...... 1,123,727 8,084 1,776,773 17,703 1,110,887 4,812 791,195 2,972 826,391 2,781
Resolutions and
repayments(2) ....... (539,353) (1,918) (484,869) (1,978) (371,228) (2,355) (300,161) (960) (265,292) (2,153)
Loans transferred to
real estate owned .. (382,904) (3,193) (292,412) (1,596) (138,543) (860) (281,344) (984) (171,300) (1,477)
Sales ................ (696,063) (7,853) (518,872) (6,609) (230,246) (680) (51,595) (379) (37,881) (417)
----------- -------- ----------- -------- ----------- -------- ----------- -------- ----------- --------
Balance at
end of period....... $ 1,300,426 8,100 $ 1,795,019 12,980 $ 1,314,399 5,460 $ 943,529 4,543 $ 785,434 3,894
=========== ======== =========== ======== =========== ======== =========== ======== =========== ========
(1) In 1998, acquisitions consisted of $613.2 million of single family
residential loans, $231.1 million multifamily residential loans, $264.7
million of commercial real estate loans and $14.7 million of consumer
loans. In 1997, acquisitions consisted of $1.06 billion of single
family residential loans, $57.7 million of multi-family residential
loans and $657.0 million of commercial real estate loans. In 1996,
acquisitions consisted of $365.4 million of single family residential
loans, $310.4 million of multi-family residential loans, $433.5 million
of commercial real estate loans and $1.5 million of other loans. The
1996 data does not include the Company's pro rata share of the $741.2
million of discount loans acquired by the LLC. 1995, acquisitions
consisted of $272.8 million of single family residential loans, $141.2
million of multi-family residential loans, $374.9 million of commercial
real estate loans and $2.3 million of other loans. In 1994,
acquisitions consisted of $395.8 million of single family residential
loans, $315.5 million of multi-family residential loans and $115.1
million of commercial real estate loans.
(2) Resolutions and repayments consists of loans which were resolved in a
manner which resulted in partial or full repayment of the loan to the
Company, as well as principal payments on loans which have been brought
current in accordance with their original or modified terms (whether
pursuant to forbearance agreements or otherwise) or on other loans
which have not been resolved.
For information relating to the activity in the Company's real estate
owned which is attributable to the Company's discount loan acquisitions, see
"Asset Quality - Real Estate Owned."
PAYMENT STATUS OF DISCOUNT LOANS. The following table sets forth
certain information relating to the payment status of loans in the Company's
discount loan portfolio at the dates indicated.
December 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
Loan status:
Current ........................................ $ 579,449 $ 673,255 $ 579,597 $ 351,630 $ 113,794
Past due 31 days to 89 days .................... 39,601 22,786 22,161 86,838 57,023
Past due 90 days or more (1) ................... 624,328 1,070,925 563,077 385,112 413,506
Acquired and servicing not
yet transferred ............................... 57,048 28,053 149,564 119,949 201,111
----------- ----------- ----------- ----------- -----------
1,300,426 1,795,019 1,314,399 943,529 785,434
Unaccreted discount ............................ (252,513) (337,350) (241,908) (273,758) (255,974)
Allowance for loan losses ...................... (21,402) (23,493) (11,538) -- --
----------- ----------- ----------- ----------- -----------
$ 1,026,511 $ 1,434,176 $ 1,060,953 $ 669,771 $ 529,460
=========== =========== =========== =========== ===========
(1) Includes $110.1 million, $432.6 million and $57.0 million of loans with
forbearance agreements at December 31, 1998, 1997 and 1996,
respectively, and $522.0 billion, $638.3 million and $506.1 million of
loans without forbearance agreements at December 31, 1998, 1997 and
1996, respectively. Of the $110.1 million of loans with forbearance
agreements past due 90 days or more in accordance with original terms,
$77.9 million were current and $32.2 million were past due 31 to 89
days under the terms of the forbearance agreements.
11
ACCOUNTING FOR DISCOUNT LOANS. The acquisition cost for a pool of
discount loans is allocated to each individual loan within the pool based upon
relative fair value using the Company's pricing methodology. Prior to January 1,
1997, the discount associated with all single family residential loans was
recognized as a yield adjustment and was accreted into interest income using the
interest method applied on a loan-by-loan basis once foreclosure proceedings
were initiated, to the extent the timing and amount of cash flows could be
reasonably determined. Effective January 1, 1997, the Company ceased accretion
of discount on its nonperforming single family residential loans. The discount
which is associated with a single family residential loan and certain
multi-family residential and commercial real estate loans which are current or
subsequently brought current by the borrower in accordance with the loan terms
is accreted into the Company's interest income as a yield adjustment using the
interest method over the contractual maturity of the loan. For all other loans
interest is earned as cash is received.
Gains on the repayment and discharge of loans are recorded in interest
income on discount loans. Upon receipt of title to property securing a discount
loan, the loans are transferred to real estate owned.
Beginning in 1996, adjustments to reduce the carrying value of discount
loans to the fair value of the property securing the loan are charged against
the allowance for loan losses on the discount loan portfolio. Prior to 1996,
such adjustments were charged against interest income on discount loans.
INVESTMENT IN UNCONSOLIDATED ENTITIES
INVESTMENT IN OAC. At December 31, 1997, the Company, through IMI,
owned 1,715,000 shares or 9.04% of the outstanding common stock of OAC. Also at
December 31, 1997, the Company, through IMI, owned 160,000 units or 0.84% of the
partnership units of OPLP. On February 17, 1998, IMI exchanged 175,000 shares of
OAC stock for 175,000 OPLP units. On May 5, 1998, IMI acquired an additional
1,473,733 OPLP units. As a result of this activity, IMI's investment in OAC
stock declined to 1,540,000 shares or 8.12% at December 31, 1998, while its
investment in OPLP increased to 1,808,733 units or 8.71%. The Company began
accounting for these entities on the equity method effective May 5, 1998, upon
the increase in its combined ownership of OAC and OPLP to 16.83%. The Company's
investment in OAC stock amounted to $16.3 million at December 31, 1998. The
Company's investment in OAC stock at December 31, 1997, was designated as
available for sale and carried at a fair value of $35.2 million ($25.5 million
cost). The Company's investment in OPLP units amounted to $22.8 million at
December 31, 1998, as compared to $2.4 million at December 31, 1997. During
1998, the Company recorded equity in the losses of its investment in OAC and
OPLP of $4.0 million and $4.7 million, respectively.
INVESTMENT IN KENSINGTON. The Company's investment in unconsolidated
entities includes its 36.07% ownership interest in Kensington, which amounted to
$46.6 million at December 31, 1998, net of the excess of the purchase price over
the net investment. The excess of the purchase price over the net investment
amounted to $34.5 million ((pound)20.9million) at December 31, 1998, net of
accumulated amortization of $2.0 million ((pound)1.2 million), and is amortized
over a period of 15 years. During 1998, the Company recorded equity in earnings
of Kensington of $439,000, net of the $2.0 million of amortization of excess
cost over purchase price.
INVESTMENT IN JOINT VENTURES. From time to time, the Company and a
co-investor have acquired discount loans by means of a co-owned joint venture.
At December 31, 1998, the Company's $1.1 million investment in joint venture,
consisted of a 10% interest in BCFL, L.L.C. ("BCFL"), a limited liability
company which was formed by the Company and BlackRock in January 1997 to acquire
discount multi-family residential loans. On December 12, 1997, the LLC, a
limited liability company formed in March 1996 between the Company and
BlackRock, distributed all of its assets to the Company and its other 50%
investor, BlackRock. Simultaneously, the Company acquired BlackRock's portion of
the distributed assets. The Company recorded equity in earnings of the LLC of
$23.7 million and $38.3 million for 1997 and 1996, respectively.
ACQUISITION OF HUD LOANS BY THE LLC. In April 1996, the LLC purchased
16,196 single family residential loans offered by HUD at an auction. Many of the
loans, which had an aggregate unpaid principal balance of $741.2 million at the
date of acquisition, were not performing in accordance with their original terms
or an applicable forbearance agreement. The aggregate purchase price paid to HUD
amounted to $626.4 million. All of the HUD loans acquired by the LLC were
secured by first mortgage liens on single family residences.
In connection with the acquisition, the Company entered into an
agreement with the LLC to service the HUD loans in accordance with its loan
servicing and loan default resolution procedures. In return for such servicing,
the Company received specific fees which were payable on a monthly basis. The
Company did not pay any additional amount to acquire these servicing rights, and
as a result, the acquisition of the right to service the HUD loans held by the
LLC did not result in the Company's recording capitalized mortgage servicing
rights for financial reporting purposes.
12
SECURITIZATION OF THE HUD LOANS BY THE LLC. During 1997, the LLC, as
part of larger transactions involving the Company and an affiliate of BlackRock,
completed securitizations of 1,730 HUD loans held by it with an unpaid principal
balance of $78.4 million, past due interest of $22.5 million and a net book
value of $60.6 million; and during 1996, the LLC completed a securitization of
9,825 HUD loans with an aggregate unpaid principal balance of $419.4 million,
past due interest of $86.1 million and a net book value of $394.2 million. The
LLC recognized gains of $14.0 million and $69.8 million (including a gain of
$12.9 million on the sale in 1996 of $79.4 million of securities to the Company)
from the sale of the senior classes in the residuals formed for purposes of
these transactions in the years ended December 31, 1997 and 1996, respectively,
of which $7.0 million and $34.9 million, respectively, were allocable to the
Company as a result of its pro rata interest in the LLC and included in
losses/equity in earnings of investment in unconsolidated entities.
ACCOUNTING FOR INVESTMENTS IN UNCONSOLIDATED ENTITIES. The Company's
investment in unconsolidated entities are accounted for under the equity method
of accounting. Under the equity method of accounting, an investment in the
shares or other interests of an investee is initially recorded at the cost of
the shares or interests acquired and thereafter is periodically increased
(decreased) by the investor's proportionate share of the earnings (losses) of
the investee and decreased by all dividends received by the investor from the
investee.
LENDING ACTIVITIES
COMPOSITION OF LOAN PORTFOLIO. At December 31, 1998, the Company's net
loan portfolio amounted to $230.3 million or 7% of the Company's total assets.
Loans held for investment in the Company's loan portfolio are carried at
amortized cost, less an allowance for loan losses, because the Company has the
ability and presently intends to hold them to maturity.
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
December 31,
-------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in Thousands)
Single family residential loans ...... $ 30,361 $ 46,226 $ 73,186 $ 75,928 $ 31,926
Multi-family residential loans (1) ... 75,599 71,382 67,842 49,047 1,800
Commercial real estate and land loans:
Hotels (2) (3) .................. 36,631 89,362 200,311 125,791 19,659
Office buildings (4) ............ 93,068 68,759 128,782 61,262 --
Land ............................ 2,266 2,858 2,332 24,904 1,315
Other ........................... 6,762 16,094 25,623 2,494 4,936
--------- --------- --------- --------- ---------
Total .......................... 138,727 177,073 357,048 214,451 25,910
Commercial non-mortgage .............. -- -- 2,614 -- --
Consumer ............................. 132 244 424 3,223 1,558
--------- --------- --------- --------- ---------
Total loans ..................... 244,819 294,925 501,114 342,649 61,194
Undisbursed loan proceeds ............ (7,099) (22,210) (89,840) (39,721) --
Unaccreted discount .................. (2,480) (2,721) (5,169) (5,376) (3,078)
Allowance for loan losses ............ (4,928) (3,695) (3,523) (1,947) (1,071)
--------- --------- --------- --------- ---------
Loans, net ...................... $ 230,312 $ 266,299 $ 402,582 $ 295,605 $ 57,045
========= ========= ========= ========= =========
(1) At December 31, 1998, 1997, 1996 and 1995, multi-family residential
loans included $22.3 million, $33.3 million and $36.6 million, and $7.7
million of construction loans, respectively.
(2) At December 31, 1998, 1997 and 1996, hotel loans included $6.9 million,
$25.3 million and $26.4 million of construction loans, respectively.
(3) During 1998 and 1997, payoffs of loans secured by hotels totaled $16.6
million and $80.5 million, respectively.
(4) During 1998 and 1997, payoffs of loans secured by office buildings
totaled $186.5 million and $107.3 million, respectively.
The Company's lending activities are conducted on a nationwide basis,
and as a result, the properties which secure its loan portfolio are located
throughout the United States. At December 31, 1998, the five states in which the
largest amount of properties securing loans in the Company's loan portfolio were
New York, New Jersey, Florida, Texas and California, which had $52.3 million,
$29.8 million, $27.9 million, $12.2 million and $11.2 million of principal
amount of loans, respectively.
13
CONTRACTUAL PRINCIPAL REPAYMENTS. The following table sets forth
certain information at December 31, 1998 regarding the dollar amount of loans
maturing in the Company's loan portfolio based on scheduled contractual
amortization, as well as the dollar amount of loans which have fixed or
adjustable interest rates. Demand loans (loans having no stated schedule of
repayments and no stated maturity) and overdrafts are reported as due in one
year or less. Loan balances have not been reduced for (i) undisbursed loan
proceeds, unearned discounts and the allowance for loan losses or (ii)
nonperforming loans.
Maturing in
After After Five
One Year Years
One Through Five Through Ten After Ten
Year or Less Years Years Years Total
------------- ------------ ------------ ------------ ------------
(Dollars in Thousands)
Single family residential loans....... $ 1,047 $ 794 $ 9,179 $ 19,341 $ 30,361
Multi-family residential loans........ 23,800 37,771 6,346 7,682 75,599
Commercial real estate and land loans. 35,517 96,183 7,027 -- 138,727
Consumer and other loans.............. 11 121 -- -- 132
------------ ------------ ------------ ------------ ------------
Total.............................. $ 60,375 $ 134,869 $ 22,552 $ 27,023 $ 244,819
============ ============ ============ ============ ============
Interest rate terms on amounts due:
Fixed.............................. $ 25,091 $ 17,488 $ 2,065 $ 12,485 $ 57,129
Adjustable......................... 35,284 117,381 20,487 14,538 187,690
------------ ------------ ------------ ------------ ------------
$ 60,375 $ 134,869 $ 22,552 $ 27,023 $ 244,819
============ ============ ============ ============ ============
Scheduled contractual principal repayments may not reflect the actual
maturities of loans because of prepayments and, in the case of conventional
mortgage loans, due-on-sale clauses. The average life of mortgage loans,
particularly fixed-rate loans, tends to increase when current mortgage loan
rates are substantially higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgages are substantially higher
than current mortgage loan rates.
ACTIVITY IN THE LOAN PORTFOLIO. The following table sets forth the
activity in the Company's loan portfolio during the periods indicated.
Year Ended December 31,
----------------------------------------------
1998 1997 1996
----------- ----------- -----------
(Dollars in Thousands)
Balance at beginning of period....................... $ 294,925 $ 501,114 $ 342,649
Originations:
Single family residential loans................... -- 1,987 10,681
Multi-family residential loans.................... 56,657 16,799 68,076
Commercial real estate loans...................... 116,452 69,948 199,017
Commercial non-mortgage and consumer loans........ -- 1,140 3,366
----------- ----------- -----------
Total loans originated......................... 173,109 89,874 281,140
----------- ----------- -----------
Purchases:
Single family residential loans................... -- 78 305
----------- ----------- -----------
Total loans purchased.......................... -- 78 305
----------- ----------- -----------
Sales ............................................... -- (2,346) --
Loans transferred from available for sale............ -- 13,782 45
Principal repayments................................. (222,668) (306,916) (121,818)
Transfer to real estate owned........................ (547) (661) (1,207)
------------ ----------- -----------
Net increase (decrease) in net loans................. (50,106) (206,189) 158,465
------------ ----------- -----------
Balance at end of period............................. $ 244,819 $ 294,925 $ 501,114
=========== =========== ===========
LOANS AVAILABLE FOR SALE. In addition to loans acquired for investment,
the Company also originates and purchases loans which it presently does not
intend to hold to maturity. Such loans are designated as loans available for
sale upon origination or purchase and generally are carried at the lower of cost
or aggregate market value. At December 31, 1998, loans available for sale
amounted to $177.8 million or 5% of the Company's total assets.
14
The following table sets forth the composition of the Company's loans
available for sale by type of loan at the dates indicated.
December 31,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
Single family residential loans...... $ 177,578 $ 176,554 $ 111,980 $ 221,927 $ 16,825
Multi-family residential loans....... -- -- 13,657 28,694 83,845
Consumer loans....................... 269 487 729 1,169 1,623
----------- ----------- ----------- ----------- -----------
$ 177,847 $ 177,041 $ 126,366 $ 251,790 $ 102,293
=========== =========== =========== =========== ===========
At December 31, 1998, the five states or countries in which the largest
amount of properties securing the Company's loans available for sale were the
U.K., California, New Jersey, Florida and Illinois which had $87.6 million,
$21.0 million, $10.8 million, $10.6 million and $7.5 million of principal amount
of loans, respectively.
Since late 1994, the Company's lending activities have included the
origination and purchase of single family residential loans to borrowers who
because of prior credit problems, the absence of a credit history or other
factors are unable or unwilling to qualify as borrowers for a single family
residential loan under guidelines of the Federal National Mortgage Association
("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC") ("conforming
loans") and who have substantial equity in the properties which secure the
loans. Loans to non-conforming borrowers are perceived by the Company as being
advantageous because they generally have higher interest rates and origination
and servicing fees and generally lower loan-to-value ratios than conforming
loans and because the Company's expertise in the servicing and resolution of
nonperforming loans can be utilized in underwriting such loans, as well as to
address loans acquired pursuant to this program which become nonperforming after
acquisition.
Through 1996, the Company acquired subprime single family residential
loans primarily through a correspondent relationship with Admiral and, to a
lesser extent, correspondent relationships with three other financial services
companies. Correspondent institutions originate loans based on guidelines
provided by the Company and promptly sell the loans to the Company on a
servicing-released basis.
In order to solidify and expand its sources of domestic subprime single
family residential loans, the Company, through OFS, acquired substantially all
of the assets of Admiral in a transaction which closed on May 1, 1997. See
"Business-Subsidiaries." In connection with the Company's acquisition of assets
from Admiral, the Bank transferred its retail and wholesale subprime single
family residential lending operations to OFS, which included, among other
things, transferring its rights under contracts with brokers and correspondent
lending institutions and its rights and obligations under leases to six loan
production offices recently opened by it, which are located in California,
Illinois, Massachusetts, Oregon and Utah.
The principal sources of funds of OFS consist of lines of credit with
unaffiliated parties of (i) a $200.0 million secured of credit, of which $100.0
million was committed, (ii) a $50.0 million secured line of credit, all of which
was committed, (iii) a $200.0 million secured line of credit, of which $100.0
million ws committed (iv) a $100.0 million secure line of credit, none of which
was committed (v) a $20.0 million secured residual line of credit, none of which
was committed and are secured by the mortgage loans acquired with such lines and
(vi) a $30.0 million unsecured, subordinated credit facility provided by the
Company to OFS at the time of the acquisition of substantially all of the assets
of Admiral. The Company has adopted policies that set forth the specific lending
requirements of the Company as they relate to the processing, underwriting,
property appraisal, closing, funding and delivery of subprime loans. These
policies include program descriptions which set forth four classes of loans,
designated A, B, C and D. Class A loans generally relate to borrowers who have
no or limited adverse incidents in their credit histories, whereas Class B, C
and D loans relate to increasing degrees of adverse incidents in the borrower's
credit histories. Factors which are considered in evaluating a borrower in this
regard are the presence or absence of a credit history, prior delinquencies in
the payment of mortgage and consumer credit and personal bankruptcies. See
"Sources of Funds - Borrowings".
The terms of the loan products offered by the Company directly or
through its correspondents emphasize real estate loans which generally are
underwritten with significant reliance on a borrower's level of equity in the
property securing the loan, which may be an owner-occupied or, depending on the
class of loan and its terms, a non-owner occupied property. Although the
Company's guidelines require information in order to enable the Company to
evaluate a borrower's ability to repay a loan by relating the borrower's income,
assets and liabilities to the proposed indebtedness, because of the significant
reliance on the ratio of the principal amount of the loans to the appraised
value of the security property, each of the four principal classes of loans
identified by the Company includes products which permit reduced documentation
for verifying a borrower's income and employment. Loans which permit reduced
documentation generally require documentation of employment and income for the
most recent six-month period, as opposed to the two-year period required in the
case of full documentation loans. Although the Company reserves the right to
verify a borrower's income, assets and liabilities and employment history, other
than as set forth above, it generally does not verify such information through
other sources.
15
The Company's strategy is to offer a broad range of products to its
borrowers and its origination sources. Loans may have principal amounts which
conform to the guidelines set by FHLMC or FNMA for conforming loans or principal
amounts which significantly exceed these amounts (so called "jumbo loans").
Loans may have fixed or adjustable interest rates and terms ranging up to 30
years.
The Company further expanded its subprime single family residential
lending operations in 1998 by entering the United Kingdom through the
acquisition of a 36.07% interest in Kensington and, through Ocwen UK, the
acquisition of Cityscape UK's mortgage loan portfolio and its residential
subprime mortgage loan origination and servicing businesses.
