<PAGE>
FILED PURSUANT TO RULE 424(b)(1)
REGISTRATION NO. 333-28035
PROSPECTUS
2,900,000 SHARES
[LOGO OF LIFE FINANCIAL CORP.]
COMMON STOCK
Life Financial Corp. (the "Company"), a Delaware corporation, is hereby
offering (the "Public Offering") 2,900,000 shares of its common stock, par
value $.01 per share (the "Common Stock"). The Common Stock has been approved
for quotation on the National Market System of the Nasdaq Stock Market, under
the symbol "LFCO."
Immediately prior to the closing of the Public Offering, the Company and
Life Savings Bank, Federal Savings Bank (the "Bank") will consummate the
"Reorganization," previously approved by the stockholders of the Bank,
pursuant to which (i) each outstanding share of the Bank's common stock will
be converted into the right to receive three shares of the Common Stock of the
Company and (ii) the Bank will become a wholly-owned subsidiary of the
Company.
---------------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" AT PAGES 13 TO 21 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE
CONSIDERED BY EACH PROSPECTIVE INVESTOR.
---------------
THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR
DEPOSITS AND ARE NOT FEDERALLY INSURED OR GUARANTEED.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION (THE "COMMISSION"), THE OFFICE OF THRIFT SUPERVISION
("OTS"), OR ANY OTHER FEDERAL AGENCY OR ANY STATE SECURITIES COMMISSION,
NOR HAS THE COMMISSION, THE OTS OR ANY OTHER AGENCY OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNDERWRITING DISCOUNTS PROCEEDS TO THE
PRICE TO PUBLIC AND COMMISSIONS(1) COMPANY(2)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share............... $11.00 $.77 $10.23
- --------------------------------------------------------------------------------
Total(3)................ $31,900,000 $2,233,000 $29,667,000
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
</TABLE>
(1) See "Underwriting" for information concerning indemnification of the
Underwriter and other matters.
(2) Before deducting expenses of the Public Offering payable by the Company
estimated to be $960,000.
(3) The Company has granted the Underwriter a 30-day option to purchase up to
435,000 additional shares of Common Stock solely to cover overallotments,
if any. To the extent that the option is exercised, the Underwriter will
offer the additional shares of Common Stock at the Price to Public shown
above. If the option is exercised in full, the total Price to Public,
Underwriting Discounts and Commissions and Proceeds to the Company will be
$36,685,000, $2,567,950, and $34,117,050, respectively. See
"Underwriting."
The Common Stock offered by the Underwriter in the Public Offering is
subject to prior sale, when, as and if delivered to and accepted by the
Underwriter, and subject to its right to withdraw, modify, correct and reject
orders in whole or in part. It is expected that delivery of the certificates
representing such shares of Common Stock will be made against payment therefor
at the offices of Keefe, Bruyette & Woods, Inc. ("KBW"), or in book entry form
through the facilities of The Depository Trust Company, on or about June 30,
1997.
KEEFE, BRUYETTE & WOODS, INC.
THE DATE OF THIS PROSPECTUS IS JUNE 24, 1997
<PAGE>
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SUCH TRANSACTIONS MAY INCLUDE STABILIZING BIDS AND PURCHASES, SYNDICATE SHORT
COVERING TRANSACTIONS AND PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS. EXCEPT AS OTHERWISE SPECIFIED, ALL INFORMATION IN THIS
PROSPECTUS ASSUMES NO EXERCISE OF THE UNDERWRITER'S OVER-ALLOTMENT OPTION OR OF
OUTSTANDING OPTIONS UNDER THE COMPANY'S 1996 STOCK OPTION PLAN OR THE BANK'S
1996 STOCK OPTION PLAN. SEE "UNDERWRITING." UNLESS THE CONTEXT OTHERWISE
REQUIRES, (I) THE INFORMATION IN THIS PROSPECTUS GIVES EFFECT TO THE
REORGANIZATION DESCRIBED ELSEWHERE HEREIN AND (II) ALL REFERENCES TO THE
COMPANY SHALL BE DEEMED TO INCLUDE THE COMPANY AND ITS SUBSIDIARIES, INCLUDING
THE BANK.
THIS PROSPECTUS CONTAINS CERTAIN STATEMENTS OF A FORWARD-LOOKING NATURE
RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY.
THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES AND ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED OR IMPLIED IN THE FORWARD-
LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED UNDER "RISK FACTORS,"
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AND "BUSINESS." FURTHER, CERTAIN FORWARD-LOOKING STATEMENTS ARE
BASED UPON ASSUMPTIONS AS TO FUTURE EVENTS THAT MAY NOT PROVE TO BE ACCURATE.
THE BANK
BACKGROUND
The Bank is a federally chartered stock savings bank whose primary business
is the origination and sale of sub-prime one- to four-family residential
mortgage loans and, to a much lesser extent, multi-family residential and
commercial mortgage loans. The Bank was originally chartered in 1983 as a stock
savings and loan association under the laws of the State of California and
became a federally chartered stock savings bank in 1991. The Bank conducts its
business from four locations: the Bank's headquarters in San Bernardino,
California, and three regional lending centers, one in Riverside, California,
one in Jacksonville, Florida and one recently established in the Denver,
Colorado metropolitan area. At March 31, 1997, the Bank had total assets of
$157.7 million, total deposits of $130.8 million and total equity of $11.5
million. During the three months ended March 31, 1997, the Bank originated or
purchased, through a network of approved correspondents and independent
mortgage brokers (the "Originators") $92.2 million of mortgage products, and
sold or securitized $83.2 million of such products. The Bank's deposits are
insured up to the maximum allowable amount by the Savings Association Insurance
Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC"). The Bank's
headquarters are located at 1598 East Highland Avenue, San Bernardino,
California 92404, and its telephone number is (909) 886-9751.