Ocwen UK's sources of funding include a Loan Facility Agreement with
Greenwich International Ltd. ("Greenwich") under which Greenwich provided a
short-term facility to finance the acquisition of Cityscape UK's mortgage loan
portfolio (the "Term Loan") and to finance Ocwen UK's further originations and
purchase of subprime single family loans (the "Revolving Facility", and together
with the Term Loan, the "Greenwich Facility"). The Greenwich Facility is secured
by Ocwen UK's loans available for sale. The Revolving Facility, which matures in
April 1999, is set at a maximum of $166.0 million ((pound)100.0 million reduced
by the amount borrowed under the Term Loan), of which $87.1 million ((pound)52.5
million) was funded at December 31, 1998, to finance subprime single family loan
originations and bears interest at a rate of the one-month LIBOR plus 1.50%. At
December 31, 1998, $5.6 million ((pound)3.4 million) had been borrowed under the
Term Loan, which matured in January 1999. In addition, Ocwen UK has entered into
a secured warehouse line of credit with Barclays Bank plc (the "Barclays
Facility") to finance subprime single family loan originations. The Barclays
Facility, which matures in November 1999, and bears interest at a rate of the
one-month LIBOR plus 0.80%, is set at a maximum of $124.5 million ((pound)75.0
million), against which $24.6 million ((pound)14.8 million) had been borrowed at
December 31, 1998. The weighted average interest rate on these lines of credit
outstanding at December 31, 1998, was 7.35%.
The following table sets forth the activity in the Company's net loans
available for sale during the periods indicated:
Year Ended December 31,
------------------------------------------------------
1998 1997 1996
------------ ------------ --------------
(Dollars in Thousands)
Balance at beginning of period................... $ 177,041 $ 126,366 $ 251,790
Purchases:
Single family residential........................ 795,053 278,081 284,598
Multi-family residential......................... -- -- 10,456
------------ ------------ --------------
795,053 278,081 295,054
------------ ------------ --------------
Originations:
Single family residential........................ 959,105 316,101 9,447
Multi-family residential...................... -- -- --
------------ ------------ --------------
959,105 316,101 9,447
------------ ------------ --------------
Sales............................................ (1,658,773) (501,079) (395,999)
Increase in lower of cost or market reserve...... (4,064) (1,034) (2,455)
Loans transferred (to)/from loan portfolio....... -- (13,674) 45
Principal repayments, net of capitalized interest (82,728) (22,151) (27,845)
Transfer to real estate owned.................... (7,787) (5,569) (3,671)
------------- ------------ --------------
Net increase (decrease) in loans................. 806 50,675 (125,424)
------------ ------------ --------------
Balance at end of period......................... $ 177,847 $ 177,041 $ 126,366
============ ============ ==============
The Company purchased and originated a total of $1.75 billion of single
family residential loans to non-conforming borrowers during 1998 and $558.3
million of such loans during 1997. At December 31, 1998, the Company had $170.1
million of subprime single family residential loans, which had a weighted
average yield of 12.18%.
The Company generally intends to sell or securitize its subprime single
family residential loans, and as a result, all of such loans were classified as
available for sale at December 31, 1998. During 1998 the Company sold $2.9
million of subprime single family residential loans for gains of $53,000; during
1997 the Company sold $82.6 million of such loans for gains of $3.3 million; and
during 1996 the Company sold $161.5 million of subprime single family
residential loans for gains of $571,000. In addition, as presented in the table
below, loans were securitized and sold in public offerings underwritten by
unaffiliated investment banking firms during 1998, 1997 and 1996, generating
gains of $61.5 million, $18.8 million and $7.2 million, respectively, upon the
sale of the securities. The Company retained subordinate and residual securities
in connection with these transactions.
16
Loan Securitized
------------------------------------------ Book Value of
Types of Loans Principal No. of Loans Securities Retained(2) Net Gain
-------------- -------------- ------------- ---------------------- --------------
1998: (Dollars in thousands)
Single family subprime (1)........ $ 1,626,282 31,235 $ 139,594 $ 61,516
============== ============= ================ =============
1997:
Single family subprime............ $ 415,830 3,640 $ 25,334 $ 18,802
============== ============= ================ =============
1996:
Single family subprime............ $ 211,204 1,180 $ 18,236 $ 7,232
============== ============= ================ =============
(1) Includes 20,819 loans securitized by Ocwen UK with an unpaid principal
balance of $558.5 million ((pound)339.4 million) for a net gain of $25.6
million ((pound)15.4 million).
(2) Consists of subordinated and/or residual securities resulting from the
Company's securitization activities, which had a fair value of $177.5
million at December 31, 1998, including $87.3 million ((pound)52.6
million) related to securitizations by Ocwen UK.
Although subprime loans generally have higher levels of default than
conforming loans, the Company believes that the borrower's equity in the
security property and its expertise in the area of resolution of nonperforming
loans will continue to make its subprime borrower loan program a successful one
notwithstanding such defaults and any resulting losses. There can be no
assurance that this will be the case, however.
From time to time the Company purchases pools of single family
residential loans for investment purposes. During 1995, the Company purchased
$29.8 million of loans which were primarily secured by properties located in the
area surrounding the Bank's physical facility in northern New Jersey.
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LOANS. The
Company's lending activities include the acquisition of loans secured by
commercial real estate, particularly loans secured by hotels and office
buildings, which the Company began originating in late 1994 and late 1995,
respectively. Commercial real estate loans currently are made to finance the
purchase and refinance of commercial properties, the refurbishment of distressed
properties and, recently, the construction of hotels. At December 31, 1998, the
Company's loans secured by commercial real estate (and land) amounted to $138.7
million and consisted primarily of $36.6 million and $93.1 million of loans
secured by hotels and office buildings, respectively.
From time to time, the Company originates loans for the construction of
multi-family residences, as well as bridge loans to finance the acquisition and
rehabilitation of distressed multi-family residential properties. At December
31, 1998, the Company's multi-family residential loan portfolio included $22.3
million of multi-family residential construction loans, of which $20.1 million
had been funded, and $53.3 million of acquisition and rehabilitation loans, of
which $51.3 million had been funded.
From time to time the Company also originates loans secured by existing
multi-family residences. Although the Company has deemphasized this type of
lending in recent periods, it previously was active in the origination and
securitization of such loans. During 1995, 1994 and 1993, the Company
securitized multi-family residential loans acquired by it with an aggregate
principal amount of $83.9 million, $346.6 million and $67.1 million,
respectively. The Company subsequently sold all of the securities backed by
these loans.
The multi-family residential and commercial real estate loans acquired
by the Company in recent periods generally have principal amounts between $3.0
million and the Bank's loan-to-one-borrower limitation (see "Regulation-The
Bank-Loans-to-One-Borrower") and are secured by properties which in management's
view have good prospects for appreciation in value during the loan term. In
addition, the Company currently is implementing a program to originate
multi-family residential and commercial real estate loans with smaller principal
amounts (generally up to $3.0 million) and which may be secured by a wide
variety of such properties.
The Company's large multi-family residential and commercial real estate
loans generally have fixed interest rates, terms of two to five years and
payment schedules which are based on amortization over 15 to 25 year periods.
The maximum loan-to-value ratio generally does not exceed 80% of the stabilized
value of the property and 88% of the total costs of the property in the case of
construction, refurbishment or rehabilitation loans.
Multi-family residential and commercial real estate loans are secured
by a first priority lien on the real property, all improvements thereon and, in
the case of hotel loans, all fixtures and equipment used in connection
17
therewith, as well as a first priority assignment of all revenue and gross
receipts generated in connection with the property. The liability of a borrower
on multi-family residential and commercial real estate loans generally is
limited to the borrower's interest in the property, except with respect to
certain specified circumstances.
In addition to stated interest, the large multi-family residential and
commercial real estate loans originated by the Company commonly include
provisions pursuant to which the borrower agrees to pay the Company as
additional interest on the loan an amount based on specified percentages
(generally between 10-38%) of the net cash flow from the property during the
term of the loan and/or the net proceeds from the sale or refinancing of the
property upon maturity of the loan. Participating interests also may be obtained
in the form of additional fees which must be paid by the borrower in connection
with a prepayment of the loan, generally after an initial lock-out period during
which prepayments are prohibited. The fees which could be payable by a borrower
during specified periods of the loan consist either of fixed exit fees or yield
maintenance payments, which are required to be paid over a specified number of
years after the prepayment and are intended to increase the yield to the Company
on the proceeds from the loan payoff to a level which is comparable to the yield
on the prepaid loan. At December 31, 1998 and 1997, the Company's loan portfolio
included $12.3 million and $89.0 million of loans in which the Company
participates in the residual profits of the underlying real estate. The Company
generally accounts for loans in which it participates in residual profits as
loans and not as investments in real estate; however, because of concerns raised
by the staff of the OTS in this regard, in December 1996 and during 1997 the
Bank sold to the Company subordinated, participating interests in a total of
eleven acquisition, development and construction loans, which interests had an
aggregate principal balance of $18.0 million. On a consolidated basis, eight of
these loans, which amounted to $64.3 million at December 31, 1997, were carried
by the Company as investments in real estate. These eight loans were repaid in
full during 1998. The Bank (but not the Company) agreed with the OTS to cease
origination of mortgage loans with profit participation features in the
underlying real estate, with the exception of existing commitments.
Construction loans generally have terms of three to four years and
interest rates which float on a monthly basis in accordance with designated
reference rates. Payments during the term of the loan may be made to the Company
monthly on an interest-only basis. The loan amount may include an interest
reserve which is maintained by the Company and utilized to pay interest on the
loan during a portion of its term.
Construction loans are secured by a first priority lien on the real
property, all improvements thereon and all fixtures and equipment used in
connection therewith, as well as a first priority assignment of all revenues and
gross receipts generated in connection with the property. Construction loans are
made without pre-leasing requirements or any requirement of a commitment by
another lender to "take-out" the construction loan by making a permanent loan
secured by the property upon completion of construction. Disbursements on a
construction loan are subject to a retainage percentage of 10% and are made only
after evidence that available funds have been utilized by the borrower,
available funds are sufficient to pay for all construction costs through the
date of the construction advance and funds remain in the construction budget and
from sources other than the loan to complete construction of the project.
The Company generally requires the general contractor selected by the
borrower, which along with the general construction contract is subject to the
Company's review and approval, to provide payment and performance bonds issued
by a surety approved by the Company in an amount at least equal to the costs
which are estimated to be necessary to complete construction of the project in
accordance with the construction contract. Moreover, the Company generally
conducts site inspections of projects under construction at least bi-monthly and
of completed projects at least semi-annually.
Multi-family residential, commercial real estate and construction
lending generally are considered to involve a higher degree of risk than single
family residential lending because such loans involve larger loan balances to a
single borrower or group of related borrowers. In addition, the payment
experience on multi-family residential and commercial real estate loans
typically is dependent on the successful operation of the project, and thus such
loans may be adversely affected to a greater extent by adverse conditions in the
real estate markets or in the economy generally. Risk of loss on a construction
loan is dependent largely upon the accuracy of the initial estimate of the
property's value at completion of construction or development and the estimated
cost (including interest) of construction, as well as the availability of
permanent take-out financing. During the construction phase, a number of factors
could result in delays and cost overruns. If the estimate of value proves to be
inaccurate, the Company may be confronted, at or prior to the maturity of the
loan, with a project which, when completed, has a value which is insufficient to
ensure full repayment. In addition to the foregoing, multi-family residential
and commercial real estate loans which are not fully amortizing over their
maturity and which have a balloon payment due at their stated maturity, as is
generally the case with the Company's multi-family residential and commercial
18
real estate loans, involve a greater degree of risk than fully amortizing loans
because the ability of a borrower to make a balloon payment typically will
depend on its ability either to timely refinance the loan or to timely sell the
security property. The ability of a borrower to accomplish these results will be
affected by a number of factors, including the level of available mortgage rates
at the time of sale or refinancing, the financial condition and operating
history of the borrower and the property which secures the loan, tax laws,
prevailing economic conditions and the availability of financing for
multi-family residential and commercial real estate generally.
LOAN SERVICING ACTIVITIES
During 1996, the Company developed a program to provide loan servicing
and various other asset management and resolution services to third party owners
of nonperforming assets, underperforming assets and subprime assets such as
Class B, C and D single family residential mortgage loans. Servicing contracts
entered into by the Company provide for the payment to the Company of specified
fees and in some cases may include terms which allow the Company to participate
in the profits resulting from the successful resolution of the assets being
serviced. Servicing fees, generally expressed as a percent of the unpaid
principal balance, are collected from the borrowers' payments. During any period
in which the borrower is not making payments, the Company is required under
certain servicing agreements to advance its own funds to meet contractual
principal and interest remittance requirements for certain investors, maintain
property taxes and insurance, and process foreclosures. The Company generally
recovers such advances from borrowers for reinstated and performing loans and
from investors for foreclosed loans.
The Bank has been approved as a loan servicer by HUD, FHLMC and FNMA.
The Bank is rated a Tier 1 servicer and as a preferred servicer for high-risk
mortgages by FHLMC, the highest rating categories. The Bank is one of only seven
special servicers of commercial mortgage loans to have received a "Strong"
rating from Standard & Poor's. The Bank is recognized and/or designated by four
rating agencies (Standard & Poor's, Duff and Phelps, IBC Fitch Investors, and
Moody's) as a "Special Servicer" for residential mortgage loans and is the only
special servicer with this designation for all mortgage categories.
The Company developed the concept of residential special servicing in
1997 and, in 1998, began entering into special servicing arrangements wherein
the Company acted as a special servicer for third parties, typically as part of
a securitization. The Company services loans that become greater than 90 days
past due and receives incentive fees to the extent certain loss mitigation
parameters are achieved. Through December 31, 1998, the Company was designated
as a special servicer for securitized pools of mortgage loans totaling
approximately $9.1 billion in unpaid principal balance. Of this amount,
approximately $8.0 billion were residential loans, and the balance was
commercial.
19
The following tables set forth the number and amount of loans serviced
by the Company for others at the dates indicated:
DECEMBER 31, 1998:
Discount Loans Subprime Loans (1) Other Loans Total
--------------------- --------------------- ------------------- ---------------------
No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans
---------- ------- ---------- -------- --------- ------ ----------- -------
(Dollars in thousands)
Loans securitized and sold with
recourse....................... $1,015,988 16,840 $1,809,533 31,607 $ -- -- $ 2,825,521 48,447
Loans serviced for third parties. 1,573,285 20,835 5,327,441 83,085 866,219 1,091 7,766,945 105,011
---------- ------- ---------- -------- --------- ------ ----------- -------
$2,589,273 37,675 $7,136,974 114,692 $ 866,219 1,091 $10,592,466 153,458
========== ======= ========== ======== ========= ====== =========== =======
DECEMBER 31, 1997:
Discount Loans Subprime Loans Other Loans Total
--------------------- --------------------- ------------------- ---------------------
No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans
---------- ------- ---------- -------- --------- ------ ----------- -------
(Dollars in thousands)
Loans securitized and sold with
recourse........................ $ 624,591 11,148 $ 555,914 4,976 $ -- -- $1,180,505 16,124
Loans serviced for third parties.. 1,682,764 23,181 2,352,352 29,911 294,198 1,092 4,329,314 54,184
---------- -------- ---------- -------- --------- ------ ---------- -------
$2,307,355 34,329 $2,908,266 34,887 $ 294,198 1,092 $5,509,819 70,308
========== ======== ========== ======== ========= ====== ========== =======
DECEMBER 31, 1996:
Discount Loans Subprime Loans Other Loans Total
--------------------- --------------------- ------------------- ---------------------
No. of No. of No. of No. of
Amount Loans Amount Loans Amount Loans Amount Loans
---------- ------- ---------- -------- --------- ------ ----------- -------
(Dollars in thousands)
Loans securitized and sold with
recourse........................ $ 204,586 4,796 $ 202,766 1,879 $ -- -- $ 407,352 6,675
Loans serviced for third parties.. 1,209,535 22,511 6,784 60 294,427 917 1,510,746 23,488
---------- --------- --------- --------- --------- ------- ---------- --------
$1,414,121 27,307 $ 209,550 1,939 $ 294,427 917 $1,918,098 30,163
========== ========= ========= ========= ========= ======= ========== ========
(1) Includes 37,955 loans with an unpaid principal balance of $857.2
million ((pound)504.4 million) which were serviced by Ocwen UK at
December 31, 1998.
The Company generally does not purchase rights to service loans for
others, and as a result, capitalized mortgage servicing rights amounted to only
$7.1 million and $5.7 million at December 31, 1998 and 1997, respectively. In
connection with the securitization and sale of loans, the Company generally
retains the rights to service such loans for investors. On January 1, 1996, the
Company adopted Statement of Financial Accounting Standards ("SFAS") No. 122,
"Accounting for Mortgage Servicing Rights." SFAS No. 122 was superseded, for
transactions recorded after December 31, 1996, by SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
which the Company adopted on January 1, 1997. Both SFAS No. 122 and SFAS No. 125
require the recognition of a servicing asset or liability and other retained
interests as an allocation of the carrying amount of the assets sold between the
asset sold and the servicing obligation and other retained interests based on
the relative fair value of the assets sold to the interests retained. The
resulting mortgage servicing asset or liability is amortized in proportion to
and over the period of estimated net servicing income or loss. The Company
evaluates the mortgage servicing asset for impairment based on the fair value of
the servicing asset. The Company estimates fair values by discounting servicing
asset cash flows using discount and prepayment rates that it believes market
participants would use.
ASSET QUALITY
The Company, like all financial institutions, is exposed to certain
credit risks related to the value of the collateral that secures its loans and
the ability of borrowers to repay their loans. Management of the Company closely
monitors the Company's loan and investment portfolios and the Company's real
estate owned for potential problems and reports to the Board of Directors at
regularly scheduled meetings.
NONPERFORMING LOANS. It is the Company's policy to establish an
allowance for uncollectible interest on loans in its loan portfolio and loans
available for sale which are past due 90 days or more and to place such loans on
non-accrual status. As a result, the Company currently does not have any loans
which are accruing interest but are past due 90 days or more. Loans also may be
placed on non-accrual status when, in the judgment of management, the
probability of collection of interest is deemed to be insufficient to warrant
further accrual. When a loan is placed on non-accrual status, previously accrued
but unpaid interest is reversed by a charge to interest income.
20
The following table sets forth certain information relating to the
Company's nonperforming loans in its loan portfolio at the dates indicated:
December 31,
---------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in Thousands)
Nonperforming loans (1):
Single family residential loans......... $ 1,169 $ 1,575 $ 2,123 $ 2,923 $ 2,478
Multi-family residential loans(2)(3).... 7,392 7,583 106 731 152
Consumer and other loans................ 488 -- 55 202 29
--------- --------- --------- --------- ---------
Total................................ $ 9,049 $ 9,158 $ 2,284 $ 3,856 $ 2,659
========= ========= ========= ========= =========
Nonperforming loans as a percentage of:
Total loans (4)......................... 3.81% 3.36% 0.56% 1.27% 4.35%
Total assets............................ 0.27% 0.30% 0.09% 0.20% 0.21%
Allowance for loan losses as a percentage of:
Total loans(4)(5).................... 2.07% 1.35% 0.87% 0.65% 1.84%
Nonperforming loans.................. 54.46% 40.35% 154.25% 50.49% 40.28%
(1) The Company did not have any nonperforming loans in its loan portfolio
which were deemed troubled debt restructurings at the dates indicated.
(2) The increase in non performing multi-family residential loans during 1997
was primarily attributable to a $7.4 million loan secured by 127-unit
condominium building located in New York, New York, which management
believes is well collateralized.
(3) Non performing multi-family residential loans at December 31, 1998 was
primarily attributable to three loans with an aggregate balance of $5.0
million, all of which management believes are well capitalized.
(4) Total loans is net of undisbursed loan proceeds.
(5) The decrease in the allowance for loan losses as a percentage of total
loans during 1995 was due to the significant increase in the loan
portfolio during 1995 as a result of the purchase of single family
residential loans and the origination of multi-family residential and
commercial real estate loans.
The following table presents a summary of the Company's nonperforming
loans in the loans available for sale portfolio at the dates indicated:
December 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Nonperforming loans:
Single family loans.................. $ 39,415 $ 13,509 $ 14,409 $ 7,833 $ --
Consumer loans....................... 9 25 36 100 120
---------- ---------- ---------- ---------- ----------
$ 39,424 $ 13,534 $ 14,445 $ 7,933 $ 120
========== ========== ========== ========== ==========
Nonperforming loans a percentage of:
Total loans available for sale....... 22.17% 7.64% 11.43% 3.15% 0.12%
Total assets......................... 1.19% 0.44% 0.58% 0.58% 0.01%
For information relating to the payment status of loans in the
Company's discount loan portfolio, see "Business-Discount Loan Acquisition and
Resolution Activities."
REAL ESTATE OWNED. Properties acquired through foreclosure or by
deed-in-lieu thereof are valued at the lower of amortized cost or fair value.
Properties included in the Company's real estate owned portfolio are
periodically re-evaluated to determine that they are being carried at the lower
of cost or fair value less estimated costs to sell. Holding and maintenance
costs related to properties are recorded as expenses in the period incurred.
Deficiencies resulting from valuation adjustments to real estate owned
subsequent to acquisition are recognized as a valuation allowance. Subsequent
increases related to the valuation of real estate owned are reflected as a
reduction in the valuation allowance, but not below zero. Increases and
decreases in the valuation allowance are charged or credited to income,
respectively. Accumulated valuation allowances amounted to $15.3 million, $12.3
million, $11.5 million, $4.6 million and $3.9 million at December 31, 1998,
1997, 1996 1995 and 1994, respectively.
21
The following table sets forth certain information relating to the
Company's real estate owned at the dates indicated.
December 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in Thousands)
Discount loan portfolio:
Single family residential $ 94,641 $ 76,409 $ 49,728 $ 75,144 $ 86,426
Multi-family residential 20,130 16,741 14,046 59,932 --
Commercial real estate 82,591 71,339 36,264 31,218 8,801
-------- -------- -------- -------- --------
Total ............ 197,362 164,489 100,038 166,294 95,227
Loan portfolio .......... 227 357 592 262 1,440
Loans available for sale 3,962 2,419 3,074 -- --
-------- -------- -------- -------- --------
Total ............ $201,551 $167,265 $103,704 $166,556 $ 96,667
======== ======== ======== ======== ========
The following table sets forth certain geographical information by type
of property at December 31, 1998 related to the Company's real estate owned.
Multi-family Residential
Single Family Residential and Commercial Total
------------------------- ------------------------ -----------------------
No. of No. of No. of
Amount Properties Amount Properties Amount Properties
--------- ---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
Florida.................. $ 5,334 114 $ 54,187 12 $ 59,521 126
California............... 29,255 469 6,491 6 35,746 475
Maryland................. 8,078 141 14,942 3 23,020 144
Connecticut.............. 5,382 109 12,481 2 17,863 111
New York................. 6,938 157 955 3 7,893 160
Other(1)................. 43,843 945 13,665 38 57,508 983
-------- -------- --------- -------- --------- --------
Total................. $ 98,830 1,935 $ 102,721 64 $ 201,551 1,999
======== ======== ========= ======== ========= ========
(1) Consists of properties located in 43 other states, none of which
aggregated over $6.7 million in any one state.
The following table sets forth the activity in the real estate owned
during the periods indicated.
Year Ended December 31,
---------------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
No. of No. of No of
Amount Properties Amount Properties Amount Properties
------ ---------- ------ ---------- ------ ----------
(Dollars in Thousands)
Balance at beginning of period... $ 167,265 1,505 $103,704 825 $ 166,556 1,070
Properties acquired through
foreclosure or deed-in-lieu
thereof....................... 280,522 3,278 205,621 1,656 102,098 918
Acquired in connection with
acquisitions of discount loans 19,949 303 38,486 545 2,529 12
Sales............................ (263,206) (3,087) (179,693) (1,521) (160,592) (1,175)
Change in allowance.............. (2,979) -- (853) -- (6,887) --
--------- --------- -------- --------- --------- ---------
Balance at end of period......... $ 201,551 1,999 $167,265 1,505 $ 103,704 825
========= ========= ======== ========= ========= =========
The following table sets forth the amount of time that the Company had
held its real estate owned at the dates indicated.
December 31,
1998 1997 1996
------------ ------------ ------------
(Dollars in Thousands)
One to two months................................. $ 38,444 $ 83,144 $ 17,695
Three to four months.............................. 79,264 28,912 15,291
Five to six months................................ 27,115 20,929 14,348
Seven to 12 months................................ 26,122 23,621 13,004
Over 12 months.................................... 30,606 10,659 43,366
------------ ------------ ------------
$ 201,551 $ 167,265 $ 103,704
============ ============ ============
22
The average period during which the Company held the $263.2 million,
$179.7 million and $160.6 million of real estate owned which was sold during the
years ended December 31, 1998, 1997 and 1996, respectively, was 6 months, 9
months and 11 months, respectively.
The following table sets forth the activity, in aggregate, in the
valuation allowances on real estate owned during the periods indicated.
Year Ended December 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in thousands)
Balance at beginning of year $ 12,346 $ 11,493 $ 4,606 $ 3,937 $ 2,455
Provisions for losses ...... 18,626 13,450 18,360 10,510 9,074
Charge-offs and sales ...... (15,647) (12,597) (11,473) (9,841) (7,592)
-------- -------- -------- -------- --------
Balance at end of year ..... $ 15,325 $ 12,346 $ 11,493 $ 4,606 $ 3,937
======== ======== ======== ======== ========
Although the Company evaluates the potential for significant
environmental problems prior to acquiring or originating a loan, there is a risk
for any mortgage loan, particularly a multi-family residential and commercial
real estate loan, that hazardous substances or other environmentally restricted
substances could be discovered on the related real estate. In such event, the
Company might be required to remove such substances from the affected properties
or to engage in abatement procedures at its sole cost and expense. There can be
no assurance that the cost of such removal or abatement will not substantially
exceed the value of the affected properties or the loans secured by such
properties, that the Company would have adequate remedies against the prior
owners or other responsible parties or that the Company would be able to resell
the affected properties either prior to or following completion of any such
removal or abatement procedures. If such environmental problems are discovered
prior to foreclosure, the Company generally will not foreclose on the related
loan; however, the value of such property as collateral will generally be
substantially reduced, and as a result, the Company may suffer a loss upon
collection of the loan.
From time to time, the Company makes loans to finance the sale of real
estate owned. At December 31, 1998, such loans amounted to $7.5 million and
consisted of $3.6 million of single family residential loans, $3.6 million of
multi-family residential loans and $262,000 of commercial loans. All of the
Company's loans to finance the sale of real estate owned were performing in
accordance with their terms at December 31, 1998.
CLASSIFIED ASSETS. OTS regulations require that each insured savings
association classify its assets on a regular basis. In addition, in connection
with examinations of insured associations, OTS examiners have authority to
identify problem assets and, if appropriate, require them to be classified.
There are three classifications for problem assets: "substandard," "doubtful"
and "loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as a loss is considered uncollectible
and of such little value that continuance as an asset of the institution is not
warranted. Another category designated "special mention" also must be
established and maintained for assets which do not currently expose an insured
institution to a sufficient degree of risk to warrant classification as
substandard, doubtful or loss but do possess credit deficiencies or potential
weaknesses deserving management's close attention. Assets classified as
substandard or doubtful require the institution to establish general allowances
for loan losses. If an asset or portion thereof is classified as a loss, the
insured institution must either establish specific allowances for loan losses in
the amount of 100% of the portion of the asset classified as a loss or charge
off such amount. In this regard, the Company establishes required reserves and
charges off loss assets as soon as administratively practicable. General loss
allowances established to cover possible losses related to assets classified
substandard or doubtful may be included in determining an institution's
regulatory capital, while specific valuation allowances for loan losses do not
qualify as regulatory capital.
In 1996, based upon discussions with the OTS and as a result of an OTS
bulletin issued on December 13, 1996 entitled "Guidance on the Classification
and Regulatory Reporting of Certain Delinquent Loans and Other Credit Impaired
Assets," the Company has classified all discount loans that are 90 or more days
contractually past due, not otherwise classified, as special mention and all
real estate owned, not otherwise classified, as special mention. The Company
also modified its policy for classifying nonperforming discount loans and real
estate owned related to its discount loan portfolio ("nonperforming discount
assets") to take into account both the holding period of such assets from the
date of acquisition and the ratio of book value to market value of such assets.
All nonperforming discount assets which are held 15 months or more after the
date of acquisition are classified substandard; nonperforming discount assets
held 12 months to less than 15 months from the date of acquisition are
23
classified as substandard if a ratio of book value to market value is 80% or
more; and nonperforming discount assets held less than 12 months from the date
of acquisition are classified as substandard if they have a ratio of book value
to market value of more than 85%. In addition, nonperforming discount assets
which are performing for a period of time subsequent to acquisition by the
Company are classified as substandard at the time such loans become
nonperforming. The Company also modified its classified assets policy to
classify all real estate owned which is not cash flowing and which has been held
for more than 15 months and three years as substandard and doubtful,
respectively. The Company's past experience indicates that classified discount
assets do not necessarily correlate to probability or severity of loss.
Excluding assets which have been classified loss and fully reserved by
the Company, the Company's classified assets at December 31, 1998 under the
above policy consisted of $49.8 million of assets classified as substandard and
$636,000 of assets classified as doubtful. In addition, at the same date, $80.5
million of assets were designated as special mention.
Substandard assets at December 31, 1998 under the above policy
consisted primarily of $5.6 million of loans and real estate owned related to
the Company's discount single family residential loan program, $22.9 million of
loans and real estate owned related to the Company's discount commercial real
estate loan program and $5.6 million of subprime single family residential
loans. Special mention assets at December 31, 1998 under the policy consisted
primarily of $26.9 million and $34.2 million of loans and real estate owned
related to the Company's discount single family residential and discount
commercial real estate loan programs, respectively.
ALLOWANCES FOR LOSSES. The Company maintains an allowance for loan
losses for each of its loan and discount loan portfolios at a level which
management considers adequate to provide for potential losses in each portfolio
based upon an evaluation of known and inherent risks in such portfolios.
The following table sets forth the breakdown of the allowance for loan
losses on the Company's loan portfolio and discount loan portfolio by loan
category and the percentage of loans in each category to total loans in the
respective portfolios at the dates indicated:
December 31,
--------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------- -------------- -------------- -------------- --------------
Amount % Amount % Amount % Amount % Amount %
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Loan portfolio:
Single family residential loans $ 215 4.4% $ 512 15.7% $ 520 14.6% $ 346 22.2% $ 615 52.2%
Multi-family residential loans 2,714 55.1 2,163 24.2 673 13.5 683 14.3 -- 2.9
Commercial real estate loans .. 1,999 40.5 1,009 60.0 2,299 71.3 875 62.6 218 42.3
Commercial non-mortgage loans . -- -- -- -- 11 0.5 -- -- -- --
Consumer loans ................ -- -- 11 0.1 20 0.1 43 0.9 238 2.6
------ ----- ------- ----- ------- ----- ------ ----- ------ -----
Total ....................... $4,928 100.0% $ 3,695 100.0% $ 3,523 100.0% $1,947 100.0% $1,071 100.0%
====== ===== ======= ===== ======= ===== ====== ===== ====== =====
Discount loan portfolio(1):
Single family residential loans $10,307 48.2% $15,017 50.2% $ 3,528 38.4% $ -- --% $ -- --%
Multi-family residential loans 2,457 11.5 2,616 10.7 3,124 26.0 -- -- -- --
Commercial real estate loans 8,607 40.2 5,860 39.0 4,886 35.4 -- -- -- --
Other loans............... 31 0.1 -- 0.1 -- 0.2 -- -- -- --
------ ----- ------- ----- ------- ------ ------ ----- ------ -----
Total................... $21,402 100.0% $23,493 100.0% $11,538 100.0% $ -- --% $ -- --%
====== ===== ======= ===== ======= ====== ====== ===== ====== =====
(1) The Company did not maintain an allowance for loan losses on its discount
loan portfolio prior to 1996.
The allocation of the allowance to each category is not necessarily
indicative of future losses and does not restrict the use of the allowance to
absorb losses in any other category.
24
The following table sets forth an analysis of activity in the allowance
for loan losses relating to the Company's loan portfolio during the periods
indicated:
Year Ended December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in Thousands)
Balance at beginning of period...... $ 3,695 $ 3,523 $ 1,947 $ 1,071 $ 884
Provision for loan losses........... 891 325 1,872 1,121 --
Charge-offs:
Single family residential loans.. (212) (100) (261) (131) (302)
Multi-family residential loans... -- -- (7) -- --
Commercial real estate loans..... -- -- -- (40) --
Consumer loans................... (7) (53) (28) (92) (170)
-------- -------- -------- -------- --------
Total charge-offs.............. (219) (153) (296) (263) (472)
Recoveries:
Single family residential loans.. -- -- -- 3 410
Multi-family residential loans... -- -- -- -- --
Commercial real estate loans..... 561 -- -- 15 --
Consumer loans................... -- -- -- -- 249
-------- -------- -------- -------- --------
Total recoveries............... 561 -- -- 18 659
-------- -------- -------- -------- --------
Net (charge-offs) recoveries... 342 (153) (296) (245) 187
-------- -------- -------- -------- --------
Balance at end of period............ $ 4,928 $ 3,695 $ 3,523 $ 1,947 $ 1,071
======== ======== ======= ======== ========
Net charge-offs (recoveries) as a
percentage of average loan
portfolio, net................... 0.13% 0.04% 0.09% 0.19% (0.28)%
The following table sets forth an analysis of activity in the allowance
for loan losses relating to the Company's discount loan portfolio during the
periods indicated:
Year Ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
(Dollars in Thousands)
Balance at beginning of period ........... $ 23,493 $ 11,538 $ --
Provision for loan losses ................ 17,618 31,894 20,578
Charge-offs:
Single family residential loans ....... (14,574) (13,281) (7,009)
Multi-family residential loans ........ (2,648) (2,056) (704)
Commercial real estate loans .......... (2,888) (5,012) (1,503)
Other loans ........................... (20) -- --
-------- -------- --------
Total charge-offs .................. (20,130) (20,349) (9,216)
-------- -------- --------
Recoveries:
Single family residential loans ....... 421 410 176
Multi-family residential loans ........ -- -- --
Commercial real estate loans .......... -- -- --
Consumer loans ........................ -- -- --
-------- -------- --------
Total recoveries ................... 421 410 176
-------- -------- --------
Net (charge-offs) .................. (19,709) (19,939) (9,040)
-------- -------- --------
Balance at end of period ................. $ 21,402 $ 23,493 $ 11,538
======== ======== ========
Net charge-offs as a percentage of average
discount loan portfolio ............... 1.53% 1.55% 1.34%
25
INVESTMENT ACTIVITIES
GENERAL. The investment activities of the Company currently include
investments in mortgage-related securities, investment securities and low-income
housing tax credit interests. The investment policy of the Company, which is
established by the Investment Committee and approved by the Board of Directors,
is designed primarily to provide a portfolio of diversified instruments while
seeking to optimize net interest income within acceptable limits of interest
rate risk, credit risk and liquidity.
MORTGAGE-BACKED AND RELATED SECURITIES. From time to time, the Company
invests in mortgage-backed and mortgage-related securities. Although
mortgage-backed and mortgage-related securities generally yield less than the
loans that back such securities because of costs associated with their payment
guarantees or credit enhancements, such securities are more liquid than
individual loans and may be used to collateralize borrowings of the Company.
Other mortgage-backed and mortgage-related securities indirectly bear the risks
of the underlying loans, such as prepayment risk (interest-only securities) and
credit risk (subordinated interests), and are generally less liquid than
individual loans.
Mortgage-related securities include senior and subordinate regular
interests and residual interests in collateralized mortgage obligations
("CMOs"), including CMOs which have qualified as REMICs. The regular interests
in some CMOs are like traditional debt instruments because they have stated
principal amounts and traditionally defined interest-rate terms. Purchasers of
certain other interests in REMICs are entitled to the excess, if any, of the
issuer's cash inflows, including reinvestment earnings, over the cash outflows
for debt service and administrative expenses. These interests may include
instruments designated as residual interests, which represent an equity
ownership interest in the underlying collateral, subject to the first lien of
the investors in the other classes of the REMIC.
A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or the Government National Mortgage Association
("GNMA"). These structures divide mortgage pools into two risk classes: a senior
class and one or more subordinated classes. The subordinated classes provide
protection to the senior class. When cash flow is impaired, debt service goes
first to the holders of senior classes. In addition, incoming cash flows also
may be held in a reserve fund to meet any future shortfalls of cash flow to
holders of senior classes. The holders of subordinated classes may not receive
any principal repayments until the holders of senior classes have been paid and,
when appropriate, until a specified level of funds has been contributed to the
reserve fund.
On July 27, 1998, the Company sold its entire portfolio of AAA-rated
agency IOs for $137.5 million, which represented book value. As a result of an
increase in prepayment speeds due to declining interest rates, the Company
recorded impairment charges of $86.1 million in 1998 prior to the sale ($77.6
million in the second quarter) resulting from the Company's decision to
discontinue this investment activity and write down the book value of the IOs.
The AAA-rated agency IOs consisted of IOs, which are classes of mortgage-related
securities that are entitled to payments of interest but no (or only nominal)
principal, and inverse IOs, which bear interest at a floating rate that varies
inversely with (and often at a multiple of) changes in a specified index.
At December 31, 1998, the fair value of the Company's investment in
subordinate and residual interests amounted to $249.1 million ($227.9 million
amortized cost) or 42% of total securities available for sale and supported
senior classes of securities having an outstanding principal balance of $3.84
billion. During 1998, the Company recorded $43.6 million of impairment charges
on its portfolio of subordinate and residual securities as a result of declines
in value that were deemed to be "other than temporary." Because of their
subordinate position, subordinated and residual classes of mortgage-related
securities provide protection to and involve more risk than the senior class.
Specifically, when cash flow is impaired, debt service goes first to the holders
of senior classes. In addition, incoming cash flows may be held in a reserve
fund to meet any future repayments until the holders of senior classes have been
paid and, when appropriate, until a specified level of funds has been
contributed to the reserve fund. Further, residual interests exhibit
considerably more price volatility than mortgages or ordinary mortgage
pass-through securities, due in part to the uncertain cash flows that result
from changes in the prepayment rates of the underlying mortgages. Lastly,
subordinate and residual interests involve substantially more credit risk than
the senior classes of the mortgage-related securities to which such interests
relate and generally are not as liquid as the senior classes.
The Company generally retains subordinate and residual securities,
which are certificated, related to its securitization of loans. Subordinate and
residual interests in mortgage-related securities provide credit support to the
more senior classes of the mortgage-related securities. Principal from the
underlying mortgage loans generally is allocated first to the senior classes,
with the most senior class having a priority right to the cash flow from the
mortgage loans until its payment requirements are satisfied. To the extent that
there are defaults and unrecoverable losses on the underlying mortgage loans,
resulting in reduced cash flows, the most subordinate security will be the first
to bear this loss. Because subordinate and residual interests generally have no
credit support, to the extent there are realized losses on the mortgage loans
26
comprising the mortgage collateral for such securities, the Company may not
recover the full amount or, indeed, any of its initial investment in such
subordinate and residual interests. The Company generally retains the most
subordinate classes of the securities from the securitization and therefore will
be the first to bear any credit losses.
The Company determines the present value of anticipated cash flows at
the time each securitization transaction closes, utilizing valuation assumptions
appropriate for each particular transaction. The significant valuation
assumptions include the anticipated prepayment speeds and the anticipated credit
losses related to the underlying mortgages. In order to determine the present
value of this estimated excess cash flow, the Company currently applies a
discount rate of 18% to the projected cash flows on the unrated classes of
securities. The annual prepayment rate of the securitized loans is a function of
full and partial prepayments and defaults. The Company makes assumptions as to
the prepayment rates of the underlying loans, which the Company believes are
reasonable, in estimating fair values of the subordinate securities and residual
securities retained. During 1998, the Company utilized proprietary prepayment
curves generated by the Company (reaching an approximate range of annualized
rates of 30% - 40%). In its estimates of annual loss rates, the Company utilizes
assumptions that it believes are reasonable. The Company estimates annual losses
of between 0.22% and 2.06% of the underlying loans.
Subordinate and residual interests are affected by the rate and timing
of payments of principal (including prepayments, repurchase, defaults and
liquidations) on the mortgage loans underlying a series of mortgage-related
securities. The rate of principal payments may vary significantly over time
depending on a variety of factors, such as the level of prevailing mortgage loan
interest rates and economic, demographic, tax, legal and other factors.
Prepayments on the mortgage loans underlying a series of mortgage-related
securities are generally allocated to the more senior classes of
mortgage-related securities. Although in the absence of defaults or interest
shortfalls all subordinates receive interest, amounts otherwise allocable to
residuals generally are used to make payments on more senior classes or to fund
a reserve account for the protection of senior classes until
overcollateralization or the balance in the reserve account reaches a specified
level. In periods of declining interest rates, rates of prepayments on mortgage
loans generally increase, and if the rate of prepayments is faster than
anticipated, then the yield on subordinates will be positively affected and the
yield on residuals will be negatively affected.
The credit risk of mortgage related securities is affected by the
nature of the underlying mortgage loans. In this regard, the risk of loss on
securities backed by commercial and multi-family loans and single family
residential loans made to borrowers who, because of prior credit problems, the
absence of a credit history or other factors, are unable or unwilling to qualify
as borrowers under guidelines established by the FHLMC and the FNMA for
purchases of loans by such agencies, generally involve more risk than securities
backed by single family residential loans which conform to the requirements
established by FHLMC and FNMA for their purchase by such agencies.
The Company adjusts its securities portfolio to fair value at the end
of each month based upon the lower of dealer quotations or internal values,
subject to an internal review process. For those securities which do not have an
available market quotation, the Company will request market values and
underlying assumptions from the various securities dealers that underwrote, are
currently financing the securities, or have had prior experience with the type
of security to be valued. When quotations are obtained from two or more dealers,
the average dealer quote will be utilized.
The Company periodically assesses the carrying value of its subordinate
securities and residual securities retained as well as the servicing assets for
impairment. There can be no assurance that the Company's estimates used to
determine the gain on securitized loan sales, subordinate securities and
residual securities retained and servicing asset valuations will remain
appropriate for the life of each securitization. If actual loan prepayments or
defaults exceed the Company's estimates, the carrying value of the Company's
subordinate securities and residual securities retained and/or servicing assets
may be decreased or the Company may increase its allowance for possible credit
losses on loans sold through a charge against earnings during the period
management recognized the disparity. Other factors may also result in a
write-down of the Company's subordinate securities and residual securities
retained in subsequent periods. Accelerated prepayment speeds were a significant
contributing factor to the $43.6 million of impairment charges recorded by the
Company in 1998 on its subordinate and residual securities.
27
The following table sets forth the fair value of the Company's
mortgage-backed and related securities available for sale at the dates
indicated.