During the early 1990's, as a result of reduced employment levels and
corporate relocations in Southern California and the general weakness of the
national economy, the Bank's market area experienced a weakening of real estate
values and a reduction in home sales and construction. When confronted with
increased competition and nominal growth during this same period, the Bank's
results of operations were adversely impacted and the Bank began to experience
increases in total non-performing loans held for investment. In response, in
1994, the Bank retained new management experienced in sub-prime lending to
redirect its business focus, revise its underwriting policies and procedures
and enhance its related servicing capabilities. A plan was developed pursuant
to which the Bank reorganized its lending operations from that of a thrift
emphasizing traditional mortgage banking and portfolio lending to that of a
diversified financial services operation focusing on the origination for sale
or securitization, with servicing retained, of various loan products. These
loan products include: (i) loans for the purchasing or refinancing of
residential real property by borrowers who may have had prior credit problems
or who do not have an adequate credit history ("sub-prime borrowers")
("Liberator Series"); (ii) debt consolidation loans for up to 125% of the
appraised value of such loans for borrowers whose credit history qualifies for
Federal National Mortgage Association ("FNMA") and Federal Home Loan
3
<PAGE>
Mortgage Corporation ("FHLMC") loans ("Agency Qualified Borrowers") ("Portfolio
Series"); and (iii) to a much lesser extent, commercial and multi-family real
estate loans. Liberator Series loans and Portfolio Series loans are the Bank's
"core products." The Bank also adopted revised underwriting policies and
instituted more aggressive procedures for resolving problem loans and for
reducing the level of non-performing assets.
In 1994, the Bank began to implement its plan which resulted in:
. An increase in total purchases and originations of loans by 171.5% from
$82.0 million for the year ended December 31, 1993 to $222.6 million for
the year ended December 31, 1996. For the three month period ended March
31, 1997, loans originated and purchased totalled $92.2 million.
. An increase in loan sales and securitizations by 191.0% from $71.0
million for the year ended December 31, 1993 to $206.6 million for the
year ended December 31, 1996. For the three month period ended March 31,
1997, loan sales and securitizations totalled $83.2 million.
. An increase in net income of 1,518.3% from $93,000 for the year ended
December 31, 1993, to $1.5 million for the year ended December 31, 1996.
For the three month period ended March 31, 1997, net income was $2.2
million.
. An increase in net gains from mortgage financing operations by 663.6%
from $1.1 million for the year ended December 31, 1993, to $8.4 million
for the year ended December 31, 1996. For the three month period ended
March 31, 1997, net gains from mortgage financing operations totalled
$5.9 million.
. A decrease in non-performing assets by 25.0% from $4.0 million at
December 31, 1993, to $3.0 million at December 31, 1996. As a percent of
total assets, non-performing assets decreased by 43.4% from 5.05% at
December 31, 1993 to 2.86% at December 31, 1996. At March 31, 1997, non-
performing assets totalled $2.9 million and, as a percentage of total
assets, were 1.85%.
. An increase in the allowance for estimated loan losses as a percent of
gross loans receivable by 263.1% from 0.65% at December 31, 1993 to 2.36%
at December 31, 1996. At March 31, 1997, the allowance for estimated loan
losses as a percent of gross loans receivable was 2.42%.
COMPETITIVE STRENGTHS
Management believes that it enjoys a competitive advantage when compared to
most other finance companies competing in its product areas as a result of the
following factors:
Expertise of Management. The change in direction of the Bank's business focus
commenced with the hiring in 1994 of Daniel L. Perl, the Bank's President and
Chief Executive Officer. Mr. Perl has more than twenty years of experience in
the financial services industry, including the areas of sub-prime lending,
commercial real estate lending, mortgage banking and investment banking. See
"Business--Competitive Strengths--Expertise of Management."
Efficiency of Operations. Management believes that the efficiency of its
operations allows the Bank to offer to its Originators very competitively
priced products. Management believes that this competitive pricing will
increase the volume of loans originated. See "Business--Competitive Strengths--
Efficiency of Operations."
Internal Controls. Management believes that it has established significant
internal controls which will help preserve and assure the overall quality of
loans originated by the Bank. See "Business--Competitive Strengths-- Internal
Controls."
Flexible Funding Sources and Structure. As a federally-chartered savings
bank, the Bank has access to funds at a lower cost than its non-regulated
finance company competitors. The Bank's flexible funding structure will be
further enhanced by the Reorganization of the Bank into the holding company
structure. See "Business--Competitive Strengths--Flexible Funding Sources and
Structure."
4
<PAGE>
Diversification Opportunities. Upon the Reorganization, the Company will
become a unitary savings and loan holding company which generally will not be
restricted in the types of business activities it may conduct provided that the
Bank continues to be a qualified thrift lender. See "Business--Competitive
Strengths-- Diversification Opportunities."
GROWTH AND OPERATING STRATEGIES
Management believes that, as a result of its competitive strengths, the Bank
and the Company will be able to implement the following growth and operating
strategies:
. Expanding Core Products Through a National Originator Network. The Bank
will continue to emphasize and to expand the origination of its core
products, Liberator Series loans and Portfolio Series loans, for sale
through securitizations and in the secondary market. Continued growth of
core products will result primarily from geographic expansion and greater
penetration in existing markets. In particular, since the beginning of
1997, the Bank has widely advertised its no income, no asset ("NINA")
loan product, which is a limited documentation, lower loan-to-value loan
program within the Liberator Series. NINA loans constituted $7.3 million
of the $80.1 million of loans in the Bank's 1997-1 securitization during
the first quarter of 1997. In order to improve its ability to service its
expanding network of Originators, the Bank has established strategically
located, low cost regional lending centers in Riverside, California,
Jacksonville, Florida and in the Denver, Colorado metropolitan area. Over
the next twelve months, the Bank intends to open two additional regional
lending centers which are likely to be strategically located in the
Northeast and Midwest sectors of the United States to better serve its
Originators.
. Expanding Retail Lending Production. The Bank's retail lending operations
focus on retail loans located in the Bank's primary market area of
Southern California. To the extent that these loans meet the criteria for
Liberator Series loans or Portfolio Series loans, the Bank's retail
lending operation acts as an origination source for the Life Financial
Services Division of the Bank while loans not meeting these criteria are
sold to investors ("Loan Purchasers"). The Bank intends to gradually and
selectively expand its retail lending operations beyond Southern
California. As part of this process, the Bank also plans to establish low
cost retail offices selectively throughout the country. In order to
reduce the possibility that its borrowers will refinance their loans with
other lenders, the Bank is seeking to refinance such loans through its
own retail lending operation.
. Expanding Multi-Family and Commercial Lending. In continuing with its
tradition as a niche market lender and in an effort to diversify product
offerings, the Bank, through its Life Income Capital Division, has
recently begun to focus its efforts on the origination and purchase of
multi-family and commercial real estate loans in the range of $50,000 to
$750,000 both in its primary market area and throughout the United States
through a selected group of originators. The Bank is currently purchasing
such loans at a discount and, although there can be no assurances,
expects to be able to continue to purchase such loans at a discount or
low premium. The Bank employs underwriters who specialize in commercial
and multi-family real estate lending and utilizes a select group of
appraisers experienced in these products. In addition, two members of
senior management have considerable expertise in multi-family and
commercial real estate lending. The Bank has been limited in its ability
to originate multi-family and commercial real estate loans by its level
of available capital. The Bank plans to gradually expand such
originations as its available capital increases. The Bank believes that
it has the infrastructure in place to accommodate this expansion. It is
anticipated that all multi-family and commercial real estate loans will
be originated for sale in the secondary market and may also be sold
through securitizations in the future. See "Business--Commercial Real
Estate and Multi-Family Real Estate Lending."
. Consistently Refining Operating Procedures. The Bank intends to maintain
loan quality by continuing to refine its underwriting criteria. A meeting
of the Bank's underwriting personnel is held each week
5
<PAGE>
in part to discuss operational issues as well as refinements to the Bank's
underwriting policies. In addition, the Bank conducts a weekly loan
delinquency meeting to discuss problem areas in the Bank's servicing
portfolio in order to reduce the likelihood of the recurrence of such
problems in future loans. As necessary, the Bank adds personnel to its
loan processing staff and continues to utilize advances in computer
technology to provide prompt turnaround on loans, efficient underwriting
procedures and accurate credit verification. In addition, in the fourth
quarter of 1996, the Bank hired a senior underwriter with corporate
responsibility (the "Quality Control Underwriter") who: is dedicated to
maintaining quality control; reviews loan files to assure that each
complies with the Bank's underwriting policies; reviews all loans upon
first payment default and loans sixty days delinquent; provides feedback
and training to the underwriters to minimize future defaults and
delinquencies; and investigates all fraudulent loans.
. Enhancing Servicing Capabilities. As the Bank has transitioned from a
traditional thrift to a diversified financial services operation, it has
expanded its servicing department from a total of four persons at
December 31, 1994 to 16 persons at March 31, 1997. In December 1996, the
Bank hired a department head with 24 years of experience in loan
servicing and collections including responsibility for a $10.0 billion
portfolio of approximately 255,000 loans and a staff of 70 people. In
anticipation of its future servicing needs, the Bank has dedicated
substantial space in its current Riverside facility to house loan
servicing operations and is in the process of implementing new technology
including computer imaging and power dialing. See "Business--Loan
Servicing."
. Diversifying Funding Sources. In addition to its traditional thrift
funding sources of deposits and loans from the Federal Home Loan Bank of
San Francisco ("FHLB"), the Bank has diversified its funding sources in
recent periods. During the fourth quarter of 1996 and the first quarter
of 1997, net cash received from the Bank's securitizations provided a
significant source of funding to the Bank, aggregating $128.1 million for
those two quarters. The Bank recently has also entered into a retail
mortgage warehouse line of credit with a national investment banking firm
in the amount of $50.0 million and may enter into additional lines of
credit in the future. Following the Reorganization, the Company may
further diversify the current sources of funding through greater access
to capital markets.
RECENT DEVELOPMENTS
Recent Loan Origination Volume. The Bank originated and purchased
approximately $99.3 million in mortgage loans during April and May 1997. Total
loan origination and purchase volume in April and May 1997 represented an
increase of approximately 61.6% over average monthly volume during the first
quarter of 1997.
Recent Securitization Activity and June 1997 Loan Sales. During the month of
April 1997, the Bank completed its prefunding of the 1997-1 securitization (see
"Business--Loan Sales and Securitizations") by securitizing $4.9 million in
loans for the 1997-1A trust and $15.0 million in loans for the 1997-1B trust,
generating a gain on sale of $1.7 million. In addition, the Bank has entered
into an agreement with one institutional purchaser to sell $53.8 million
Portfolio Series loans and has reached a preliminary agreement with a second
institutional purchaser to sell $19.8 million Liberator Series loans, for an
aggregate of $73.6 million for the two loan sale transactions. The aggregate
gain on sale from the transactions is anticipated to be $2.3 million, or 3.12%
of the loans sold. This amount will be partially offset by a loss of $175,000
from a hedge position entered into by the Bank for the purpose of reducing
interest rate risk on fixed-rate loans and commitments to originate fixed-rate
loans prior to sale. The effect of the hedge would reduce the anticipated gain
as a percentage of loans sold to 2.89%. The sales are expected to be
consummated prior to June 30, 1997. The sales will be subject to standard loan
repurchase or substitution obligations. See "Risk Factors--Contingent Risks."
The Bank's agreement with one of the purchasers is preliminary and there is no
assurance that a definitive agreement will be reached. With respect to both
loan sale transactions, there is no assurance that the transactions will be
consummated, that they will involve the same volume of loans or gain on sale
stated herein, or that they will close when anticipated.
6
<PAGE>
RESTRUCTURING
Historically, all operations have been conducted through the Bank and its
internal divisions, Life Financial Services Division, Life Income Capital
Division, Life Asset Management Division, Retail Lending Division and Banking
Depository Division. In order to increase operating flexibility and provide a
broader range of services to its customers, management has determined (i) to
reorganize into the holding company form of organization, (ii) to form separate
holding company subsidiaries, and (iii) to restructure the Bank by forming
separate operating subsidiaries in order to realize possible future values from
such subsidiaries, as follows:
LIFE FINANCIAL CORP.
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK LIFE WAREHOUSE
(RETAIL LENDING DIVISION AND BANKING INVESTMENT FINANCING
DEPOSITORY DIVISION) HOLDINGS, SUBSIDIARY
INC.
LIFE LIFE LIFE ASSET
FINANCIAL INCOME CAPITAL MANAGEMENT, INC.
SERVICES, SERVICES, INC.
INC.
. Life Financial Services, Inc. ("Life Financial Services") will continue
to focus on the Bank's core products. See "Business--Core Lending
Products."