December 31,
---------------------------------------------
1998 1997 1996
---------- ---------- ---------
Mortgage-related securities: (Dollars in Thousands)
Single family residential:
CMOs (AAA-rated)............................ $ 344,199 $ 160,451 $ 73,935
Interest only:
AAA-rated................................. -- 13,863 1,173
FHLMC..................................... -- 64,745 47,571
FNMA...................................... -- 59,715 49,380
GNMA...................................... -- 29,766 --
BB-rated subordinates....................... 8,517 2,515 --
B-rated subordinates........................ 6,344 -- --
Unrated subordinates ..................... 40,595 39,219 19,164
AAA-rated subprime residuals .............. 6,931 -- --
BBB-rated subprime residuals .............. 17,593 -- --
Unrated subprime residuals ................ 152,951 41,790 20,560
Futures contracts and swaps................. -- (94) (1,921)
---------- ---------- ---------
Total..................................... 577,130 411,970 209,862
---------- ---------- ---------
Multi-family residential and commercial:
Interest only:
AAA-rated................................. 71 3,058 83,590
BB-rated.................................. 2 189 --
Unrated................................... -- -- 3,799
B-rated subordinates........................ 8,813 8,512
Unrated..................................... -- -- 13,848
Unrated subordinates........................ 7,331 6,795 43,686
Futures contracts........................... -- -- (780)
---------- ---------- ---------
Total..................................... 16,217 18,554 144,143
---------- ---------- ---------
Marketable equity securities:
Common stocks............................... -- 46,272 --
---------- ---------- ---------
Total.................................. $ 593,347 $ 476,796 $ 354,005
========== ========== =========
Under a regulatory bulletin issued by the OTS, a federally-chartered
savings institution such as the Bank generally may invest in "high risk"
mortgage securities only to reduce its overall interest rate risk and after it
has adopted various policies and procedures, although under specified
circumstances such securities also may be acquired for trading purposes. A "high
risk" mortgage security for this purpose generally is any mortgage-related
security which meets one of three tests which are intended to measure the
average life or price volatility of the security in relation to a benchmark
fixed rate, 30-year mortgage-backed pass-through security. At December 31, 1998,
the Bank held mortgage-related securities with a fair value of $19.5 million
(amortized cost of $19.5 million) which were classified as "high-risk" mortgage
securities by the OTS.
28
The following tables detail the Company's securities available for sale
portfolio at December 31, 1998, and its estimates of expected yields on such
securities, taking into consideration expected prepayment and loss rates
together with other factors.
CLASS COLLATERAL BALANCE
ISSUE DESIGNATION RATING ------------------- PRODUCT TYPE AT
SECURITIZATION SECURITY DATE LETTER AGENCIES ISSUANCE 12/31/98 12/31/98
-------------- -------- ---- ------ -------- --------- -------- ---------------
SINGLE-FAMILY RESIDENTIAL (Dollars in Thousands)
Subordinates:
BCF 1996 R1............. B3 Oct-96 NR S&P, Moody's $ 505,513 $ 358,075 93% Fixed, 7% ARM
BCF 1997 R1............. B4 Mar-97 NR Moody's, Fitch 177,823 138,739 93% Fixed, 7% ARM
BCF 97 R2............... B4 Jun-97 Ba2, BB Moody's, Fitch 251,790 193,342 24% Fixed, 75% ARM
B5 B2,B
B6 NR
BCF 1997 R3............. B4 Dec-97 NR Moody's DCR 579,851 519,213 93% Fixed, 6% ARM
ORMBS 1998 R1........... B4 Mar-98 NR Moody's, DCR 565,411 546,176 94% Fixed, 6% ARM
ORMBS 1998 R2........... B4A Jun-98 Ba2 Moody's 123,917 115,320 39% Fixed, 61% ARM
B4F Ba2
B5A B2
B5F B2
B6F NR
B6A NR
ORMBS 1998 R3........... B4 Sep-98 BB Moody's, DCR 261,452 259,873 95% Fixed, 5% ARM
B5 B2,B
B6 NR
Subprime residuals:
SMBS 1996-3............. R Jun-96 NR S&P, Moody's 130,062 48,578 56% Fixed, 44% ARM
MLM1 1996-1............. R Sep-96 NR S&P, Moody's 81,142 33,469 30% Fixed, 70% ARM
MS 1997-1............... X1,X2 Jun-97 NR S&P, Moody's 104,846 66,732 22% Fixed, 78% ARM
1997 OFS(2)............. X Sep-97 NR S&P, Moody's 102,201 67,850 16% Fixed 84% ARM
1997 OFS(3)............. X Dec-97 NR S&P, Moody's 208,784 167,604 16% Fixed 84% ARM
1998 OFS(1)............. X Mar-98 NR Moody's, DCR 161,400 137,641 13% Fixed 87% ARM
1998 OFS(2)............. X Jun-98 NR S&P, Moody's 382,715 304,266 37% Fixed 63% ARM
1998 OFS(3)............. X Sep-98 NR S&P, DCR 261,649 253,156 27% Fixed 73% ARM
1998 OFS(4)............. X Dec-98 NR S&P, 262,055 262,055 37% Fixed 63% ARM
Moody's,Fitch
OML(1).................. R Jun-98 NR S&P, DCR 368,742 321,916 100% UK Subprime
OML(2).................. DAC-IO Nov-98 Aaa,AAA Moody's, Fitch 195,832 195,832 100% UK Subprime
S&R NR
B Baa2, BBB
MULTI-FAMILY AND COMMERCIAL
Subordinates:
CMAC 1996 C2............ G Dec-96 B Fitch 164,418 133,997 37% Retail, 19% Hotel,
H NR 16% Multi-family
XI,X2 AAA
BCF 97-C1............... F,G Oct-97 B Fitch 128,387 86,959 19% Multi-family, 18%
E-IO BB Hotel, 15% Industrial
X1,X2 AAA
29
WEIGHTED WEIGHTED TOTAL ACTUAL LIFE ACTUAL LIFE
AVERAGE COUPON AVERAGE DELINQUENCY TO DATE CPR TO DATE SUBORDINATION
AT: LTV AT: AT: AT: LOSSES AT: LEVEL YIELD TO MATURITY AT:
SECURITIZATION 12/31/98 12/31/98 12/31/98 12/31/98 12/31/98 AT 12/31/98 PURCHASE 12/31/98
- - -------------------------- --------------- -------- ----------- ----------- ----------- ------------- -------- ------------
SINGLE-FAMILY RESIDENTIAL (Dollars in Thousands)
Subordinates:
BCF 1996 R1 B3(5)....... 10.06% 101.05% 22.00% 12.47% $14,199 None 15.70% 14.73%
BCF 1997 R1 B4(5)....... 10.08 108.90 39.87 11.78 6,145 None 13.46 -0.04
BCF 97 R2 B4(5)......... 8.30 85.64 72.88 11.87 3,876 8.06 9.58 11.97
B5............ 4.94 10.74 15.97
B6............ None 15.98 5.35
BCF 1997 R3(5).......... 9.65 113.90 38.32 7.81 5,045 None 15.84 5.56
ORMBS 1998 R1(6)........ 8.98 117.19 30.83 4.45 1,945 None 20.50 8.96
ORMBS 1998 R3(6)........ 8.98 122.50 24.05 3.69 79 13.73 11.71 11.03
ORMBS 1998 R2 BA4(6).... 9.20 89.63 54.01 9.83 139 6.86 13.22 13.48
B4F....... 8.30 19.23 11.01
B5A....... 5.51 23.78 18.41
B5F....... 6.47 11.78 15.66
B5........ 10.16 16.54 8.82
B6A....... None 16.72 15.53
B6F....... None 19.50 22.33
ORMBS 1998 R3 B6(6)..... 8.98 122.50 24.05 3.69 79 None 18.00 1.58
Subprime residuals:
SMBS 1996-3(1).......... 11.24 70.00 19.93 31.74 1,896 10.14 15.52 3.94
MLM1 1996-1(2).......... 11.57 73.36 25.84 32.28 970 12.62 15.16 5.52
MS 1997-1 X1(3)......... 10.45 74.41 17.34 24.89 191 4.51 21.47 13.30
X2............ 20.38 8.60
OML 1(7)................ 14.08 64.00 22.05 22.36 24 Reserve Fund 20.72 29.98
- (pound) 7.0
million
OML 2 DAC IO(7)......... 13.79 65.80 30.95 n/a -- Reserve Fund 28.50 28.50
- (pound)2.5
million
B.......... 12.50 12.50
R.......... 36.50 36.50
S.......... 25.30 25.30
1997 OFS 2 X(4)......... 10.30 74.23 15.51 27.56 121 4.52 19.65 9.70
1997 OFS 3 X(4)......... 10.16 77.77 13.73 19.23 99 3.74 19.59 12.16
1998 OFS 1X(4).......... 10.34 77.14 12.74 18.73 148 2.23 18.00 12.13
1998 OFS 2 X(4)......... 10.82 73.51 8.94 36.43 -- 2.66 19.46 8.16
1998 OFS 3 X(4)......... 10.39 75.64 8.76 11.85 -- 1.09 18.00 13.52
1998 OFS 4 X(4)......... 10.57 76.01 -- -- -- -- 18.00 18.00
MULTI-FAMILY AND COMMERCIAL
Subordinates:
BCF 97-C1 F(5).......... 10.54 2.31 15.16 20.50 -- n/a 10.35 11.99
G............. 15.00 20.27
CMAC 1996 C2 G.......... 8.37 1.29 -- 8.07 -- n/a 11.11 14.60
18.46 31.13
H Interest-only:
CMAC 96 C2 X1 IO(8)..... 8.37 1.29 -- 8.07 -- n/a 54.86 39.01
X2 IO........ 25.94 3.67
BCF 97-C1 X1(3)......... 10.54 2.31 15.16 20.50 -- n/a 6.93 51.95
X2............ 8.53 35.63
E -IO......... 7.00 37.48
30
ISSUERS:
(1) Salomon Brothers Mortgage Securities VII
(2) Merrill Lynch Mortgage Investors, Inc.
(3) Morgan Stanley ABS Capital I, Inc.
(4) Ocwen Mortgage Loan Asset Backed Certificates
(5) BlackRock Capital Finance L.P.
(6) Ocwen Residential MBS Corporation
(7) Ocwen Mortgage Loans
(8) Commercial Mortgage Acceptance Corporation
n/a - not available
The following table sets forth the principal amount of mortgage loans
by the geographic location of the property securing the mortgages that underly
the Company's securities available for sale portfolio at December 31, 1998.
Description California Florida Texas New York Illinois Other (1) Total
----------- ---------- -------- --------- --------- --------- ----------- ----------
(Dollars In Thousands)
Single family residential .. $752,249 $254,751 $ 266,869 $ 226,727 $ 170,015 $ 1,794,782 $3,465,393
Multi-family and commercial 72,260 16,261 3,021 15,701 29,971 83,609 220,823
-------- -------- --------- --------- --------- ----------- ----------
Total ..................... $824,509 $271,012 $ 269,890 $ 242,428 $ 199,986 $ 1,878,391 $3,686,216
======== ======== ========= ========= ========= =========== ==========
Percentage (2) ............ % 22.4 % 7.4 % 7.3 % 6.6 % 5.4 % 50.9 % 100.0
======== ======== ========= ========= ========= =========== ==========
(1) No other individual state makes up more than 5% of the total. See
"Certain Transaction" under Item 13.
(2) Based on a percentage of the total unpaid principal balance of the
underlying loans.
31
The following table summarizes information relating to the Company's
mortgage-related securities available for sale at December 31, 1998.
ANTICIPATED ANTICIPATED
ORIGINAL UNLEVERAGED WEIGHTED
ANTICIPATED YIELD TO AVERAGE
AMORTIZED PERCENT YIELD TO MATURITY AT REMAINING
RATING/DESCRIPTION COST FAIR VALUE OWNED MATURITY 12/31/98(1) COUPON LIFE (2)
SINGLE-FAMILY RESIDENTIAL:
BB-rated subordinates......... $8,517 $8,517 84.27% 13.99% 11.29% 6.99% 6.08%
B-rated subordinates.......... 6,344 6,344 83.95 16.44 11.37 7.04 3.06
Unrated subordinates.......... 37,872 40,595 86.79 14.33 9.89 8.18 3.74
AAA-rated subprime securities. 6,178 6,931 100.00 28.50 28.50 10.90 1.70
BBB-rated subprime securities. 15,681 17,593 100.00 12.50 12.50 9.97 4.54
Unrated subprime residuals ... 141,526 152,951 100.00 24.35 30.78 -- 2.69
MULTI-FAMILY AND COMMERCIAL:
B-rated subordinates.......... 7,684 8,813 85.34 11.05 13.90 8.93 5.23
Unrated subordinates.......... 4,126 7,331 85.34 21.62 26.81 9.15 4.46
AAA-rated interest-only....... 71 71 85.41 4.87 (3.77) 2.02 1.23
BB-rated interest only........ -- 2 85.41 26.00 34.85 2.45 0.07
(1) Changes in the December 31, 1998 anticipated yield to maturity
from that originally anticipated are primarily the result of
changes in prepayment assumptions and to a lesser extent loss
assumptions.
(2) Equals the weighted average duration based off of December 31,
1998 book value.
The following table sets forth the property types of the Company's
commercial mortgage-backed securities at December 31, 1998, based upon the
principal amount.
Percentage
Property type Invested
------------- ----------
Retail........................ 26.3
Multi-family.................. 24.8%
Lodging....................... 18.7
Office........................ 13.1
Warehouse..................... 6.0
Mixed use..................... 6.2
Self storage.................. 1.1
Other......................... 3.8
--------
Total......................... 100.0%
========
The following is a glossary of terms included in the above tables.
ACTUAL DELINQUENCY - Represents the total unpaid principal balance of
loans more than 30 days delinquent at the indicated date as a percentage of the
unpaid principal balance of the collateral at such date.
ACTUAL LIFE-TO-DATE CPR - The Constant Prepayment Rate is used to
measure the average prepayment rate for the underlying mortgage pool(s) over the
period of time lapsed since the issuance of the securities through the date
indicated and is calculated as follows:
_ _
| ( 12 ) |
| ( ---------------- ) |
| ( months in period ) |
| ( 1 - Final Aggregate Balance actual ) |
| ( ---------------------------------- ) |
| ( Final Aggregate Balance scheduled ) |
Actual Life-to-Date CPR = 100 X | |
|_ _|.
ACTUAL LIFE-TO-DATE LOSSES - Represents cumulative losses expressed as
a percentage of the unpaid balance of the original collateral at the indicated
date.
32
CLASS DESIGNATION LETTER - Refers to the credit rating designated by
the rating agency for each securitization transaction. Classes designated "A"
have a superior claim on payment to those rated "B", which are superior to those
rated "C." Additionally, multiple letters have a superior claim to designations
with fewer letters. Thus, for example, "BBB" is superior to "BB," which in turn
is superior to "B." The lower class designations in any securitization will
receive interest payments subsequent to senior classes and will experience
losses prior to any senior class. The lowest potential class designation is not
rated ("NR") which, if included in a securitization, will always receive
interest last and experience losses first. IO securities receive the excess
interest remaining after the interest payments have been made on all senior
classes of bonds based on their respective principal balances. There is no
principal associated with IO securities and they are considered liquidated when
the particular class they are contractually tied to is paid down to zero.
Principal only ("PO") securities receive excess principal payments after the
principal has been made on all classes of bonds based on their respective
payment schedules. There is no interest associated with PO securities and they
are sold at a discount. The return on PO securities is earned through the
receipt of the payments and the collection of the discounted amount.
CLASS SIZE - Represents the percentage size of a particular class
relative to the total outstanding balance of all classes.
COLLATERAL BALANCE - Represents, in the case of residuals, the unpaid
principal balance of the collateral of the entire securities at the indicated
date and, in the case of subordinates, the outstanding principal balance of the
entire securitization at the indicated date.
ISSUE DATE - Represents the date on which the indicated securities were
issued.
OVER-COLLATERIZATION LEVEL - For residual interests in residential
mortgage-backed securities, over-collaterization ("OC") is the amount by which
the collateral balance exceeds the sum of the bond principal amounts. OC is
achieved by applying monthly a portion of the interest payments of the
underlying mortgages toward the reduction of the class certificate principal
amounts, causing them to amortize more rapidly than the aggregate loan balance.
The OC percentage, expressed as a percentage of the outstanding collateral
balance, represents the first tier of loss protection afforded to the
non-residual holders. The OC percentage also determines whether the
over-collaterization target has been satisfied as of a specific date, such that
cash flows to the residual holder are warranted. To the extent not consumed by
losses on more highly rated bonds, OC is remitted to the residual holders.
Reserve funds ("RF") are actual cash reserves expressed as a percentage of the
original collateral balance at issuance.
RATING - Represents the rating, if any, on the security or securities
by the indicated rating agencies.
SECURITIZATION - Series description.
SECURITY - Represents the name of the class associated with each
securitization held by the Company. This has no relationship to a formal rating
but is for identification purposes (although the names are usually in
alphabetical or numeric order from the highest rated to the lowest rated).
SUBORDINATION LEVEL - Represents the credit support for each
mortgage-backed security by indicating the percentage of outstanding bonds whose
right to receive payment is subordinate to the referenced security. The
subordinate classes must experience a complete loss before any additional losses
would affect the particular referenced security.
WEIGHTED AVERAGE DSCR - Represents debt service coverage ratio, which
is calculated by dividing cash flow available for debt service by debt service.
WEIGHTED AVERAGE LTV- Represents the ratio of the loan amount to the
value of the underlying collateral.
YIELD TO MATURITY - Yield to maturity represents a measure of the
average rate of return that is earned on a security if held to maturity.
INVESTMENT SECURITIES. Investment securities amounted to $10.8 million,
$10.8 million and $8.8 million at December 31, 1998, 1997 and 1996,
respectively, and consisted of the Company's required investment in FHLB stock.
As a member of the FHLB of New York, the Bank is required to purchase and
maintain stock in the FHLB of New York in an amount equal to at least 1% of its
aggregate unpaid residential mortgage loans, home purchase contracts and similar
obligations at the beginning of each year or 5% of borrowings, whichever is
greater. Because the Company has the ability and the intent to hold these
securities to maturity they are considered non-marketable equity securities held
for investment and are stated at cost.
TRADING SECURITIES. When securities are purchased with the intent to
resell in the near term, they are classified as trading securities and reported
on the Company's consolidated statement of financial condition as a separately
identified trading account.
33
Securities in this account are carried at fair market value. All trading
securities are marked-to-market, and any increase or decrease in unrealized
appreciation or depreciation is included in the Company's consolidated
statements of operations.
Under guidelines approved by the Board of Directors of the Company, the
Company is authorized to hold a wide variety of securities as trading
securities, including U.S. Government and agency securities and mortgage-backed
and mortgage-related securities. The Company also is authorized by such
guidelines to use various hedging techniques in connection with its trading
activities, as well as to effect short sales of securities, pursuant to which
the Company sells securities which are to be acquired by it at a future date.
Under current guidelines, the amount of securities held by the Company in a
trading account may not exceed on a gross basis the greater of $200 million or
15% of the Company's total assets, and the total net amount of securities
(taking into account any related hedge or buy/sell agreement relating to similar
securities) may not exceed the greater of $150 million or 10% of total assets.
The Company's securities held for trading at December 31, 1996 amounted
to $75.6 million and represented one AAA-rated CMO which was sold in January
1997. The Company held no securities for trading at December 31, 1998 and 1997.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. The Company
invests in low-income housing tax credit interests primarily through limited
partnerships for the purpose of obtaining Federal income tax credits pursuant to
Section 42 of the Code, which provides a tax credit to investors in qualified
low-income rental housing that is constructed, rehabilitated or acquired after
December 31, 1986. To be eligible for housing tax credits, a property generally
must first be allocated an amount of tax credits by the tax credit allocating
agency, which in most cases also serves as the housing finance agency, of the
state in which the property is located. If the property is to be constructed or
rehabilitated, it must be completed and placed in service within a specified
time, generally within two years after the year in which the tax credit
allocation is received. A specified portion of the apartment units in a
qualifying project may be rented only to qualified tenants for a period of 15
years, or a portion of any previously claimed tax credits will be subject to
recapture, as discussed below.
At December 31, 1998, the Company's investment in low-income housing
tax credit interests amounted to $144.2 million or 4% of total assets, as
compared to $128.6 million or 4% of total assets at December 31, 1997, and $93.3
million or 4% of total assets at December 31, 1996. The Company's investments in
low-income housing tax credit interests are made by the Company indirectly
through subsidiaries of the Company, which may be a general partner and/or a
limited partner in the partnership.
In accordance with a 1995 pronouncement of the Emerging Issues Task
Force, the Company's accounting for investments in low-income housing tax credit
partnerships in which it acts solely as a limited partner, which amounted to
$75.9 million in the aggregate at December 31, 1998, depends on whether the
investment was made on or after May 18, 1995.
Low-income housing tax credit partnerships in which the Company,
through a subsidiary, acts as a general partner, are presented on a consolidated
basis. At December 31, 1998, the Company's investment in low-income housing tax
credit interests included $68.3 million of assets related to low-income housing
tax credit partnerships in which a subsidiary of the Company acts as a general
partner. At December 31, 1998, the Company had no commitments to make additional
investments in such partnerships.