. Life Income Capital Services, Inc. ("Life Income Capital") expects to
expand the nationwide origination of multi-family and commercial real
estate loans in the $50,000 to $750,000 range previously conducted by the
Bank. Although there can be no assurances in this regard, management
expects the operations of this subsidiary to create an increased source
of revenue for the Company, because of the perceived demand for and
higher yield on such loans. See "Business--Commercial Real Estate and
Multi-Family Real Estate Lending."
. Life Asset Management, Inc. ("Life Asset Management") is being
established as a direct subsidiary of the Bank to continue to service
loans and real estate owned ("REO") for both the Bank and for Loan
Purchasers. At March 31, 1997, the Bank's mortgage servicing portfolio
totalled $316.6 million, including $242.3 million of loans serviced for
others.
. The Bank will continue to operate the Retail Lending Division and the
Banking Depository Division. In addition, as part of its liquidity and
investment portfolios, the Bank will continue to hold investments in U.S.
government and agency securities.
. Life Investment Holdings, Inc. ("Life Investment") will hold residuals
and other related assets resulting from the Bank's securitization
activities. The Bank currently utilizes an independent third party
trustee for this purpose. Immediately following the completion of the
Public Offering, Life Investment will acquire from the Bank residual
assets of approximately $12.5 million and $6.9 million in restricted cash
resulting from the securitizations completed by the Bank in the fourth
quarter of 1996 and the first quarter of 1997. It is intended that any
future residuals and restricted cash retained by the Company will be held
by this subsidiary.
. Upon the completion of this Public Offering, the Company intends to
acquire or establish a subsidiary to provide warehouse lines of credit to
meet the cash flow needs of smaller loan originators on a short-term
basis, which it expects will in turn create additional sources of loans
for the Company to originate and securitize.
7
<PAGE>
THE COMPANY
The Company was incorporated in Delaware in 1996. The Company has received
the approval of the OTS to become a savings and loan holding company to acquire
all of the issued and outstanding common stock of the Bank in the
Reorganization, which will be consummated immediately prior to the closing of
the Public Offering. Such approval was subject to the affirmative vote of the
holders of a majority of the outstanding shares of the Bank's common stock,
which was obtained at the annual meeting of stockholders held on June 20, 1997.
The Company's principal executive offices are located at 4110 Tigris Way,
Riverside, California 92503 and its telephone number at that location is (909)
280-4100. In addition to its executive offices, the Company conducts its
business from the Bank's home office in San Bernardino, California, and three
regional lending centers located in Riverside, California, Jacksonville,
Florida, and a recently established lending center in the Denver, Colorado,
metropolitan area.
THE PUBLIC OFFERING
<TABLE>
<C> <S>
Common Stock offered in the Public
Offering............................ 2,900,000 shares
Common Stock to be outstanding after
the Public Offering and the
Reorganization...................... 6,111,716 shares
Dividend Policy...................... The Company intends to retain its
earnings to support its future growth
strategy and does not anticipate paying
cash dividends on the Common Stock in
the foreseeable future. See "Dividend
Policy."
Use of Proceeds...................... Net proceeds will be used to (i) pay
$9.8 million in cash to the Bank, which
together with the assumption of the
Bank's $9.6 million, net, subordinated
debt liability, will be used to acquire
residual assets of approximately $12.5
million and $6.9 million in the Reserve
Account from the Bank, see "Business--
Sources of Funds--Borrowings";
(ii) downstream proceeds to the Bank if
necessary to fund additional purchases
of loans; (iii) acquire an interest in
or establish a subsidiary for the
purpose of providing short term
warehouse lines of credit; and (iv)
fund general business activities,
including possible acquisitions of
related businesses as opportunities
arise. No determination has been made
as to the amount of proceeds that will
be allocated to each use, with the
exception of the acquisition of the
residual assets and the Reserve
Account. See "Use of Proceeds."
Dilution............................. Upon completion of the Public Offering,
there will be an immediate dilution of
the net tangible book value per share
of Common Stock of $4.42 per share
based on an offering price of $11.00
per share. See "Risk Factors--Dilution"
and "Dilution."
Nasdaq National Market Symbol........ "LFCO"
</TABLE>
8
<PAGE>
SELECTED FINANCIAL AND OTHER DATA OF THE BANK
The selected financial and other data of the Bank, the primary operating
subsidiary of the Company from and after the effective date of the
Reorganization, at or for the years ended December 31, 1996, 1995, 1994, 1993
and 1992 and at or for the three months ended March 31, 1997 and 1996, set
forth below is derived in part from, and should be read in conjunction with,
the Financial Statements of the Bank and Notes thereto as of December 31, 1996
and 1995 and for each of the three years in the period ended December 31, 1996
presented elsewhere in this Prospectus. Financial information at March 31,
1997, and for the three month periods ended March 31, 1997 and 1996 is derived
from unaudited financial data, but in the opinion of management, reflects all
adjustments (consisting only of normal recurring adjustments) which are
necessary to present fairly the results for such interim periods. Interim
results at and for the three months ended March 31, 1997 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997. The Bank did not pay any cash dividends in any of the periods set forth.
<TABLE>
<CAPTION>
AT AT DECEMBER 31,
MARCH 31, -------------------------------------------------
1997 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
SELECTED BALANCE SHEET
DATA:
Total assets............ $ 157,707 $ 104,010 $ 74,136 $ 71,402 $ 78,256 $ 78,788
Securities held-to-
maturity and FHLB
stock.................. 9,021 8,837 2,700 2,860 3,883 4,829
Loans held for sale..... 38,296 31,018 21,688 17,070 2,348 4,499
Loans held for
investment............. 36,472 38,520 42,870 47,939 64,820 61,182
Allowance for estimated
loan losses............ 1,801 1,625 1,177 832 436 308
Deposit accounts........ 130,808 85,711 67,535 65,689 72,008 71,719
FHLB advances........... -- -- -- 1,250 1,200 2,000
Stockholders' equity.... 11,515 9,273 4,268 3,748 4,419 4,326
Book value per share
(pro forma)(1)......... $ 3.59 $ 2.89 $ 2.29 $ 2.01 $ 2.37 $ 2.55
Shares outstanding (pro
forma)(1).............. 3,211,716 3,211,716 1,866,216 1,866,216 1,866,216 1,696,410
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,
MARCH 31, --------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Interest income......... $ 2,304 $ 1,662 $ 6,929 $ 5,825 $ 4,824 $ 5,445 $ 6,143
Interest expense........ 1,561 929 3,766 3,448 2,721 3,045 3,687
--------- --------- --------- --------- --------- --------- ---------
Net interest income... 743 733 3,163 2,377 2,103 2,400 2,456
Provision for estimated
loan losses............ 500 68 963 1,194 1,306 404 129
--------- --------- --------- --------- --------- --------- ---------
Net interest income
after provision for
estimated loan
losses............... 243 665 2,200 1,183 797 1,996 2,327
Net gains from mortgage
financing operations... 5,877 887 8,352 3,575 1,428 1,144 1,380
Other non-interest in-
come................... 208 153 760 445 260 253 352
Non-interest expense:
Compensation and
benefits............. 1,582 814 5,233 2,544 1,575 1,403 1,426
Net loss on foreclosed
real estate.......... 63 91 158 53 280 228 78
SAIF special
assessment........... -- -- 448 -- -- -- --
Other expense......... 847 616 2,842 1,792 1,601 1,562 2,045
--------- --------- --------- --------- --------- --------- ---------
Total non-interest
expense.............. 2,492 1,521 8,681 4,389 3,456 3,193 3,549
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before
income tax provision
(benefit).............. 3,836 184 2,631 814 (971) 200 510
Income tax provision
(benefit).............. 1,594 79 1,126 294 (300) 107 148
--------- --------- --------- --------- --------- --------- ---------
Net income (loss)....... $ 2,242 $ 105 $ 1,505 $ 520 $ (671) $ 93 $ 362
========= ========= ========= ========= ========= ========= =========
Earnings (loss) per
share (pro forma)(2)... $ 0.70 $ 0.06 $ 0.63 $ 0.28 $ (0.36) $ 0.05 $ 0.22
========= ========= ========= ========= ========= ========= =========
Weighted average shares
outstanding
(pro forma)(2)......... 3,211,716 1,866,216 2,370,779 1,866,216 1,866,216 1,823,765 1,644,886
========= ========= ========= ========= ========= ========= =========
</TABLE>
(continued on following page)
9
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE
THREE MONTHS
ENDED
MARCH 31, AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------- ----------------------------------------------
1997 1996 1996 1995 1994 1993 1992
------- ------- -------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
SELECTED FINANCIAL
RATIOS AND OTHER
DATA(3):
PERFORMANCE RATIOS:
Return on average
assets............... 6.32% 0.48% 1.74% 0.69% (0.89)% 0.12% 0.46%
Return on average
equity............... 90.48 9.73 24.99 13.64 (17.01) 2.11 8.92
Average equity to
average assets....... 6.99 4.95 6.98 5.04 5.22 5.51 5.17
Equity to total assets
at end of period..... 7.30 5.04 8.92 5.76 5.25 5.65 5.49
Average interest rate
spread(4)............ 2.32 3.52 3.76 3.09 2.79 3.02 3.04
Net interest
margin(5)............ 2.44 3.71 3.94 3.25 2.88 3.14 4.29
Average interest-
earning assets to
average interest-
bearing liabilities.. 102.43 104.12 103.90 103.50 102.27 103.08 103.64
Efficiency Ratio(6)... 35.57 80.65 69.43 67.78 83.78 78.09 82.88
LOAN ORIGINATIONS AND
PURCHASES.............. $92,190 $50,928 $222,553 $134,772 $72,815 $82,015 $90,870
REGULATORY CAPITAL
RATIOS(7):
Tangible capital...... 7.19% 4.99% 8.90% 5.68% 5.25% 5.65% 5.49%
Core capital.......... 7.19 4.99 8.90 5.68 5.25 5.65 5.49
Risk-based capital.... 10.51 8.91 9.43 10.17 10.00 10.87 10.56
ASSET QUALITY RATIOS:
Non-performing assets
as a percent of total
assets(8)............ 1.85 3.69 2.86 3.00 3.42 5.05 4.15
Allowance for
estimated loan losses
as a percent of non-
performing loans..... 103.62 52.65 67.26 84.25 44.04 20.02 16.29
</TABLE>
- -------
(1) Book value per share is based upon the shares outstanding at the end of
each period, adjusted for a 100% stock dividend which occurred during 1996.
Book value per share (pro forma) is then adjusted for the exchange of three
shares of Company Common Stock for one share of Bank common stock in the
Reorganization.
(2) Earnings per share is based upon the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred during
1996. Earnings per share (pro forma) is then adjusted for the exchange of
three shares of Company Common Stock for one share of Bank common stock in
the Reorganization.
(3) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average daily or average month-end balances during the indicated periods.
(4) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
(5) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(6) The efficiency ratio represents noninterest expense less (gain) loss on
foreclosed real estate divided by noninterest income plus net interest
income before provision for estimated loan losses.
(7) For definitions and further information relating to the Bank's regulatory
capital requirements, see "Regulation--Federal Savings Institution
Regulation--Capital Requirements." See "Capitalization" for the Company's
pro forma capital levels as a result of the Offerings.
(8) Non-performing assets consist of non-performing loans and REO. See
"Business--Lending Overview--Non-Accrual and Past-Due Loans" and "--REO."
10
<PAGE>
QUARTERLY OPERATING AND OTHER DATA OF THE BANK
Financial information of the Bank at March 31, 1997 and December 31,
September 30, June 30 and March 31, 1996 and for the quarters ended March 31,
1997, and December 31, September 30, June 30 and March 31, 1996 is derived from
unaudited financial data, but in the opinion of management, reflects all
adjustments (consisting of only normal recurring adjustments) which are
necessary to present fairly the results of such interim periods. Interim
results at or for the three months ended March 31, 1997 are not necessarily
indicative of the results for the year ending December 31, 1997.