The Company also makes loans to low-income housing tax credit
partnerships in which it has invested to construct the affordable housing
project owned by the partnerships. At December 31, 1998, the Company had $15.0
million of construction loans outstanding to low-income housing tax credit
partnerships and commitments to fund an additional $63.4 million of such loans.
Approximately $6.5 million of such funded construction loans at December 31,
1998 were made to partnerships in which subsidiaries of the Company acted as the
general partner and thus were consolidated with the Company for financial
reporting purposes. The risks associated with these construction loans generally
are the same as those made by the Company to unaffiliated third parties. See
"Lending Activities".
The affordable housing projects owned by the low-income housing tax
credit partnerships in which the Company had invested at December 31, 1998 are
geographically located throughout the United States. At December 31, 1998, the
Company's largest investment in a low-income housing tax credit interest was a
$10.0 million investment in a partnership which owned a 170-unit qualifying
project located in Racine, Wisconsin.
At December 31, 1998, the Company had invested in or had commitments to
invest in 47 low-income housing tax credit partnerships, of which 33 had been
allocated tax credits. The Company estimates that the investment in low-income
housing tax credit interests in which it had invested at December 31, 1998 will
provide approximately $299.4 million of tax credits.
During 1998, the Company sold its investment in five low-income housing
tax credit projects which had a carrying value of $28.9 million for gains of
$7.4 million. During 1997, the Company sold an investment in a low-income
housing tax credit interest which had a carrying value of $15.7 million for a
gain of $6.1 million.
34
During 1996, the Company sold $19.8 million of its investments in low-income
housing tax credit interests for a gain of $4.9 million. Depending on available
prices, its ability to utilize tax credits and other factors, the Company may
seek to sell other of its low-income housing tax credit interests in the future.
The ownership of low-income housing tax credit interests produces two
types of tax benefits. The primary tax benefit flows from the low-income housing
tax credits under the Code which are generated by the ownership and operation of
the real property in the manner required to obtain such tax credits. These
credits may be used to offset Federal income tax on a dollar for dollar basis
but may not offset the alternative minimum tax; tax credits thus may reduce the
overall Federal income tax to an effective rate of 20%. In addition, the
operation of the rental properties produces losses for financial statement and
tax purposes in the early years and sometimes throughout the anticipated
ownership period. These tax losses may be used to offset taxable income from
other operations and thereby reduce income tax which would otherwise be paid on
such taxable income.
Tax credits may be claimed over a ten-year period on a straight-line
basis once the underlying multi-family residential properties are placed in
service. Tax credits claimed reduce the tax payments computed based upon taxable
income to not less than the alternative minimum tax computed for that year or
any year not more than three years before or 15 years after the year the tax
credit is earned. The Taxpayer Relief Act of 1997 changed the tax credit
carryback period from 3 years to 1 year and the carry forward period from 15
years to 20 years for credits that become available for use in years beginning
after December 31, 1997. Tax credits are realized even if units in the project
do not continue to be occupied once the units in the project have been initially
rented to a qualifying tenant, and tax credits are not dependent on a project's
operating income or appreciation. Tax credits can be claimed over a ten-year
period and generally can be lost or recaptured only if non-qualifying tenants
are placed in units, ownership of the project is transferred or the project is
destroyed and not rebuilt during a 15-year compliance period for the project.
The Company has established specific investment criteria for investment in
multi-family residential projects which have been allocated tax credits, which
require, among other things, a third party developer of the project and/or the
seller of the interest therein to provide a guarantee against loss or recapture
of tax credits and to maintain appropriate insurance to fund rebuilding in case
of destruction of the project. Notwithstanding the Company's efforts, there can
be no assurance that the multi-family residential projects owned by the
low-income housing tax credit partnerships in which it has invested will satisfy
applicable criteria during the 15-year compliance period and that there will not
be loss or recapture of the tax credits associated therewith.
Investments made pursuant to the affordable housing tax credit program
of the Code are subject to numerous risks resulting from changes in the Code.
For example, the Balanced Budget Act of 1995, which was vetoed by the President
of the United States in December 1995 for reasons which were unrelated to the
tax credit program, generally would have established a sunset date for the
affordable housing tax credit program of the Code for housing placed in service
after December 31, 1997 and would have required a favorable vote by Congress to
extend the credit program. Although this change would not have impacted the
Company's existing investments, other potential changes in the Code, which have
been discussed from time to time, could reduce the benefits associated with the
Company's existing investments in low-income housing tax credit interests,
including the replacement of the current graduated income taxation provisions in
the Code with a "flat tax" based system and increases in the alternative minimum
tax, which cannot be reduced by tax credits. Management of the Company is unable
to predict whether any of the foregoing or other changes to the Code will be
subject to future legislation and, if so, what the contents of such legislation
will be and its effects, if any, on the Company.
SOURCES OF FUNDS
GENERAL. Deposits, FHLB advances, reverse repurchase agreements, lines
of credit, and maturities and payments of principal and interest on loans and
securities and proceeds from the sales and securitizations thereof currently are
the principal sources of funds for use in the Company's investment and lending
activities and for other general business purposes. Management of the Company
closely monitors rates and terms of competing sources of funds on a regular
basis and generally utilizes the sources which are the most cost effective.
DEPOSITS. The primary source of deposits for the Company currently is
brokered certificates of deposit obtained primarily through national investment
banking firms which, pursuant to agreements with the Company, solicit funds from
their customers for deposit with the Company ("brokered deposits"). Such
deposits obtained through national investment banking firms amounted to $1.48
billion or 68% of the Company's total deposits at December 31, 1998. In
addition, during 1995, the Company commenced a program to obtain certificates of
deposit from customers of regional and local investment banking firms which are
made aware of the Company's products by the Company's direct solicitation and
marketing efforts. At December 31, 1998, $242.2 million or 11% of the Company's
deposits were obtained in this manner through over 140 regional and local
investment banking firms. The Company also solicits certificates of deposit from
institutional investors and high net worth individuals identified by the
Company. At December 31, 1998, $135.2 million or 6% of the Company's total
deposits consisted of deposits obtained by the Company from such efforts. The
Company's brokered deposits at December 31, 1998 were net of $9.6 million of
unamortized deferred fees. The amortization of deferred fees is computed using
the interest method and is included in interest expense on certificates of
deposit.
35
The Company believes that the effective cost of brokered and other
wholesale deposits is more attractive to the Company than deposits obtained on a
retail basis from branch offices after the general and administrative expense
associated with the maintenance of branch offices is taken into account.
Moreover, brokered and other wholesale deposits generally give the Company more
flexibility than retail sources of funds in structuring the maturities of its
deposits and in matching liabilities with comparably maturing assets. At
December 31, 1998, $976.7 million or 51% of the Company's certificates of
deposits were scheduled to mature within one year.
Although management of the Company believes that brokered and other
wholesale deposits are advantageous in certain respects, such funding sources,
when compared to retail deposits attracted through a branch network, are
generally more sensitive to changes in interest rates and volatility in the
capital markets and are more likely to be compared by the investor to competing
investments. In addition, such funding sources may be more sensitive to
significant changes in the financial condition of the Company. There are also
various regulatory limitations on the ability of all but well-capitalized
insured financial institutions to obtain brokered deposits. See "Regulation -
The Bank - Brokered Deposits." These limitations currently are not applicable to
the Company because the Bank is a well-capitalized financial institution under
applicable laws and regulations. See "Regulation - The Bank -Regulatory Capital
Requirements." There can be no assurances, however, that the Company will not
become subject to such limitations in the future.
As a result of the Company's reliance on brokered and other wholesale
deposits, significant changes in the prevailing interest rate environment, in
the availability of alternative investments for individual and institutional
investors or in the Company's financial condition, among other factors, could
affect the Company's liquidity and results of operations much more significantly
than might be the case with an institution that obtained a greater portion of
its funds from retail or core deposits attracted through a branch network.
In addition to brokered and other wholesale deposits, the Company
obtains deposits from its office located in New Jersey. These deposits include
non-interest bearing checking accounts, NOW and money market checking accounts,
savings accounts and certificates of deposit and are obtained through
advertising, walk-ins and other traditional means. At December 31, 1998, the
deposits which were allocated to this office amounted to $66.0 million or 3% of
the Company's deposits.
The following table sets forth information related to the Company's
deposits at the dates indicated.
December 31,
---------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- -------------------------
Amount Avg. Rate Amount Avg. Rate Amount Avg. Rate
----------- --------- ---------- --------- ---------- ---------
(Dollars in Thousands)
Non-interest bearing checking
accounts................. $ 233,427 --% $ 130,372 --% $ 96,563 --%
NOW and money market
checking accounts........ 33,272 3.40 27,624 4.73 22,208 2.99
Savings accounts............ 1,326 2.30 1,664 2.30 2,761 2.30
----------- ---------- ----------
268,025 159,660 121,532
----------- ---------- ----------
Certificates of deposit(1).. 1,916,548 1,834,899 1,809,098
Unamortized deferred fees... (9,557) (11,737) (10,888)
------------ ---------- ----------
Total certificates of deposit 1,906,991 5.78 1,823,162 6.00 1,798,210 5.80
----------- ---------- ----------
Total deposits......... $ 2,175,016 5.18 $1,982,822 5.95 $1,919,742 5.47
=========== ========== ==========
(1) At December 31, 1998, 1997 and 1996, certificates of deposit issued on an
uninsured basis amounted to $100.5 million, $133.7 million and $147.5
million, respectively. Of the $100.5 million of uninsured deposits at
December 31, 1998, $47.8 million were from political subdivisions in New
Jersey and secured or collateralized as required under state law.
36
The following table sets forth, by various interest rate categories, the
certificates of deposit in the Company at the dates indicated.
December 31,
--------------------------------------------------
1998 1997 1996
----------- ----------- -----------
(Dollars in Thousands)
2.99% or less.............................. $ 819 $ 841 $ 1,442
3.00-3.50%................................. -- -- 4
3.51-4.50.................................. 3,515 41 1,149
4.51-5.50.................................. 724,241 292,192 595,730
5.51-6.50.................................. 1,006,860 1,300,463 990,621
6.51-7.50.................................. 171,065 229,134 208,774
7.51-8.50.................................. 491 491 490
----------- ----------- -----------
$ 1,906,991 $ 1,823,162 $ 1,798,210
=========== =========== ===========
The following table sets forth the amount and maturities of the
certificates of deposit in the Company at December 31, 1998.
Over Six
Months and One Year
Six Months Less than Through Two Over Two
and Less One Year Years Years Total
------------ ------------ ------------ -------------- ------------
(Dollars in Thousands)
2.99% or less............. $ 819 $ -- $ -- $ -- $ 819
3.00-3.50%................ -- -- -- -- --
3.51-4.50................. 3,030 352 133 -- 3,515
4.51-5.50................. 305,953 169,001 104,209 145,078 724,241
5.51-6.50................. 301,399 122,447 236,637 346,377 1,006,860
6.51-7.50................. 23,100 50,412 25,432 72,122 171,065
7.51-8.50................. 99 196 196 -- 491
------------ ------------ ------------ -------------- ------------
$ 634,400 $ 342,408 $ 366,607 $ 563,577 $ 1,906,991
============ ============ ============ -------------- ============
At December 31, 1998, the Company had $156.6 million of certificates of
deposit in amounts of $100,000 or more outstanding maturing as follows: $56.1
million within three months; $41.9 million over three months through six months;
$15.9 million over six months through 12 months; and $42.7 million thereafter.
BORROWINGS. Through the Bank, the Company obtains advances from the
FHLB of New York upon the security of certain of its residential first mortgage
loans, mortgage-backed and mortgage-related securities and other assets,
including FHLB stock, provided certain standards related to the creditworthiness
of the Bank have been met. FHLB advances are available to member financial
institutions such as the Bank for investment and lending activities and other
general business purposes. FHLB advances are made pursuant to several different
credit programs, each of which has its own interest rate, which may be fixed or
adjustable, and range of maturities.
The Company also obtains funds pursuant to securities sold under
reverse repurchase agreements. Under these agreements, the Company sells
securities (generally mortgage-backed and mortgage-related securities) under an
agreement to repurchase such securities at a specified price at a later date.
Reverse repurchase agreements have short-term maturities (typically 90 days or
less) and are deemed to be financing transactions. All securities underlying
reverse repurchase agreements are reflected as assets in the Company's
consolidated financial statements and are held in safekeeping by broker-dealers.
Beginning in 1997, borrowings of the Company include lines of credit
obtained by OFS to finance its subprime lending as follows: (i) a $200.0 million
secured line of credit, of which $100.0 million was committed, (ii) a $50.0
million secured line of credit, all of which was committed, (iii) a $200.0
million secured line of credit, of which $100.0 million was committed and (iv) a
$100.0 million secured line of credit, none of which was committed, and (v) a
$20.0 million secured residual line of credit, none of which was committed. The
lines of credit mature between March 1999 and July 2001 and bear interest at
rates that float in accordance with designated indices. The terms of the line of
credit agreements contain, among other provisions, requirements for maintaining
certain profitability, defined levels of net worth and debt-to-equity ratios.
For the period ended December 31, 1998, OFS obtained a lender's agreement
waiving compliance with the maintenance of a profitability covenant for one of
OFS' line of credit agreements, with which OFS failed to comply. The agreements
also require annual commitment fees to be paid based on the used and unused
portion of the facilities, as well as a facility fee based on the total
committed amount. Such commitment fees are capitalized and amortized on a
straight-line basis over a twelve-month period. An aggregate of $59.5 million
and $118.3 million was outstanding to OFS under these lines of credit at
December 31, 1998 and 1997, respectively.
37
In connection with the Company's acquisition of substantially all of
the assets of Cityscape UK, Ocwen UK has entered into a Loan Facility Agreement
with Greenwich which provided a short-term facility to finance the acquisition
of Cityscape UK's mortgage loan portfolio and to finance Ocwen UK's further
originations and purchase of subprime single family loans. The Greenwich
Facility is secured by Ocwen UK's loans available for sale. The Revolving
Facility, which matures in April 1999, is set at a maximum of $166.0 million
((pound)100.0 million reduced by the amount borrowed under the Term Loan) of
which $87.1 million ((pound)52.5 million) was funded at December 31, 1998, to
finance subprime single family loan originations and bears interest at a rate of
the one-month LIBOR plus 1.50%. At December 31, 1998, $5.6 million ((pound)3.4
million) had been borrowed under the Term Loan, which matured in January 1999.
In addition, Ocwen UK has entered into a secured warehouse line of credit with
Barclays Bank plc to finance subprime single family loan originations. The
Barclays Facility, which matures in November 1999 and bears interest at a rate
of the one-month LIBOR plus 0.80%, is set at a maximum of $124.5 million
((pound)75.0 million), against which $24.6 million ((pound)14.8 million) had
been borrowed at December 31, 1998.
The Company's borrowings also include notes, subordinated debentures
and other interest-bearing obligations. At December 31, 1998, this category of
borrowings consisted of $100.0 million of 12.000% Subordinated Debentures issued
by the Bank in June 1995 and due 2005 (the "Debentures") and $125.0 million of
11.875% Notes (the "Notes") issued by the Company through a public offering on
September 25, 1996 and due 2003.
The following table sets forth information relating to the Company's
borrowings and other interest-bearing obligations at the dates indicated.
December 31,
--------------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
(Dollars in Thousands)
FHLB advances...................................... $ -- $ -- $ 399
Reverse repurchase agreements...................... 72,051 108,250 74,546
Obligations outstanding under lines of credit...... 179,285 118,304 --
Notes, debentures and other interest bearing
obligations:
Notes......................................... 125,000 125,000 125,000
Debentures.................................... 100,000 100,000 100,000
Hotel mortgages payable....................... -- -- 573
Short-term notes.............................. -- 1,975 --
-------------- -------------- --------------
225,000 226,975 225,573
-------------- -------------- --------------
$ 476,336 $ 453,529 $ 300,518
============== ============== ==============
38
The following table sets forth certain information relating to the
Company's short term borrowings having average balances during any of the
reported periods of greater than 30% of stockholders' equity at the end of the
reported period.
At or for the Year Ended December 31,
----------------------------------------------
1998 1997 1996
----------- ---------- ---------
(Dollars in Thousands)
FHLB ADVANCES:
Average amount outstanding during the period.... $ 2,201 $ 9,482 $ 71,221
Maximum month-end balance outstanding
During the period........................... $ -- $ 399 $ 81,399
Weighted average rate:
During the period............................ 5.45% 5.56% 5.69%
At end of period............................. --% --% 7.02%
OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT:
Average amount outstanding during the period.... $ 481,212 $ 84,272 $ --
Maximum month-end balance outstanding
during the period............................ $ 572,707 $ 267,095 $ --
Weighted average rate:
During the period............................ 7.19% 6.62% --%
At end of period............................. 6.9% 6.32% --%
COMPUTER SYSTEMS AND USE OF TECHNOLOGY
The Company believes that its use of information technology has been a
key factor in achieving success in the acquisition, management and resolution of
discount loans and believes that this technology also has applicability to other
aspects of its business which involve servicing intensive assets, including
subprime residential mortgage lending, servicing of nonperforming or
underperforming loans for third parties and asset management services.
In addition to its standard industry software applications which have
been customized to meet the Company's requirements, the Company has internally
developed fully integrated proprietary applications designed to provide decision
support, automation of decision execution, tracking and exception reporting
associated with the management of nonperforming and underperforming loans. The
Company also has deployed: a predictive dialing solution which permits the
Company to direct the calls made by its collectors to increase the productivity
of the department; an interactive voice response system which provides automated
account information to customers; a document imaging system which permits
immediate access to pertinent loan documents; and a data warehouse which permits
corporate data to be shared on a centralized basis for decision support. The
Company is also implementing electronic commerce initiatives which further
automates the Company's communications with its third party service providers.
The Company's proprietary systems result in a number of benefits
including consistency of service to customers, reduced training periods for
employees, resolution decisions which evaluate on an automated basis the optimal
means to maximize the net resolution proceeds (which may include a variety of
resolution alternatives including placing the borrowers on forbearance plans,
pursuing a pre-approved sale of the property, or completing foreclosure
proceedings), the ability to effect foreclosure as quickly as possible within
state-specific foreclosure timelines and the management of third party service
providers to ensure quality of service. The federal mortgage agencies and
credit-rating agencies have established a variety of measurements for approved
servicers, against which the Company compares favorably. See "Business-Loan
Servicing Activities."
Through its document imaging system, the Company is able to produce
complete foreclosure packages within minutes. The Company believes that the
industry standard generally is to prepare a complete foreclosure package within
sixty days. Delays in the time to resolution result in increased third party
costs, opportunity costs and direct servicing expenses. As a result, the Company
has designed its systems and procedures to move a loan through the foreclosure
process in a timely manner.
The Company has invested in a sophisticated computer infrastructure to
support its software applications. The Company uses an IBM RISC AS400 and
NetFrame and COMPAQ Proliant and SunUNIX 5500 file servers as its primary
hardware platform. The Company uses CISCO Routers, Cabletron Hubs and chassis
with fiber optic cabling throughout and between buildings. The Company also has
deployed a DAVOX predicative dialer which currently has capacity for 120 seats.
The Company's document imaging system currently stores 6 million images. The
Company's systems have significant capacity for expansion and upgrade.
39
The Company protects its proprietary information by developing,
maintaining and enforcing a comprehensive set of information security policies;
by having each employee execute an intellectual property agreement with the
Company, which among other things, prohibits disclosure of confidential
information and provides for the assignment of developments; by affixing a
copyright symbol to copies of any of the Company's proprietary information to
which a third party has access; by emblazoning the start-up screen of any of the
Company's proprietary software with the Company's logo and a copyright symbol;
by having third-party contract employees and consultants execute a contract with
the Company which contains, among other things, confidentiality and assignment
provisions; and by otherwise limiting third-party access to the Company's
proprietary information.
RISK FACTORS
Information related to risk factors which could directly or indirectly,
affect the Company's results of operations and financial condition are included
in Exhibit 99.1 and are incorporated herein by reference.
ECONOMIC CONDITIONS
GENERAL. The success of the Company is dependent to a certain extent
upon the general economic conditions in the geographic areas in which it
conducts substantial business activities. Adverse changes in national economic
conditions or in the economic conditions of regions in which the Company
conducts substantial business likely would impair the ability of the Company to
collect on outstanding loans or dispose of real estate owned and would otherwise
have an adverse effect on its business, including the demand for new loans, the
ability of customers to repay loans and the value of both the collateral pledged
to the Company to secure its loans and its real estate owned. Moreover,
earthquakes and other natural disasters could have similar effects. Although
such disasters have not significantly adversely affected the Company to date,
the availability of insurance for such disasters in California, in which the
Company conducts substantial business activities, is severely limited. At
December 31, 1998, the Company had loans with an unpaid balance aggregating
$243.7 million (including loans available for sale) secured by properties
located in California and $35.7 million of the Company's real estate owned was
located in California, which collectively represent 8.4% of the Company's total
assets at such date.
EFFECTS OF CHANGES IN INTEREST RATES. The Company's operating results
depend to a large extent on its net interest income, which is the difference
between the interest income earned on interest-earning assets and the interest
expense incurred in connection with its interest-bearing liabilities. Changes in
the general level of interest rates can affect the Company's net interest income
by affecting the spread between the Company's interest-earning assets and
interest-bearing liabilities, as well as, among other things, the ability of the
Company to originate loans; the value of the Company's interest-earning assets
and its ability to realize gains from the sale of such assets; the average life
of the Company's interest-earning assets; the value of the Company's mortgage
servicing rights; and the Company's ability to obtain deposits in competition
with other available investment alternatives. Interest rates are highly
sensitive to many factors, including governmental monetary policies, domestic
and international economic and political conditions and other factors beyond the
control of the Company. The Company actively monitors its assets and liabilities
and employs a hedging strategy which seeks to limit the effects of changes in
interest rates on its operations. Although management believes that the
maturities of the Company's assets currently are well balanced in relation to
its liabilities (based on various estimates as to how changes in the general
level of interest rates will impact its assets and liabilities), there can be no
assurance that the profitability of the Company would not be adversely affected
during any period of changes in interest rates.