<TABLE>
<CAPTION>
AT OR FOR THE QUARTER ENDED
--------------------------------------------------------
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1997 1996 1996 1996 1996
--------- ------------ ------------- -------- ---------
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING DATA:
Interest income......... $ 2,304 $ 2,007 $ 1,569 $ 1,691 $ 1,662
Interest expense........ 1,561 1,067 844 926 929
------- ------- ------- ------- -------
Net interest income... 743 940 725 765 733
Provision for estimated
loan losses............ 500 604 251 40 68
------- ------- ------- ------- -------
Net interest income
after provision for
estimated loan
losses............... 243 336 474 725 665
Net gains from mortgage
financing operations... 5,877 4,593 1,599 1,273 887
Other non-interest in-
come................... 208 256 192 159 153
Non-interest expense:
Compensation and
benefits............. 1,582 2,026 1,056 1,337 814
Net loss (gain) on
foreclosed real
estate............... 63 (13) 71 9 91
SAIF Special
Assessment........... -- -- 448 -- --
Other expense......... 847 851 671 704 616
------- ------- ------- ------- -------
Total non-interest
expense............ 2,492 2,864 2,246 2,050 1,521
------- ------- ------- ------- -------
Income before income tax
provision.............. 3,836 2,321 19 107 184
Income tax provision.... 1,594 984 17 46 79
------- ------- ------- ------- -------
Net income.............. $ 2,242 $ 1,337 $ 2 $ 61 $ 105
======= ======= ======= ======= =======
Earnings per share (pro
forma)(1).............. $ 0.70 $ 0.42 $ 0.00 $ 0.03 $ 0.06
======= ======= ======= ======= =======
SELECTED FINANCIAL
RATIOS AND OTHER
DATA(2):
PERFORMANCE RATIOS:
Return on average
assets............... 6.32% 5.56% 0.01% 0.30% 0.48%
Return on average
equity............... 90.48 61.35 0.12 5.44 9.73
Average equity to
average assets....... 6.99 8.77 8.42 5.56 4.95
Equity to total assets
at end of period..... 7.30 8.92 9.40 5.62 5.04
Average interest rate
spread(3)............ 2.32 4.09 3.93 3.71 3.52
Net interest
margin(4)............ 2.44 4.22 3.95 3.85 3.71
Average interest-
earning assets to
average interest-
bearing liabilities.. 102.43 104.64 103.25 103.10 104.12
Efficiency Ratio(5)... 35.57 49.70 86.45 92.90 80.65
LOAN ORIGINATIONS AND
PURCHASES.............. $92,190 $74,164 $44,536 $52,925 $50,928
REGULATORY CAPITAL
RATIOS(6):
Tangible capital...... 7.19% 8.90% 9.40% 5.62% 4.99%
Core capital.......... 7.19 8.90 9.40 5.62 4.99
Risk-based capital.... 10.51 9.43 16.06 9.82 8.91
ASSET QUALITY RATIOS:
Non-performing assets
as a percent of total
assets(7)............ 1.85 2.86 3.36 3.59 3.69
Allowance for
estimated loan losses
as a percent of non-
performing loans..... 103.62 67.26 55.66 66.06 52.65
</TABLE>
(footnotes on following page)
11
<PAGE>
- --------
(1) Earnings per share is based on the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred during
1996. Earnings per share (pro forma) is then adjusted for the exchange of
three shares of Company Common Stock for one share of Bank common stock in
the Reorganization.
(2) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based on
average closing or average month-end balances during the indicated periods
and are annualized where appropriate.
(3) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
(4) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(5) The efficiency ratio represents noninterest expense less (gain) loss on
foreclosed real estate divided by noninterest income plus net interest
income before provision for estimated loan losses.
(6) For definitions and further information relating to the Bank's regulatory
capital requirements, see "Regulation--Federal Savings Institution
Regulation--Capital Requirements." See "Capitalization" for the Company's
pro forma capital levels as a result of the Offerings.
(7) Non-performing assets consist of non-performing loans and REO. See
"Business--Lending Overview--Non-Accrual and Past-Due Loans" and "--REO."
12
<PAGE>
RISK FACTORS
The following risk factors, in addition to those discussed elsewhere in this
Prospectus, should be considered by investors in deciding whether to purchase
the Common Stock offered hereby.
ABILITY OF THE BANK TO IMPLEMENT ITS BUSINESS STRATEGY
The Bank's business strategy is dependent upon its ability to increase its
loan volume through the nationwide growth of its network of Originators, while
maintaining its existing levels of origination costs, interest rate spreads
and underwriting criteria. Implementation of this strategy will depend in
large part on the Bank's ability to: (i) expand its network of Originators in
markets with a sufficient concentration of borrowers meeting the Bank's
underwriting criteria; (ii) obtain adequate financing on favorable terms to
fund its growth strategy; (iii) profitably sell its loans through
securitizations or in the secondary market on a regular basis; (iv) attract
and retain skilled employees; and (v) continue to expand in the face of
increasing competition from other mortgage lenders. The Bank's failure with
respect to any of these factors could impair its ability to successfully
implement its business strategy, which would have a material adverse effect on
the Bank's results of operations and financial condition. In addition, there
can be no assurance that the Company will achieve its planned expansion in a
timely and cost-effective manner or, if achieved, that the expansion will
result in profitable operations. Although the Bank has no current plans to
modify its current strategy, because of the dynamic changes occurring in the
financial services industry, the Bank may revise its business plan by
developing new consumer or commercial loan products or expanding into new
markets. There can be no assurance that any such revised strategy would be as
profitable or successful as the existing strategy has been historically. See
"Business."
RISKS ASSOCIATED WITH MORTGAGE ORIGINATION, PURCHASE AND SALE ACTIVITIES
The Bank has been actively involved in the origination, purchase and sale to
Loan Purchasers and, more recently, in securitizations of real estate secured
loans. Generally, the profitability of such mortgage financing operations
depends on maintaining a sufficient volume of loans for sale and the
availability of Loan Purchasers. Changes in the level of interest rates and
economic factors may affect the amount of loans originated or available for
purchase by the Bank, and thus the availability of net gains from mortgage
financing operations and servicing fee income. Changes in the purchasing
policies of Loan Purchasers or increases in defaults after funding could
substantially reduce the amount of loans sold to such Loan Purchasers or
through asset securitizations. Any such changes could have a material adverse
effect on the Bank's results of operations and financial condition. Therefore,
between the time the Bank originates loans and purchase commitments are issued
or securitizations are completed, the Bank is exposed to downward movements in
the market price of such loans due to upward movements in interest rates. In
order to reduce these risks, the Bank has recently adopted a hedging policy.
There can be no assurances, however, that the Bank's exposure to such risks
will be reduced by pursuing this policy. See "Business--Core Lending
Products--Origination and Purchase of Loans" and "--Loan Sales and Asset
Securitizations" and "--Sources of Funds."
In addition to its lending activity in California, the Bank has originated
or purchased a significant number of one- to four-family residential mortgage
loans on a nationwide basis through its network of Originators. Management
believes that originating and purchasing loans secured by properties located
across the country results in a geographically diversified lending operation
which reduces certain risks associated with loan concentrations in a single
area. However, there are certain other risks involved in nationwide lending.
The Bank may not have the same depth of experience or knowledge about
particular markets in which it lends as other lenders with staff physically
located in such market areas. Some of the properties may be located in states
which are experiencing adverse economic conditions, including a general
softening in real estate markets and the local economies, which may result in
increased loan delinquencies and loan losses. Additionally, regulations and
practices regarding the liquidation of properties (e.g., foreclosure) and the
rights of mortgagors in default vary greatly from state to state, and these
restrictions may limit the Bank's ability to foreclose on a property or seek
other recovery. See "Business--Core Lending Products--Origination and Purchase
of Loans" and "--Lending Overview--Delinquencies and Classified Assets."
13
<PAGE>
DEPENDENCE ON ASSET SECURITIZATIONS AND IMPACT ON QUARTERLY OPERATING RESULTS
During the fourth quarter of 1996 and the first quarter of 1997, the Bank,
through its Financial Services Division, completed its first and second
securitizations, which involved $51.9 million and $83.2 million of loans,
respectively, which generated net gains from securitizations of approximately
$4.3 million and $5.9 million, respectively. Although the Bank will not
complete a securitization in the second quarter of 1997, a significant
component of the management's business strategy is to generate revenue and net
income and provide funding for future originations and purchases of loans
through securitizations on a regular basis. There can be no assurance,
however, that the Bank will be able to successfully implement this strategy.
Several factors will affect the Bank's ability to complete securitizations,
including conditions in the securities markets generally and in the asset-
backed securities markets specifically, the credit quality of the Bank's loan
portfolio and the Bank's ability to obtain credit enhancements. In addition,
although the Bank has tracked the performance of its portfolio of loans, it
did not, prior to the fourth quarter of 1996, have the ability to track loans
by core products. As a result, if loans do not perform up to original
expectations, the Bank may not be able to securitize loans on economic terms
as favorable as those conducted to date. Although the Bank obtained a credit
enhancement in the securitizations completed during the fourth quarter of 1996
and the first quarter of 1997 which facilitated a "AAA" rating for the
securitization interests in both instances, there can be no assurance that the
Bank will be able to obtain future credit enhancements on acceptable terms or
that future securitizations will be similarly rated. Any substantial reduction
in the ability of the Bank to complete securitizations could have a material
adverse effect on the Bank's results of operations and financial condition.
The Bank records net gains from mortgage financing operations through
securitizations based in part on the fair value of the residuals received by
the Bank related to such loans, which are classified as trading securities.
The fair values of such residuals are in turn based in part on market interest
rates and projected loan prepayment and credit loss rates. Increases in
interest rates or higher than anticipated rates of loan prepayments or credit
losses of these or similar securities may require the Bank to write down the
value of such residuals and result in a material adverse effect on the Bank's
results of operations and financial condition. The Bank is not aware of an
active market for the residuals. No assurance can be given that the residuals
could in fact be sold at their carrying value, if at all.
The Bank's future revenues and net income are expected to fluctuate in large
part as a result of the timing and size of its future securitizations. A delay
in closing a scheduled securitization during a particular quarter would
postpone recognition of net gains from mortgage financing operations. In
addition, unanticipated delays in closing a securitization could also increase
the Bank's exposure to credit risks and interest rate fluctuations by
increasing the period during which the Bank holds its loans. If the Bank were
unable to profitably securitize a sufficient number of its loans in a
particular reporting period, the Bank's revenues for such period would decline
and would result in lower net income and possibly a net loss for such period,
and could have a material adverse effect on the Bank's results of operations,
financial condition and capital ratios. In addition, the Bank projects the
expected cash flows over the life of the residual interests, using prepayment
and default assumptions that market participants would use for similar
financial instruments that are subject to prepayment, credit and interest rate
risks. The Bank then determines the present value of these cash flows using an
interest rate commensurate with the risks involved. If the Bank's actual
experience differs materially from the assumptions used in the determination
of the present value of the residual interests, future cash flows and earnings
could be negatively impacted. See "Business--Loan Sales and Asset
Securitizations."
Although the Bank has typically maintained the delinquency, loss and
prepayment experience in its total loan portfolio, prior to its first
securitization in December 1996, the Bank did not separately track the
delinquency, loss and prepayment experience of core product loans in any
meaningful fashion. Consequently, the Bank does not have representative
historical delinquency, bankruptcy, foreclosure, default or prepayment
experience that may be referred to for purposes of estimating the future
delinquency, loss and prepayment experience of its core product loans. In view
of the Bank's lack of core product loan performance data, the Bank relied on a
third party evaluation of its core product loan portfolio and therefore it is
extremely difficult to validate the Bank's loss or prepayment assumptions used
to calculate its gain on sale in connection with its
14
<PAGE>
securitizations or with future securitizations. Any material difference
between these assumptions and actual performance could have a material adverse
impact on the timing and/or receipt of the Bank's future revenues, the value
of the residual interests held on the Bank's balance sheet and the Bank's cash
flow.
RISKS ASSOCIATED WITH SUB-PRIME LENDING
Through its Liberator Series program, the Bank has developed a lending niche
for the origination and purchase of mortgage loans to sub-prime borrowers
(e.g., borrowers who do not qualify for credit under traditional FHLMC, FNMA
or Government National Mortgage Association ("GNMA") guidelines). Loans to
sub-prime borrowers present a higher level of risk of default than conforming
loans because of the increased potential for default by borrowers who may have
had previous credit problems or who do not have an adequate credit history.