COMPETITION
The businesses in which the Company is engaged generally are highly
competitive. The acquisition of discount loans is particularly competitive, as
acquisitions of such loans are often based on competitive bidding. The Company
also encounters significant competition in connection with its other lending
activities, its investment and in its deposit-gathering activities. Many of the
Company's competitors are significantly larger than the Company and have access
to greater capital and other resources. In addition, many of the Company's
competitors are not subject to the same extensive federal regulations that
govern federally-insured institutions such as the Bank and their holding
companies. As a result, many of the Company's competitors have advantages over
the Company in conducting certain businesses and providing certain services.
SUBSIDIARIES
Set forth below is a brief description of the operations of the
Company's significant non-banking subsidiaries.
INVESTOR'S MORTGAGE INSURANCE HOLDING COMPANY. Through subsidiaries,
IMI owns an interest in the Westin Hotel in Columbus, Ohio, residential units in
cooperative buildings which are acquired in connection with the foreclosure on
loans held by the Bank or by deed-in-lieu thereof, as well as other real estate
related ventures. During 1997, IMI sold a 69% partnership interest in the Westin
Hotel for a small gain. At December 31, 1998, IMI had a combined ownership of
16.83% of the outstanding common stock of OAC and OPLP units.
40
OCWEN FINANCIAL SERVICES, INC. OFS was formed by the Company under
Florida law in October 1996 for the purpose of purchasing substantially all of
the assets of Admiral, the Company's primary correspondent mortgage banking firm
for subprime single family residential loans, and assuming all of the Bank's
subprime single family residential lending operations. Under the terms of the
acquisition, which closed on May 1, 1997, the Company agreed to pay Admiral $6.8
million and to transfer to Admiral 20% of the voting stock of OFS. In addition,
OFS assumed specified liabilities of Admiral in connection with this
transaction, including a $3.0 million unsecured loan which was made by the Bank
to Admiral at the time OFS entered into the asset acquisition agreement with
Admiral, which loan was repaid with the proceeds from a $30.0 million unsecured,
subordinated credit facility provided by the Company to OFS at the time of the
closing of such acquisition. On December 3, 1997, OCN purchased 2,705 additional
shares of common stock of OFS for $15.0 million, increasing its ownership
percentage from 80% to 93.7%. On March 31, 1998, OCN purchased 7,518 additional
shares of common stock in exchange for $40.0 million, further increasing its
ownership to 97.8%. The value of each share of stock was computed based on total
stockholders' equity at December 31, 1997 divided by the shares of stock
outstanding at that date.
OCWEN CAPITAL CORPORATION. OCC is a wholly-owned subsidiary of the
Company which was formed under Florida law to manage the day-to-day operations
of OAC, subject to supervision by OAC's Board of Directors. The directors and
executive officers of OCC consist solely of William C. Erbey, Chairman,
President and Chief Executive Officer, and other executive officers of the
Company. OAC is a Virginia corporation which elected to be taxed as a REIT under
the Code. In May 1997, OAC conducted an initial public offering of 17,250,000
shares of its common stock, which resulted in net proceeds of $238.8 million,
inclusive of the $27.9 million contributed by the Company for an additional
1,875,000 shares, or 9.8% of the outstanding shares of OAC common stock. The OAC
common stock is traded on the New York Stock Exchange under the symbol "OAC."
Pursuant to a management agreement between OCC and OAC, and subject to
supervision by OAC's Board of Directors, OCC formulates operating strategies for
OAC, arranges for the acquisition of assets by OAC, arranges for various types
of financing for OAC, monitors the performance of OAC's assets and provides
certain administrative and managerial services in connection with the operation
of OAC. For performing these services, OCC receives (i) a base management fee in
an amount equal to 1% of total assets per annum, calculated and paid quarterly
based upon the average invested assets, as defined, by OAC, and (ii) a quarterly
incentive fee in an amount equal to the product of (A) 25% of the dollar amount
by which (1)(a) funds from operations, as defined, per share of OAC common stock
plus (b) gains (or minus losses) from debt restructuring and sales of property
per share of OAC common stock, exceeds (2) an amount equal to (a) the weighted
average of the initial public offering price per share of the OAC common stock
and the prices per share of any secondary offerings of OAC common stock by OAC
multiplied by (b) the ten-year U.S. Treasury rate plus 5% per annum, multiplied
by (B) the weighted average number of shares of OAC common stock outstanding.
The Board of Directors of OAC may adjust the base management fee in the future
if necessary to align the fee more closely with the actual costs of such
services. OCC also may be reimbursed for the costs of certain due diligence
tasks performed by it on behalf of OAC and will be reimbursed for the
out-of-pocket expenses incurred by it on behalf of OAC.
During 1997, the Company transferred the lending operations associated
with its large multi-family residential and commercial real estate loans to OCC.
To date, OCC has emphasized originating loans for OAC (in order to enable OAC to
invest the proceeds from the initial public offering of OAC's common stock) and
not the Company.
OCWEN UK. In April 1998, the Company, through its wholly-owned
subsidiary Ocwen UK, acquired substantially all of the assets, and certain
liabilities of the U.K. operations of Cityscape Financial Corp., an originator
of subprime mortgages. As consummated, the Company acquired Cityscape UK's
mortgage loan portfolio and its residential subprime mortgage loan origination
and servicing businesses.
OCWEN TECHNOLOGY XCHANGE, INC. ("OTX"), a wholly-owned subsidiary of
the Company, is the Company's software solutions subsidiary which was formed in
May 1998 by combining the Company's Information Technology Group and two
previously acquired subsidiaries, AMOS and DTS. OTX designs advances software
solutions for mortgage and real estate transactions, including software systems
for managing the loan servicing cycle.
EMPLOYEES
At December 31, 1998 the Company had 1,462 full time employees. The
employees are not represented by a collective bargaining agreement. Management
considers the Company's employee relations to be satisfactory.
REGULATION
Financial institutions and their holding companies are extensively
regulated under federal and state laws. As a result, the business, financial
condition and prospects of the Company can be materially affected not only by
management decisions and general economic conditions, but also by applicable
statutes and regulations and other regulatory pronouncements and policies
promulgated by regulatory agencies with jurisdiction over the Company and the
Bank, such as the OTS and the FDIC. The effect of such statutes, regulations and
other pronouncements and policies can be significant, cannot be predicted with a
high degree of certainty and can change over time. Moreover, such statutes,
regulations and other pronouncements and policies are intended to protect
depositors and the insurance funds administered by the FDIC and not stockholders
or holders of indebtedness which are not insured by the FDIC.
41
The enforcement powers available to Federal banking regulators are
substantial and include, among other things, the ability to assess civil
monetary penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties, as defined. In general, these enforcement actions must be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with regulatory authorities.
The following discussion and other references to and descriptions of
the regulation of financial institutions contained herein constitute brief
summaries thereof as currently in effect. This discussion is not intended to
constitute, and does not purport to be, a complete statement of all legal
restrictions and requirements applicable to the Company and the Bank and all
such descriptions are qualified in their entirety by reference to applicable
statutes, regulations and other regulatory pronouncements.
THE COMPANY
GENERAL. The Company is a registered savings and loan holding company
under the Home Owner's Loan Act (the "HOLA"). As such, the Company is subject to
regulation, supervision and examination by the OTS.
ACTIVITIES RESTRICTION. There are generally no restrictions on the
activities of a savings and loan holding company, such as the Company, which
holds only one subsidiary savings institution. However, if the Director of the
OTS determines that there is reasonable cause to believe that the continuation
by a savings and loan holding company of an activity constitutes a serious risk
to the financial safety, soundness or stability of its subsidiary savings
institution, the Director may impose such restrictions as are deemed necessary
to address such risk, including limiting: (i) payment of dividends by the
savings institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of unitary savings and loan holding
companies, if the savings institution subsidiary of such a holding company fails
to meet the qualified thrift lender ("QTL") test set forth in OTS regulations,
then such unitary holding company shall become subject to the activities and
restrictions applicable to multiple savings and loan holding companies and,
unless the savings institution requalifies as a QTL within one year thereafter,
shall register as, and become subject to the restriction applicable to, a bank
holding company. See "The Bank-Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisition and where each subsidiary savings institution meets the QTL
test, as set forth below, the activities of the Company and any of its
subsidiaries (other than the Bank or other subsidiary savings institutions)
would thereafter be subject to further restrictions. Among other things, no
multiple savings and loan holding company or subsidiary thereof which is not a
savings institution generally shall commence or continue for a limited period of
time after becoming a multiple savings and loan holding company or subsidiary
thereof any business activity, other than: (i) furnishing or performing
management services for a subsidiary savings institution; (ii) conducting an
insurance agency or escrow business; (iii) holding, managing, or liquidating
assets owned by or acquired from a subsidiary savings institution; (iv) holding
or managing properties used or occupied by a subsidiary savings institution; (v)
acting as trustee under deeds of trust; (vi) those activities authorized by
regulation as of March 5, 1987 to be engaged in by multiple savings and loan
holding companies; or (vii) unless the Director of the OTS by regulation
prohibits or limits such activities for savings and loan holding companies,
those activities authorized by the Federal Reserve Board as permissible for bank
holding companies. Those activities described in clause (vii) above also must be
approved by the Director of the OTS prior to being engaged in by a multiple
savings and loan holding company.
RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS: (i) control of any other savings
institution or savings and loan holding company or substantially all of the
assets thereof; or (ii) more than 5% of the voting shares of a savings
institution or holding company thereof which is not a subsidiary. Except with
the prior approval of the Director of the OTS, no director or officer of a
savings and loan holding company, or person owning or controlling by proxy or
otherwise more than 25% of such company's stock, may acquire control of any
savings institution, other than a subsidiary savings institution, or of any
other savings and loan holding company.
42
The Director of the OTS may approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state only if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office located in the state of the institution to be acquired as of March
5, 1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered savings institutions located in the state where the
acquiring entity is located (or by a holding company that controls such
state-chartered savings institutions).
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between the
Company or any of its non-bank subsidiaries and the Bank are subject to various
restrictions, which are described below under "The Bank-Affiliate Transactions."
THE BANK
GENERAL. The Bank is a federally-chartered savings bank organized under
the HOLA. As such, the Bank is subject to regulation, supervision and
examination by the OTS. The deposit accounts of the Bank are insured up to
applicable limits by the SAIF administered by the FDIC and, as a result, the
Bank also is subject to regulation, supervision and examination by the FDIC.
The business and affairs of the Bank are regulated in a variety of
ways. Regulations apply to, among other things, insurance of deposit accounts,
capital ratios, payment of dividends, liquidity requirements, the nature and
amount of the investments that the Bank may make, transactions with affiliates,
community and consumer lending laws, internal policies and controls, reporting
by and examination of the Bank and changes in control of the Bank.
INSURANCE OF ACCOUNTS. Pursuant to legislation enacted in September
1996, a fee was required to be paid by all SAIF-insured institutions at the rate
of $0.657 per $100 of deposits held by such institutions at March 31, 1995. The
money collected recapitalized the SAIF reserve to the level of 1.25% of insured
deposits as required by law. In 1996, the Bank recorded a pre-tax charge of $7.1
million for this assessment. The recapitalization of the SAIF has resulted in
lower deposit insurance premiums for most SAIF-insured financial institutions,
including the Bank.
Insured institutions also are required to share in the payment of
interest on the bonds issued by a specially created government entity ("FICO"),
the proceeds of which were applied toward resolution of the thrift industry
crisis in the 1980s. Beginning on January 1, 1997, in addition to the insurance
premiums paid by SAIF-insured institutions to maintain the SAIF reserve at its
required level pursuant to the current risk classification system, SAIF-insured
institutions pay deposit insurance premiums at the annual rate of 6.4 basis
points of their insured deposits and BIF-insured institutions will pay deposit
insurance premiums at the annual rate of 1.3 basis points of their insured
deposits towards the payment of interest on the FICO bonds.
Under the current risk classification system, institutions are assigned
to one of three capital groups which are based solely on the level of an
institution's capital--"well capitalized," "adequately capitalized" and
"undercapitalized"--which are defined in the same manner as the regulations
establishing the prompt corrective action system under Section 38 of the FDIA,
as discussed below. These three groups are then divided into three subgroups,
which are based on supervisory evaluations by the institution's primary federal
regulator, resulting in nine assessment classifications. Assessment rates
currently range from 0 basis points for well capitalized, healthy institutions
to 27 basis points for undercapitalized institutions with substantial
supervisory concerns.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Bank's deposit insurance.
REGULATORY CAPITAL REQUIREMENTS. Federally-insured savings associations
are subject to three capital requirements of general applicability: a tangible
capital requirement, a core or leverage capital requirement and a risk-based
capital requirement. All savings associations currently are required to maintain
tangible capital of at least 1.5% of adjusted total assets (as defined in the
regulations), core capital equal to 3% of adjusted total assets and total
capital (a combination of core and supplementary capital) equal to 8% of
risk-weighted assets (as defined in the regulations). For purposes of the
regulation, tangible capital is core capital less all intangibles other than
qualifying purchased mortgage servicing rights, of which the Bank had $3.7
million at December 31, 1998. Core capital includes common stockholders' equity,
non-cumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries and certain
nonwithdrawable accounts and pledged deposits. Core capital generally is reduced
by the amount of a savings association's intangible assets, other than
qualifying mortgage servicing rights.
43
A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital included does not exceed the savings association's core capital.
Supplementary capital consists of certain capital instruments that do not
qualify as core capital, including subordinated debt (such as the Bank's
Debentures) which meets specified requirements, and general valuation loan and
lease loss allowances up to a maximum of 1.25% of risk-weighted assets. In
determining the required amount of risk-based capital, total assets, including
certain off-balance sheet items, are multiplied by a risk weight based on the
risks inherent in the type of assets. The risk weights assigned by the OTS for
principal categories of assets currently range from 0% to 100%, depending on the
type of asset.
OTS policy imposes a limitation on the amount of net deferred tax
assets under SFAS No. 109 that may be included in regulatory capital. (Net
deferred tax assets represent deferred tax assets, reduced by any valuation
allowances, in excess of deferred tax liabilities.) Application of the limit
depends on the possible sources of taxable income available to an institution to
realize deferred tax assets. Deferred tax assets that can be realized from the
following generally are not limited: taxes paid in prior carryback years and
future reversals of existing taxable temporary differences. To the extent that
the realization of deferred tax assets depends on an institution's future
taxable income (exclusive of reversing temporary differences and carryforwards),
or its tax-planning strategies, such deferred tax assets are limited for
regulatory capital purposes to the lesser of the amount that can be realized
within one year of the quarter-end report date or 10% of core capital.
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk
will be subject to a deduction of its interest rate risk component from total
capital for purposes of determining whether it has met the risk-based capital
requirement. As a result, such an institution will be required to maintain
additional capital in order to comply with the risk-based capital requirement.
Although the final rule was originally scheduled to be effective as of January
1994, the OTS has indicated that it will delay invoking its interest rate risk
rule until appeal procedures are implemented and evaluated. The OTS has not yet
established an effective date for the capital deduction. Management of the
Company does not believe that the adoption of an interest rate risk component to
the risk-based capital requirement will adversely affect the Bank if it becomes
effective in its current form.
Effective April 1, 1999, the OTS minimum core capital ratio will
provide that only those institutions with a Uniform Financial Institution Rating
System ("UFIRS") rating of "1" will be subject to a 3% minimum core capital
ratio. All other institutions will be subject to a 4% minimum core capital
ratio. The 3% minimum core capital ratio currently applies to all federal
savings associations.
PROMPT CORRECTIVE ACTION. Federal law provides the Federal banking
regulators with broad power to take "prompt corrective action" to resolve the
problems of undercapitalized institutions. The extent of the regulators' powers
depends on whether the institution in question is "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
or "critically undercapitalized." Under regulations adopted by the Federal
banking regulators, an institution shall be deemed to be: (i) "well capitalized"
if it has a total risk-based capital ratio of 10.0% or more, has a Tier 1
risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratio of
5.0% or more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based
capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized," (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is
less than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances), (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based
capital ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is
less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of
tangible equity to adjusted total assets that is equal to or less than 2.0%. The
regulations also permit the appropriate Federal banking regulator to downgrade
an institution to the next lower category (provided that a significantly
undercapitalized institution may not be downgraded to critically
undercapitalized) if the regulator determines: (i) after notice and opportunity
for hearing or response, that the institution is in an unsafe or unsound
condition or (ii) that the institution has received (and not corrected) a
less-than-satisfactory rating for any of the categories of asset quality,
management, earnings or liquidity in its most recent exam. At December 31, 1998,
the Bank was a "well capitalized" institution under the prompt corrective action
regulations of the OTS.
44
Depending upon the capital category to which an institution is
assigned, the regulators' corrective powers, many of which are mandatory in
certain circumstances, include: prohibition on capital distributions;
prohibition on payment of management fees to controlling persons; requiring the
submission of a capital restoration plan; placing limits on asset growth;
limiting acquisitions, branching or new lines of business; requiring the
institution to issue additional capital stock (including additional voting
stock) or to be acquired; restricting transactions with affiliates; restricting
the interest rates that the institution may pay on deposits; ordering a new
election of directors of the institution; requiring that senior executive
officers or directors be dismissed; prohibiting the institution from accepting
deposits from correspondent banks; requiring the institution to divest certain
subsidiaries; prohibiting the payment of principal or interest on subordinated
debt; and, ultimately, appointing a receiver for the institution.
QUALIFIED THRIFT LENDER TEST. All savings associations are required to
meet the QTL test set forth in the HOLA and regulations of the OTS thereunder to
avoid certain restrictions on their operations. Under the QTL test provisions, a
savings institution must maintain at least 65% of its portfolio assets in
qualified thrift investments. In general, qualified thrift investments include
loans, securities and other investments that are related to housing, small
business and credit card lending, and to a more limited extent, consumer lending
and community service purposes. Portfolio assets are defined as an institution's
total assets less goodwill and other intangible assets, the institution's
business property and a limited amount of the institution's liquid assets. A
savings association that does not meet the QTL test set forth in the HOLA and
implementing regulations must either convert to a bank charter or comply with
the following restrictions on its operations: (i) the association may not engage
in any new activity or make any new investment, directly or indirectly, unless
such activity or investment is permissible for a national bank; (ii) the
branching powers of the association shall be restricted to those of a national
bank; (iii) the association shall not be eligible to obtain any advances from
its FHLB; and (iv) payment of dividends by the association shall be subject to
the rules regarding payment of dividends by a national bank. Upon the expiration
of three years from the date the association ceases to be a QTL, it must cease
any activity and not retain any investment not permissible for a national bank
and immediately repay any outstanding FHLB advances (subject to safety and
soundness considerations). The Bank met the QTL test throughout 1998, and its
qualified thrift investments comprised 68.47% of its portfolio assets at
December 31, 1998.
RESTRICTIONS ON CAPITAL DISTRIBUTIONS. The OTS has promulgated a
regulation governing capital distributions by savings associations, which
include cash dividends, stock redemptions or repurchases, cash-out mergers,
interest payments on certain convertible debt and other transactions charged to
the capital account of a savings association as a capital distribution.
Generally, the regulation creates three tiers of associations based on
regulatory capital, with the top two tiers providing a safe harbor for specified
levels of capital distributions from associations so long as such associations
notify the OTS and receive no objection to the distribution from the OTS.
Associations that do not qualify for the safe harbor provided for the top two
tiers of associations are required to obtain prior OTS approval before making
any capital distributions.
Tier 1 associations may make the highest amount of capital
distributions, and are defined as savings associations that, before and after
the proposed distribution, meet or exceed their fully phased-in regulatory
capital requirements. Tier 1 associations may make capital distributions during
any calendar year equal to the greater of: (i) 100% of net income for the
calendar year-to-date plus 50% of its "surplus capital ratio" at the beginning
of the calendar year; and (ii) 75% of its net income over the most recent
four-quarter period. The "surplus capital ratio" is defined to mean the
percentage by which the association's ratio of total capital to assets exceeds
the ratio of its fully phased-in capital requirement to assets, and "fully
phased-in capital requirement" is defined to mean an association's capital
requirement under the statutory and regulatory standards applicable on December
31, 1994, as modified to reflect any applicable individual minimum capital
requirement imposed upon the association. At December 31, 1998, the Bank was a
Tier 1 association under the OTS capital distribution regulation.
The OTS recently published amendments to its capital distribution
regulation which become effective April 1, 1999. Under the revised regulation,
the Bank will be required to file either an application or a notice with the OTS
at least 30 days prior to making a capital distribution. The OTS may deny the
Bank's application or disapprove its notice if the OTS determines that (a) the
Bank will be "undercapitalized," "significantly undercapitalized" or "critically
under capitalized," as defined in the OTS capital regulations, following the
capital distribution, (b) the proposed capital distribution raises safety and
soundness concerns or (c) the proposed capital distribution violates a
prohibition contained in any statute, regulation or agreement between the Bank
and the OTS or a condition imposed on the Bank in an application or notice
approved by the OTS.
LOAN-TO-ONE BORROWER. Under applicable laws and regulations, the amount
of loans and extensions of credit which may be extended by a savings institution
such as the Bank to any one borrower, including related entities, generally may
not exceed the greater of $500,000 or 15% of the unimpaired capital and
unimpaired surplus of the institution. Loans in an amount equal to an additional
10% of unimpaired capital and unimpaired surplus also may be made to a borrower
if the loans are fully secured by readily marketable collateral. An
institution's "unimpaired capital and unimpaired surplus" includes, among other
things, the amount of its core capital and supplementary capital included in its
total capital under OTS regulations.
45
At December 31, 1998, the Bank's unimpaired capital and surplus
amounted to $345.8 million, resulting in a general loans-to-one borrower
limitation of $51.9 million under applicable laws and regulations. See "Discount
Loan Acquisition and Resolution Activities-Composition of the Discount Loan
Portfolio" and "Lending Activities-Composition of Loan Portfolio."
BROKERED DEPOSITS. Under applicable laws and regulations, an insured
depository institution may be restricted in obtaining, directly or indirectly,
funds by or through any "deposit broker," as defined, for deposit into one or
more deposit accounts at the institution. The term "deposit broker" generally
includes any person engaged in the business of placing deposits, or facilitating
the placement of deposits, of third parties with insured depository institutions
or the business of placing deposits with insured depository institutions for the
purpose of selling interests in those deposits to third parties. In addition,
the term "deposit broker" includes any insured depository institution that is
well-capitalized, and any employee of any such insured depository institution,
which engages, directly or indirectly, in the solicitation of deposits by
offering rates of interest (with respect to such deposits) which are
significantly higher than the prevailing rates of interest on deposits offered
by other insured depository institutions having the same type of charter in such
depository institution's normal market area. As a result of the definition of
"deposit broker," all of the Bank's brokered deposits, as well as possibly its
deposits obtained through customers of regional and local investment banking
firms and the deposits obtained from the Bank's direct solicitation efforts of
institutional investors and high net worth individuals, are potentially subject
to the restrictions described below. Under FDIC regulations, well-capitalized
institutions are not subject to the brokered deposit limitations, while
adequately capitalized institutions are able to accept, renew or roll over
brokered deposits only: (i) with a waiver from the FDIC; and (ii) subject to the
limitation that they do not pay an effective yield on any such deposit which
exceeds by more than (a) 75 basis points, the effective yield paid on deposits
of comparable size and maturity in such institution's normal market area for
deposits accepted in its normal market area or (b) 120% for retail deposits and
130% for wholesale deposits, respectively, of the current yield on comparable
maturity U.S. Treasury obligations for deposits accepted outside the
institution's normal market area. Undercapitalized institutions are not
permitted to accept brokered deposits and may not solicit deposits by offering
an effective yield that exceeds by more than 75 basis points the prevailing
effective yields on insured deposits of comparable maturity in the institution's
normal market area or in the market area in which such deposits are being
solicited. At December 31, 1998, the Bank was a well-capitalized institution
which was not subject to restrictions on brokered deposits. See "Business -
Sources of Funds - Deposits."
LIQUIDITY REQUIREMENTS. All savings associations are required to
maintain an average daily balance of liquid assets, which include specified
short-term assets and certain long-term assets, equal to a certain percentage of
the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. In November 1997, the OTS amended its
liquidity regulations to, among other things, provide that a savings association
shall maintain liquid assets of not less than 4% of the amount of its liquidity
base at the end of the preceding calendar quarter as well as to provide that
each savings association must maintain sufficient liquidity to ensure its safe
and sound operation. Prior to November 1997, the required liquid asset ratio was
5%. Historically, the Bank has operated in compliance with these requirements.
AFFILIATE TRANSACTIONS. Under federal law and regulation, transactions
between a savings association and its affiliates are subject to quantitative and
qualitative restrictions. Affiliates of a savings association include, among
other entities, companies that control, are controlled by or are under common
control with the savings association. As a result, the Company, OAC and the
Company's non-bank subsidiaries are affiliates of the Bank.
Savings associations are restricted in their ability to engage in
"covered transactions" with their affiliates. In addition, covered transactions
between a savings association and an affiliate, as well as certain other
transactions with or benefiting an affiliate, must be on terms and conditions at
least as favorable to the savings association as those prevailing at the time
for comparable transactions with non-affiliated companies. Savings associations
are required to make and retain detailed records of transactions with
affiliates.
Notwithstanding the foregoing, a savings association is not permitted
to make a loan or extension of credit to any affiliate unless the affiliate is
engaged only in activities the Federal Reserve Board has determined to be
permissible for bank holding companies. Savings associations also are prohibited
from purchasing or investing in securities issued by an affiliate, other than
shares of a subsidiary.
Savings associations are also subject to various limitations and
reporting requirements on loans to insiders. These limitations require, among
other things, that all loans or extensions of credit to insiders (generally
executive officers, directors or 10% stockholders of the institution) or their
"related interests" be made on substantially the same terms (including interest
rates and collateral) as, and follow credit underwriting procedures that are not
less stringent than, those prevailing for comparable transactions with the
general public and not involve more than the normal risk of repayment or present
other unfavorable features.
46
COMMUNITY INVESTMENT AND CONSUMER PROTECTIONS LAWS. In connection with
its lending activities, the Bank is subject to a variety of federal laws
designed to protect borrowers and promote lending to various sectors of the
economy and population. Included among these are the Federal Home Mortgage
Disclosure Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act,
Equal Credit Opportunity Act, Fair Credit Reporting Act and the Community
Reinvestment Act.
SAFETY AND SOUNDNESS. Other regulations include: (i) real estate
lending standards for insured institutions, which provide guidelines concerning
loan-to-value ratios for various types of real estate loans; (ii) risk-based
capital rules to account for interest rate risk, concentration of credit risk
and the risks posed by "non-traditional activities;" (iii) rules requiring
depository institutions to develop and implement internal procedures to evaluate
and control credit and settlement exposure to their correspondent banks; and
(iv) rules addressing various "safety and soundness" issues, including
operations and managerial standards, standards for asset quality, earnings and
stock valuations, and compensation standards for the officers, directors,
employees and principal stockholders of the insured institution.
FEDERAL TAXATION
GENERAL. The Company and all of its domestic subsidiaries currently
file, and expect to continue to file, a consolidated Federal income tax return
based on a calendar year. Prior to October 1, 1996, IMI and its subsidiaries
filed a separate Federal consolidated tax return. Ocwen UK is a foreign entity
owned by the Company that is not included in the consolidated federal income tax
return but files its own tax return in the United Kingdom. Consolidated returns
have the effect of eliminating inter-company transactions, including dividends,
from the computation of taxable income.
ALTERNATIVE MINIMUM TAX. In addition to the regular corporate income
tax, corporations, including qualifying savings institutions, are subject to an
alternative minimum tax. The 20% tax is computed on Alternative Minimum Taxable
Income ("AMTI") and applies if it exceeds the regular tax liability. AMTI is
equal to regular taxable income with certain adjustments. For taxable years
beginning after 1989, AMTI includes an adjustment for 75% of the excess of
"adjusted current earnings" over regular taxable income. Net operating loss
carrybacks and carryforwards are permitted to offset only 90% of AMTI.
Alternative minimum tax paid can be credited against regular tax due in later
years.
TAX RESIDUALS. From time to time, the Company acquires REMIC residuals
or retains residual securities in REMICs which were formed by the Company in
connection with the securitization and sale of loans. Although a tax residual
may have little or no future economic cash flows from the REMIC from which it
has been issued, the tax residual does bear the income tax liability or benefit
resulting from the difference between the interest rate paid on the securities
by the REMIC and the interest rate received on the mortgage loans held by the
REMIC. This generally results in taxable income for the Company in the first
several years of the REMIC and equal amounts of tax deductions thereafter. The
Company receives cash payments in connection with the acquisition of tax
residuals to compensate the Company for the time value of money associated with
the tax payments related to these securities and the costs of modeling,
recording, monitoring and reporting the securities. The Company defers all fees
received and recognizes such fees in interest income on a level yield basis over
the expected life of the deferred tax asset related to tax residuals. The
Company also adjusts the recognition in interest income of fees deferred based
upon the changes in the actual prepayment rates of the underlying mortgages held
by the REMIC and periodic reassessments of the expected life of the deferred tax
asset related to tax residuals. At December 31, 1998, the Company's gross
deferred tax assets included $5.3 million which was attributable to the
Company's tax residuals and related deferred income.
INVESTMENTS IN LOW-INCOME HOUSING TAX CREDIT INTERESTS. For a
discussion of the tax effects of investments in low-income housing tax credit
interests, see "Business-Investment Activities-Investment in Low-Income Housing
Tax Credit Interests."
EXAMINATIONS. The most recent examination by the IRS of the Company's
Federal income tax return was of the tax return filed for 1996. The statute of
limitations has run with respect to 1994 and all prior tax years. Thus, the
Federal income tax returns for the years 1995 through 1997 are open for
examination. Management of the Company does not anticipate any material
adjustments as a result of any examination, although there can be no assurances
in this regard.
STATE TAXATION
The Company's income is subject to tax by the States of Florida and
California, which have statutory tax rates of 5.5% and 10.84%, respectively, and
is determined based on certain apportionment factors. The Company is taxed in
New Jersey on income, net of expenses, earned in New Jersey at a statutory rate
of 3.0%. No state return of the Company has been examined, and no notification
has been received by the Company that any state intends to examine any of the
Company's tax returns.
47
ITEM 2. PROPERTIES
The following table sets forth information relating to the Company's
facilities at December 31, 1998.
Net Book Value of
Leasehold
Improvements
Location Owned/Leased (Dollars in Thousands)
- - ----------------------------------------------- ------------ ----------------------
Executive offices:
1675 Palm Beach Lakes Blvd.
West Palm Beach, FL....................... Leased $ 6,066
Main office:
2400 Lemoine Ave
Fort Lee, NJ.............................. Leased $ 17
Foreign offices (Ocwen UK):
St. David's Court
Union Street
Wolverhampton, United Kingdom............. Leased $ --
Malvern House
Croxley Business Park
Watford, Hertfordshire
United Kingdom............................ Leased $ --
In addition to the above offices, OFS maintained 25 loan production
offices in 4 states of December 31, 1998. These offices are operated pursuant to
leases with up to three-year terms, each of which can be readily replaced on
commercially reasonable terms. Also, the Company is currently constructing a
national loan servicing center in Orlando, Florida which will have capacity for
900 loan servicing representatives per shift upon planned completion in the
summer of 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently not involved in any material litigation. To
the Company's knowledge, no material litigation is currently threatened against
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
48
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Information required by this Item appears under the caption
"Shareholder Information" on page 96 of the Annual Report to Stockholders and is
incorporated herein by reference.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION
Information required by this Item appears under the caption "Selected
Consolidated Financial Information" on pages 18 to 19 of the Annual Report to
Stockholders and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Information required by this Item appears under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 21 to 43 of the Annual Report to Stockholders and is
incorporated herein by reference.
49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item appears under the caption "Asset and
Liability Management" on pages 36 to 40, "Note 1: Summary of Significant
Accounting Policies" on pages 52 to 58 and "Note 21: Derivative Financial
Instruments" on pages 79 to 80 of the Annual Report to Stockholders and is
incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS
Information required by this Item appears on pages 45 to 95 in the
Annual Report to Stockholders and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS
The following table sets forth certain information concerning the
directors of the Company.
Name Age (1) Director Since
----------------------------------------------------------- ------- --------------
William C. Erbey........................................... 49 1988
Hon. Thomas F. Lewis....................................... 74 1997
W.C. Martin................................................ 50 1996
Howard H. Simon............................................ 58 1996
Barry N. Wish.............................................. 57 1988
(1) As of March 15, 1999.
The principal occupation for the last five years of each director of
the Company, as well as some other information, is set for the below.
WILLIAM C. ERBEY. Mr. Erbey has served as the Chairman of the Board of
Directors of the Company since September 1996, as the Chief Executive Officer of
the Company since January 1988, as the Chief Investment Officer of the Company
since January 1992, and as the President of the Company from January 1988 to May
1988. Mr. Erbey has served as the Chairman of the Board of Directors of the Bank
since February 1988 and as the Chief Executive Officer of the Bank since June
1990. Mr. Erbey has served as the Chairman and Chief Executive Officer of OAC
since February 1997. He also serves as a director and officer of many
subsidiaries of the Company and OAC. From 1983 to 1995, Mr. Erbey served as a
Managing General Partner of The Oxford Financial Group ("Oxford"), a private
investment partnership that was the predecessor of the Company. From 1975 to
1983, Mr. Erbey served at General Electric Capital Corporation ("GECC") in
various capacities, most recently as the President and Chief Operating Officer
of General Electric Mortgage Insurance Corporation. Mr. Erbey also served as the
Program General Manager of GECC's Commercial Financial Services Department and
as the President of Acquisition Funding Corporation. He received a Bachelor of
Arts in Economics from Allegheny College and a Master's degree from the Harvard
Graduate School of Business Administration.
HON. THOMAS F. LEWIS. Mr. Lewis has served as a director of the Company
and of the Bank since May 1997. Mr. Lewis served as a United States Congressman,
representing the 12th District of Florida from 1983 to 1995. Mr. Lewis served in
the House and Senate of the Florida State Legislature at various times. Mr.
Lewis is a principal of Lewis Properties, Vice President of Marian V. Lewis Real
Estate and Investments and a director of T&M Ranch & Nursery.
50
He currently is Chairman of the Board of Directors of the U.S. Department of
Veterans Affairs and Research Foundation. He is also a member of the Economic
Council of Palm Beach County. Mr. Lewis formerly served as a United States
delegate to the North Atlantic Treaty Organization and as a member of the
Presidents Advisory Commission on Global Trade Policies. He attended the
University of Florida and holds an Associate's Degree from Palm Beach Junior
College, a Certificate in Engineering from the Massachusetts Institute of
Technology and honorary doctorates from the Florida Institute of Technology and
Nova University.
W.C. MARTIN. Mr. Martin has served as a director of the Company since
July 1996 and of the Bank since June 1996. Since 1982, Mr. Martin has been
associated with Holding Capital Group ("HCG") and has been engaged in the
acquisition and turnaround of business in a broad variety of industries. Since
March 1993, Mr. Martin also has served as President and Chief Executive Officer
of SV Microwave, a company he formed along with other HCG investors to acquire
the assets of the former Microwave Division of Solitron Devices, Inc. Prior to
1982, Mr. Martin was a Manager in Touche Ross & Company's Management Consulting
Division, and prior to that he held positions in financial management with
Chrysler Corporation. Mr. Martin received a Masters of Business Administration
from Notre Dame and a Bachelor of Science in Industrial Management from LaSalle
University.
HOWARD H. SIMON. Mr. Simon has served as a director of the Company
since July 1996 and of the Bank since 1987. Mr. Simon is the Managing Director
of Simon, Master & Sidlow, P.A., a certified public accounting firm which Mr.
Simon founded in 1978 and which is based in Wilmington, Delaware. Mr. Simon is a
past Chairman and current member of the Board of Directors of CPA Associates
International, Inc. Prior to 1978, Mr. Simon was a Partner of Touche Ross &
Company. Mr. Simon is a Certified Public Accountant in the State of Delaware and
a graduate of the University of Delaware.
BARRY N. WISH. Mr. Wish has served as Chairman, Emeritus of the Board
of Directors of the Company since September 1996, and he previously served as
Chairman of the Board of the Company from January 1988 to September 1996. Mr.
Wish has served as a director of the Bank since February 1988. From 1983 to
1995, he served as a Managing General Partner of Oxford, which he founded. From
1979 to 1983, he was a Managing General Partner of Walsh, Greenwood, Wish & Co.,
a member firm of the New York Stock Exchange. Prior to founding that firm, Mr.
Wish was a Vice President and shareholder of Kidder, Peabody & Co., Inc. He is a
graduate of Bowdoin College.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth certain information with respect to each
person who currently serves as an executive officer of the Company but does not
serve on the Company's Board of Directors. Executive officers of the Company are
elected annually by the Board of Directors and generally serve at the discretion
of the Board. There are no arrangements or understandings between the Company
and any person pursuant to which such person was elected as an executive officer
of the Company. Other than William C. Erbey and John R. Erbey, who are brothers,
no director or executive officer is related to any other director or executive
officer of the Company or any of its subsidiaries by blood, marriage or
adoption.
Name Age(1) Position
------------------------------------ ----------- ---------------------------------------------------------------------------
John R. Barnes...................... 56 Senior Vice President
Joseph A. Dlutowski................. 34 Senior Vice President of the Bank and Chief Executive Officer of Ocwen UK
John R. Erbey....................... 58 Senior Managing Director, General Counsel and Secretary
Ronald M. Faris..................... 36 Executive Vice President
Christine A. Reich.................. 37 President
Mark S. Zeidman..................... 47 Senior Vice President and Chief Financial Officer
(1) As of March 15, 1999.
The background for the last five years of each executive officer of the
Company who is not a director, as well as certain other information, is set
forth below.
JOHN R. BARNES. Mr. Barnes has served as a Senior Vice President of the
Company and the Bank since May 1994 and served as a Vice President of the
Company and the Bank from October 1989 to May 1994. Mr. Barnes also has served
as Senior Vice President of OAC since February 1997 and serves as an officer of
many subsidiaries of the Company and OAC. Mr. Barnes was a Tax Partner in the
firm of Deloitte Haskins & Sells from 1986 to 1989 and in the firm of Arthur
Young & Co. from 1979 to 1986. Mr. Barnes was the Partner in Charge of the
Cleveland Office Tax Department of Arthur Young & Co. from 1979 to 1984. He is a
graduate of Ohio State University.
51
JOSEPH A. DLUTOWSKI. Mr. Dlutowski has served as Senior Vice President
of the Bank since March 1997 and as Chief Executive Officer of Ocwen UK since
April 1998. Mr. Dlutowski also served as Senior Vice President of the Company
from May 1997 to May 1998 and of OAC from February 1997 to May 1998. He joined
the Bank in October 1992 and served as a Vice President from May 1993 until
March 1997. From 1989 to 1991, Mr. Dlutowski was associated with the law firm of
Baker and Hostetler. He holds a Bachelor of Science degree from the Wharton
School of Business at the University of Pennsylvania and a Master of Business
and a Juris Doctor from the University of Pittsburgh.
JOHN R. ERBEY. Mr. Erbey has served as Senior Managing Director of the
Company since May 1998, as Secretary of the Company since June 1989, as a
Managing Director of the Company from January 1993 to May 1998, and as Senior
Vice President of the Company from June 1989 until January 1993. Mr. Erbey has
served as a director of the Bank since 1990, as a Senior Managing Director of
the Bank since May 1998, and as Secretary of the Bank since July 1989. Mr. Erbey
also has served as Senior Managing Director of OAC since May 1998 and as
Secretary of OAC since February 1997. He also serves as an officer and/or a
director of many subsidiaries of the Company and OAC. From 1971 to 1989, Mr.
Erbey was a member of the Law Department of Westinghouse Electric Corporation
and held various management positions, including Associate General Counsel and
Assistant Secretary from 1984 to 1989. Previously, he held the positions of
Assistant General Counsel of the Industries and International Group and
Assistant General Counsel of the Power Systems Group of Westinghouse. He is a
graduate of Allegheny College and Vanderbilt University School of Law.
RONALD M. FARIS. Mr. Faris has served as Executive Vice President of
the Company and the Bank since May 1998, as a Senior Vice President of the Bank
from May 1997 to May 1998, as Vice President and Chief Accounting Officer of the
Company from June 1995 to May 1998 and of the Bank from July 1994 to May 1997.
From March 1991 to July 1994 he served as Controller for a subsidiary of the
Company. From 1986 to 1991, Mr. Faris was a Vice President with Kidder, Peabody
& Co., Inc., and from 1984 to 1986 worked in the General Audit Department of
Price Waterhouse. He holds a Bachelor of Science from Pennsylvania State
University and is a Certified Public Accountant.
CHRISTINE A. REICH. Ms. Reich has served as President of the Company
since May 1998, as a Managing Director of the Company from June 1994 to May
1988, as Chief Financial Officer of the Company from January 1990 to May 1997,
as a Senior Vice President of the Company from January 1993 until June 1994 and
as a Vice President of the Company from January 1990 until January 1993. Ms.
Reich has served as a director of the Bank since June 1993 and as the President
of the Bank since May 1998. From 1987 to 1990, Ms. Reich served as an officer of
another subsidiary of the Company. Ms. Reich has served as the President and a
director of OAC since February 1997. Ms. Reich also serves as an officer and/or
a director of many subsidiaries of the Company and OAC. Prior to 1987, Ms. Reich
was employed by KPMG Peat Marwick LLP, most recently in the position of Manager.
She holds a Bachelor of Science in Accounting from the University of Southern
California.
MARK S. ZEIDMAN. Mr. Zeidman has served as Senior Vice President and
Chief Financial Officer of the Company and the Bank since May 1997. Mr. Zeidman
also has served as Senior Vice President and Chief Financial Officer of OAC
since June 1997 and serves as an officer of many subsidiaries of the Company and
OAC. From 1986 until May 1997, Mr. Zeidman was employed by Nomura Securities
International, Inc., most recently as Managing Director. Prior to 1986, he held
positions with Shearson Lehman Brothers and Coopers & Lybrand. Mr. Zeidman is a
Certified Public Accountant. He holds a Bachelor of Arts degree from the
University of Pennsylvania, a Master of International Affairs from Columbia
University and a Master of Business Administration from the Wharton School of
Business at the University of Pennsylvania.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's executive officers and directors, and persons who own
more than 10% of the Common Stock, to file reports of ownership and changes in
ownership with the Commission. Officers, directors and greater than 10%
shareholders are required by Commission regulations to furnish the Company with
copies of all Section 16(a) forms they file. Specific due dates for these
reports have been established by the Commission, and the Company is required to
report any failure to timely file such reports by those due dates during the
1998 fiscal year.
To the Company's knowledge, based solely upon review of the copies of
such reports furnished to the Company and written representations that no other
reports were required, all Section 16(a) filing requirements applicable to its
officers, directors and greater than 10% shareholders were complied with during
1998.
52
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table discloses compensation received by the Company's
chief executive officer and the four other most highly paid directors and
executive officers of the Company for the years indicated.
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------------------- --------------------------------------
AWARDS PAYOUTS
-------------------------- -------
NUMBER OF
SECURITIES ALL
RESTRICTED UNDERLYING OTHER
STOCK OPTIONS LTIP COMPEN-
NAME AND POSITION YEAR SALARY BONUS (1) AWARDS (#)(2) PAYOUTS SATION (4)
- - -------------------------------- ---- -------- ---------- ---------- ----------- ------- ----------
William C. Erbey................ 1998 $357,499 $ 197,438 -- 14,143(3) -- $10,000
Chairman of the Board and 1997 150,000 1,300,000 -- 235,756 -- 3,000
Chief Executive Officer 1996 150,000 650,000 -- 115,790 -- 3,000
Christine A. Reich.............. 1998 317,976 175,500 -- 12,572(3) -- 10,000
President 1997 150,000 850,000 -- 147,348 -- 3,000
1996 150,000 487,500 -- 163,158 -- 3,000
John R. Erbey................... 1998 298,214 329,063 -- 15,715(3) -- 10,000
Senior Managing Director 1997 150,000 925,000 -- 162,083 -- 3,000
and Secretary 1996 150,000 525,000 -- 178,948 -- 3,000
Ronald M. Faris................. 1998 218,916 219,933 -- 11,524(3) -- 10,000
Executive Vice President
Joseph A. Dlutowski............. 1998 297,916 223,988 -- 7,483(3) -- 10,000
Chief Executive Officer 1997 120,673 300,000 -- 39,293 -- 3,000
of Ocwen UK and Senior
Vice President of the Bank
(1) Consists of bonuses paid pursuant to the Company's 1998 Annual Incentive
Plan in the first quarter of the following year for services rendered in
the year indicated.
(2) Consists of options granted pursuant to the Company's 1991 Non-Qualified
Stock Option Plan, as amended (the "Stock Option Plan").
(3) Consists of grants made as of January 31, 1999 for services rendered in
1998.
(4) Consists of contributions by the Company pursuant to the Company's 401(k)
Savings Plan.
53
OPTION GRANTS FOR 1998
The following table provides information relating to option grants made
pursuant to the Company's 1991 Stock Option Plan in January 1999 to the
individuals named in the Summary Compensation Table for services rendered in
1998.
PERCENT OF
SECURITIES
NO. OF UNDERLYING
SECURITIES TOTAL POTENTIAL REALIZABLE VALUE AT ASSUMED
UNDERLYING OPTIONS RATES OF STOCK PRICE APPRECIATION
OPTION GRANTED TO EXERCISE FOR OPTION TERM (3)
GRANTED EMPLOYEES PRICE EXPIRATION -------------------------------------
NAME (#)(1) (2) (%) (2) ($/SH) DATE 0%($) 5%($) 10%($)
------------------------ ----------- ----------- -------- ---------- ------- -------- -------
William C. Erbey........ 14,143 7.8 12.3125 1/31/09 -- 109,573 277,592
Christine A. Reich...... 12,572 6.9 12.3125 1/31/09 -- 97,402 246,757
John R. Erbey........... 15,715 8.6 12.3125 1/31/09 -- 121,752 308,446
Ronald M. Faris......... 11,524 6.3 12.3125 1/31/09 -- 89,282 226,187
Joseph A. Dlutowski..... 7,483 4.1 12.3125 1/31/09 -- 57,975 146,873
(1) All options are to purchase shares of Common Stock, and one third vests
and becomes exercisable on each of January 31, 1999, 2000 and 2001.
(2) Indicated grants were made in January 1999 for services rendered in
1998. The percentage of securities underlying these options to the
total number of securities underlying all options granted to employees
of the Company is based on options to purchase a total of 181,945
shares of Common Stock granted to employees of the Company under the
Stock Option Plan as of January 31, 1999.
(3) Assumes future prices of shares of Common Stock of $12.3125, $20.06 and
$31.94 at compounded rates of return of 0%, 5% and 10%, respectively.
AGGREGATED OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES
The following table provides information relating to option exercises
in 1998 by the individuals named in the Summary Compensation Table and the value
of each such individual's unexercised options at December 31, 1998.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
NUMBER OF UNDERLYING UNEXERCISED OPTIONS AT IN-THE MONEY OPTIONS AT
SHARES DECEMBER 31, 1998 (1) DECEMBER 31, 1998 (2)
ACQUIRED VALUE --------------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- - ---- ----------- -------- ----------- ------------- ----------- -------------
William C. Erbey..................... -- -- 467,336 14,143 $303,949 $ --
Christine A. Reich................... 163,158 2,528,949 147,348 12,572 -- --
John R. Erbey........................ -- -- 430,031 15,715 1,074,362 --
Ronald M. Faris...................... -- -- 60,345 11,524 27,631 --
Joseph A. Dlutowski.................. -- -- 20,870 7,483 80,874 --
(1) All options are to purchase shares of Common Stock and were granted
pursuant to the Stock Option Plan. Options listed as "exercisable"
consist of options granted in or prior to January 1998 which became
exercisable in or prior to January 1999. Options listed as
"unexercisable" consist of options granted in January 1999 which become
exercisable in January 2000.
(2) Based on the $12.3125 closing price of a share of Common Stock on the
New York Stock Exchange on December 31, 1998.
54
LONG-TERM INCENTIVE PLANS - AWARDS IN 1998
The following table provides information relating to basis points
awards made pursuant to the Company's Long-Term Incentive Plan (the "LTIP") to
the individuals named in the Summary Compensation Table.
ESTIMATED FUTURE PAYOUTS UNDER
NON-STOCK PRICE-BASED PLANS (1)
-------------------------------
NUMBER OF
BASIS POINTS
NAME AWARDED IN 1998 THRESHOLD TARGET
- - ---------------------------------- ---------------- --------- ------
William C. Erbey................. 15 $2,679,000 $3,855,000
John R. Erbey.................... 15 2,679,000 3,855,000
Christine A. Reich............... 15 2,679,000 3,855,000
Ronald M. Faris.................. 15 2,679,000 3,855,000
Joseph A. Dlutowski.............. 10 1,786,000 2,570,000
(1) Payout figures are for the entire five year performance period, which
runs from January 1, 1998 to December 31, 2002 (the "Performance
Period"). The maximum value of Basis Points that may be earned by any
LTIP participant for any Performance Period is $25 million.
The value of Basis Points awards under the LTIP (the "Basis Points
Awards") is tied to the Company's achievement of specified levels of return on
equity and growth in earnings per share during the Performance Period. The
threshold amount will be earned if average return on equity and average annual
growth in earnings per share are each five percentage points below their
respective target levels. The Basis Points Awards are subject to complete
forfeiture upon termination and partial forfeiture in any year certain personal
performance goals are not achieved. At the end of the Performance Period, the
Company will pay to the LTIP participants, as more fully described below, Basis
Points Awards in the form of shares of restricted stock based on the fair market
value of the Common Stock on the last day of the Performance Period. Ten percent
of the shares received shall vest on each of the first ten anniversaries of the
last day of the Performance Period. Upon vesting, the shares received shall be
automatically placed into a nonqualified irrevocable trust established by the
Company for the benefit of the recipient (the "Deferred Compensation Trust")
until such shares are payable. Upon the termination of employment with the
Company of an LTIP participant, all restrictions on the shares held in the
Deferred Compensation Trust shall lapse, and such shares of Common Stock shall
be payable in five equal annual installments.
COMPENSATION OF DIRECTORS
Pursuant to a Directors Stock Plan adopted by the Board of Directors
and shareholders of the Company in July 1996, the Company compensates directors
by delivering a total annual value of $10,000 payable in shares of Common Stock
(which may be prorated for a director serving less than a full one-year term, as
in the case of a director joining the Board of Directors after an annual meeting
of shareholders), subject to review and adjustment by the Board of Directors
from time to time. Such payment is made after the annual organizational meeting
of the Board of Directors which follows the annual meeting of shareholders of
the Company. An additional annual fee payable in shares of Common Stock, which
currently amounts to $2,000, subject to review and adjustment by the Board of
Directors from time to time, is paid to committee chairs after the annual
organizational meeting of the Board of Directors. During 1998, an aggregate of
2,235 shares of Common Stock was granted to the five directors of the Company
and the three committee chairs.
The number of shares issued pursuant to the Directors Stock Plan is
based on their "fair market value" on the date of grant. The term "fair market
value" is defined in the Directors Stock Plan to mean the average of the high
and low prices of the Common Stock as reported on the New York Stock Exchange on
the relevant date.
Shares issued pursuant to the Directors Stock Plan, other than the
committee fee shares, are subject to forfeiture during the 12 full calendar
months following election or appointment to the Board of Directors or a
committee thereof if the director does not attend an aggregate of at least 75%
of all meetings of the Board of Directors and committees thereof of which he is
a member during such period.
55
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Determinations regarding compensation of the Company's employees are
made by the Company's Nominating and Compensation Committee. Currently, the
members of the Nominating and Compensation committee are Directors Martin
(Chairman), Lewis, Simon and Wish.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the
beneficial ownership of the Common Stock as of the date indicated by (i) each
director and executive officer of the Company, (ii) all directors and executive
officers of the Company as a group and (iii) all persons known by the Company to
own beneficially 5% or more of the outstanding Common Stock. The table is based
upon information supplied to the Company by directors, officers and principal
stockholders and filings under the Exchange Act.
SHARES BENEFICIALLY OWNED AS OF
MARCH 15, 1999
------------------------------------
NAME OF BENEFICIAL OWNER AMOUNT(1) PERCENT(1)
----------------------------------------------------- ------------ ----------
J.P. Morgan & Co. Incorporated....................... 4,276,200(2) 7.0%
60 Wall Street
New York, NY 10260
Directors and Executive Officers:
William C. Erbey................................. 19,617,505(3) 32.0
Hon. Thomas F. Lewis............................. 1,469(4) *
W.C. Martin...................................... 6,285(5) *
Howard H. Simon.................................. 2,885(6) *
Barry N. Wish.................................... 9,372,648(7) 15.4
Christine A. Reich............................... 587,650(8) *
John R. Erbey.................................... 2,190,491(9) 3.6
Ronald M. Faris.................................. 157,674(10) *
Joseph A. Dlutowski.............................. 84,123(11) *
All Directors and Executive Officers as a Group
(11 persons)..................................... 32,202,127(12) 51.9%
* Less than 1%.
(1) For purposes of this table, pursuant to rules promulgated under the
Exchange Act, an individual is considered to beneficially own any
shares of Common Stock if he or she directly or indirectly has or
shares: (i) voting power, which includes the power to vote or to direct
the voting of the shares, or (ii) investment power, which includes the
power to dispose or direct the disposition of the shares. Unless
otherwise indicated, (i) an individual has sole voting power and sole
investment power with respect to the indicated shares and (ii)
individual holdings amount to less than 1% of the outstanding shares of
Common Stock.
(2) Based on information contained in a Schedule 13G filed with the
Commission on February 23, 1999 by J.P. Morgan & Co. Incorporated, a
parent holding company whose subsidiaries include Morgan Guaranty Trust
Company of New York (a bank), J.P. Morgan Investment Management, Inc.
(an investment advisor) and J.P. Morgan Florida Federal Savings Bank
(an investment advisor). Includes 4,275,900 shares as to which sole
voting power is claimed and 3,439,600 shares as to which sole disposal
power is claimed.
(3) Includes 13,740,465 shares held by FF Plaza Partners, a Delaware
partnership of which the partners are William C. Erbey, his spouse, E.
Elaine Erbey, and Delaware Permanent Corporation, a corporation wholly
owned by William C. Erbey. Mr. and Mrs. William C. Erbey share voting
and dispositive power with respect to the shares owned by FF Plaza
Partners. Also includes 5,409,704 shares held by Erbey Holding
Corporation, a corporation wholly owned by William C. Erbey. Also
includes options to acquire 467,336 shares which were exercisable at or
within 60 days of March 15, 1999. Included in the shares held by FF
Plaza Partners are 2,885 shares held pursuant to the Directors Stock
Plan.
56
(4) Includes 400 shares held jointly with spouse. Also includes 1,069
shares held pursuant to the Directors Stock Plan.
(5) Includes 3,400 shares held by the Martin & Associates Management
Consultants, Inc. Defined Contribution Pension Plan & Trust. Also
includes 2,885 shares held pursuant to the Directors Stock Plan.
(6) Consists of shares held pursuant to the Directors Stock Plan.
(7) Includes 8,878,305 shares held by Wishco, Inc., a corporation
controlled by Barry N. Wish pursuant to his ownership of 93.0% of the
common stock thereof; 351,940 shares held by B.N.W. Partners, a
Delaware partnership of which the partners are Mr. Wish and B.N.W.,
Inc., a corporation wholly owned by Mr. Wish; and 140,000 shares held
by the Barry Wish Family Foundation, Inc., a charitable foundation of
which Mr. Wish is a director. Also includes 2,403 shares held pursuant
to the Directors Stock Plan.
(8) Includes 440,300 shares held by CPR Family Limited Partnership, a
Georgia limited partnership whose general partner is a corporation
wholly owned by Christine A. Reich and whose limited partners are
Christine A. Reich and her spouse. Also includes options to acquire
147,348 shares of Common Stock which were exercisable at or within 60
days of March 15, 1999.
(9) Includes 1,747,330 shares held by John R. Erbey Family Limited
Partnership, a Georgia limited partnership whose general partner is a
corporation wholly owned by John R. Erbey and whose limited partners
consist of John R. Erbey, his spouse and children. Also includes
options to acquire 430,031 shares of Common Stock which were
exercisable at or within 60 days of March 15, 1999.
(10) Includes 5,000 shares held jointly with spouse. Also includes options
to acquire 60,345 shares of Common Stock which were exercisable at or
within 60 days of March 15, 1999.
(11) Includes 23,960 shares held jointly with spouse. Also includes options
to acquire 60,163 shares of Common Stock which were exercisable at or
within 60 days of March 15, 1999.
(12) Includes options to acquire an aggregate of 1,209,427 shares of Common
Stock which were exercisable at or within 60 days of March 15, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
On January 20, 1998, the Company purchased indirectly from William C.
Erbey and Barry N. Wish, 159,156 shares and 159,155 shares of Common Stock,
respectively, which equaled the aggregate number of shares of Common Stock
issued by the Company on the same date in connection with its acquisition of
DTS. The per share price of the shares of Common Stock purchased from Messrs.
Erbey and Wish was $24.42, which was equal to the average per share price of the
Common Stock determined pursuant to the Agreement of Merger, dated as of January
7, 1998, among the Company, DTS and certain other parties for purposes of
determining the number of shares of Common Stock to be issued by the Company in
connection with the acquisition of DTS (which price was equal to the average of
the high and low per share sales price of the Common Stock on the New York Stock
Exchange during each of the 20 trading days ending three trading days prior to
consummation of the acquisition of DTS).
In September1998, Howard H. Simon repaid the remaining principal
balance outstanding on a residential mortgage loan with an interest rate of
8.5%. The lender was an institution that had been acquired by the Bank.
The highest principal balance of this loan during 1998 was $99,131.
In October 1998, the Company indirectly loaned $600,000 to John R.
Erbey and $250,000 to John R. Barnes in order to prevent them from having to
sell shares of Common Stock to meet or avoid margin calls. Each loan was: (i)
evidenced by a promissory note bearing interest at a rate of 9.5% per annum,
(ii) payable in two equal installments at 18 and 30 months from the date of
issuance, and (iii) secured by pledges of Common Stock. As of December 31, 1998,
John R. Erbey had prepaid approximately $86,860 on his note.
57
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
EXHIBITS
3.1 Amended and Restated Articles of Incorporation (1)
3.2 Amended and restated Bylaws
4.0 Form of Certificate of Common Stock (1)
4.1 Form of Indenture between the Company and Bank One, Columbus,
NA, as Trustee (1)
4.2 Form of Note due 2003 (included in Exhibit 4.1)(1)
4.3 Certificate of Trust of Ocwen Capital Trust I (2)
4.4 Amended and Restated Declaration of Trust of Ocwen Capital
Trust I (2)
4.5 Form of Capital Security of Ocwen Capital Trust I (3)
4.6 Form of Indenture between the Company and the Chase Manhattan
Bank, a Trustee (3)
4.7 Form of 10 7/8% Junior Subordinated Debentures due 2027 of the
Company (3)
4.8 Form of Guarantee of the Company relating to the Capital
Securities of Ocwen Capital Trust I (2)
4.9 Form of Indenture between the Company and The Bank of New York
as Trustee (4)
4.10 Form of Subordinated Debentures due 2005 (included in Exhibit
4.2) (4)
10.1 Ocwen Financial Corporation 1991 Non-Qualified Stock Option
Plan, as amended (5)
10.3 Ocwen Financial Corporation 1996 Stock Plan for Directors, as
amended (5)
10.4 Ocwen Financial Corporation 1998 Annual Incentive Plan (6)
10.5 Ocwen Financial Corporation Long-Term Incentive Plan (6)
11.1 Computation of earnings per share (7)
12.1 Ratio of Earnings to Fixed Charges
13.1 Annual Report to Stockholders for the year ended December 31,
1998
21.0 Subsidiaries (see "Business-General")
23.0 Consent of PricewaterhouseCoopers LLP
27.1 Financial Data Schedule - For the year ended December 31, 1998
99.1 Risk Factors
(1) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-1, File
No. 333-5153, declared effective by the commission on September 25, 1996.
(2) Incorporated by reference to the similarly identified exhibit filed in
connection with the Registrant's Registration Statement on Form S-1 (File
No. 333-28889), as amended, declared effective by the Commission on
August 6, 1997.
(3) Incorporated by reference to the similarly described exhibit included
with Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997.
(4) Incorporated by reference to the similarly described exhibit filed in
connection with Amendment No. 2 to Offering Circular on Form OC (on Form
S-1) filed on June 7, 1995.
(5) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-8, File
No. 333-44999, effective when filed with the Commission on January 28,
1998.
(6) Incorporated by reference to the similarly described exhibit to the
Company's Definitive Proxy Statement with respect to the Company's 1998
Annual Meeting as filed with the Commission on March 31, 1998.
(7) Computation of earnings per share appears on page 78 in the Annual Report
to Stockholders and is incorporated herein by reference.
FINANCIAL STATEMENTS AND SCHEDULES. The following Consolidated Financial
Statements of Ocwen Financial Corporation and Report of PricewaterhouseCoopers
LLP, Independent Certified Public Accountants, are incorporated herein by
reference from pages 45 to 95 of the Company's Annual Report to Stockholders:
Report of Independent Certified Public Accountants
58
Consolidated Statements of Financial Condition at December 31, 1998 and
1997
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1998
Consolidated Statements of Changes in Stockholders' Equity for each of
the three years in the period ended December 31, 1998
Consolidated Statements of Comprehensive Income for each of the three
years in the period ended December 31, 1998
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1998.
Notes to Consolidated Financial Statements
Financial statement schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated
Financial Statements or notes thereto.
REPORTS ON FORM 8-K FILED DURING THE QUARTER ENDED DECEMBER, 31, 1998.
(1) A Form 8-K was filed by the Company on October 28, 1998 which contained a
news release announcing the Company's financial results for the three and
nine months ended September 30, 1998.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
OCWEN FINANCIAL CORPORATION
BY: /s/ WILLIAM C. ERBEY
------------------------------------
William C. Erbey
Chairman of the Board and
Chief Executive Officer
(duly authorized representative)
Date: March 31, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
/s/ WILLIAM C. ERBEY Date: March 31,1999
- - ------------------------------------------------
William C. Erbey, Chairman of the Board and
Chief Executive Officer
(principal executive officer)
/s/ CHRISTINE A. REICH Date: March 31,1999
- - ------------------------------------------------
Christine A. Reich, President
/s/ BARRY N. WISH Date: March 31,1999
- - ------------------------------------------------
Barry N. Wish, Director
/s/ W.C. MARTIN Date: March 31,1999
- - ------------------------------------------------
W.C. Martin, Director
/s/ HOWARD H. SIMON Date: March 31,1999
- - ------------------------------------------------
Howard H. Simon, Director
/s/ HON. THOMAS F. LEWIS Date: March 31,1999
- - ------------------------------------------------
Hon. Thomas F. Lewis, Director
/s/ MARK S. ZEIDMAN Date: March 31,1999
- - ------------------------------------------------
Mark S. Zeidman, Senior Vice President and
Chief Financial Officer
(principal financial and accounting officer)
60