Loans to sub-prime borrowers also involve additional liquidity risks, as these
loans generally have a more limited secondary market than conventional loans.
The actual rates of delinquencies, foreclosures and losses on loans to sub-
prime borrowers could be higher under adverse economic conditions than those
currently experienced in the mortgage lending industry in general. The FDIC
has recently issued a letter to all FDIC-insured institutions highlighting the
special risks associated with sub-prime lending and the need for management
controls. While the Bank believes that the underwriting procedures and
appraisal processes it employs enable it to somewhat mitigate the higher risks
inherent in loans made to these borrowers, no assurance can be given that such
procedures or processes will afford adequate protection against such risks.
See "Business--Core Lending Products--Origination and Purchase of Loans" and
"--Underwriting."
HIGH LOAN TO VALUE RATIOS OF PORTFOLIO SERIES LOANS
Through its Portfolio Series program, the Bank originates debt consolidation
loans for Agency Qualified Borrowers. Portfolio Series loans are primarily
home equity lines of credit and second deeds of trust up to 125% of the
appraised value of the real estate underlying the loans. In the event of a
default on a Portfolio Series loan by a borrower, there generally would be
insufficient collateral to pay off the balance of such loan and the Bank, as
holder of a second position on the property, would likely lose a substantial
portion, if not all, of its investment. While the Bank believes that the
underwriting procedures it employs enable it to mitigate somewhat the higher
risks inherent in such loans, no assurance can be given that such procedures
will afford adequate protection against such risks. During the fourth quarter
of 1996 and the first quarter of 1997, of the core product loans originated by
the Bank, 42.9% and 55.3%, respectively, consisted of Portfolio Series loans.
See "Business--Core Lending Products--Origination and Purchase of Loans," "--
Underwriting," and "--Loan Sales and Asset Securitizations."
CONTINGENT RISKS
Although the Bank sells without recourse substantially all of the mortgage
loans it originates or purchases, the Bank retains some degree of credit risk
on substantially all of the loans it sells. In addition, during the period of
time that the loans are held for sale, the Bank is subject to various business
risks associated with the lending business, including borrower default,
foreclosure and the risk that a rapid increase in interest rates would result
in a decline of the value of loans held for sale to potential purchasers.
In connection with its securitizations, the Bank is required to repurchase
or substitute loans in the event of a breach of a representation or warranty
made by the Bank. While the Bank may have recourse to the sellers of loans it
purchased, there can be no assurance of the sellers' abilities to honor their
respective obligations to the Bank. Likewise, in connection with its whole
loan sales, the Bank enters agreements which generally require the Bank to
repurchase or substitute loans in the event of a breach of a representation or
warranty made by the Bank to the Loan Purchaser, any misrepresentation during
the mortgage loan origination process or, in some cases, upon any fraud or
early default on such mortgage loans. The remedies available to a Loan
Purchaser from the Bank are generally broader than those available to the Bank
against the sellers of such loans, and if a Loan
15
<PAGE>
Purchaser enforces its remedies against the Bank, the Bank may not be able to
enforce whatever remedies the Bank may have against such sellers. If the loans
were originated directly by the Bank, the Bank will be solely responsible for
any breaches of representations or warranties.
In addition, borrowers, Loan Purchasers, monoline insurance carriers and
trustees in the Bank's securitizations may make claims against the Bank
arising from alleged breaches of fiduciary obligations, misrepresentations,
errors and omissions of employees, officers and agents of the Bank, including
appraisers, incomplete documentation and failure by the Bank to comply with
various laws and regulations applicable to its business. Any claims asserted
in the future may result in liabilities or legal expenses that could have a
material adverse effect on the Bank's results of operations, financial
condition and business prospects.
DEPENDENCE ON KEY PERSONNEL
The Bank depends to a considerable degree on the contributions of a limited
number of key management personnel who have had, and will continue to have, a
significant role in the development and management of the Bank's mortgage
financing operations. The continued development of the Bank's business
strategy depends to a large extent upon the continued employment of Daniel L.
Perl, President and Chief Executive Officer of both the Company and the Bank.
In addition, many members of senior management have had working relationships
with Mr. Perl prior to joining the Bank. The loss of such personnel, Mr. Perl
or other key personnel could materially adversely affect the Bank's and the
Company's business. The Bank has entered into an interim employment agreement
with Mr. Perl and concurrently with the closing of this Public Offering, the
Company and the Bank will each enter into a three year employment agreement
with Mr. Perl. See "The Board of Directors and Management of the Bank--Letter
Agreement" and "--Employment Agreements."
RISKS RELATED TO DEBENTURES
In March 1997, the Bank issued $10.0 million of subordinated debentures
("the Debentures") through a private placement and pursuant to a Debenture
Purchase Agreement (the "Debenture Offering"). In the event that the Company
and the Bank elect to substitute the Company as obligor on the Debentures (the
"Substitution") following the Public Offering, the holders of the Debentures
will have the option, at September 15, 1998 or at such later time as the
Substitution occurs, to require the Company to purchase all or part of their
Debentures. In the event that all of the holders of the Debentures opt to
require the Company to purchase their Debentures at September 15, 1998, the
Company would be required to fund $10.0 million plus accrued interest to
holders of the Debentures. Such an event would have a material adverse effect
on the Company's liquidity. Furthermore, in the event that the Company has
insufficient funds available to repurchase the Debentures, the Company may be
required to borrow funds at more expensive rates than the interest rate on the
Debentures, which would have a material adverse effect on the Company's
results of operations. See "Business--Sources of Funds--Borrowings."
RISKS RELATED TO MORTGAGE SERVICING RIGHTS
To determine the fair value of its mortgage servicing rights, the Bank
projects net cash flows expected to be received over the life of the
underlying loans. Such projections assume certain servicing costs, prepayment
rates and delinquencies. As of March 31, 1997, the carrying value of the
Bank's mortgage servicing rights totalled $4.1 million, up from $683,000 at
December 31, 1995. In addition, the pooling and servicing agreements relating
to the Bank's securitizations contain provisions with respect to the maximum
permitted loan delinquency rates and loan default rates, which, if exceeded,
would allow the termination of the Bank's right to service the related loans.
The mortgage servicing rights on the loans securitized during the fourth
quarter of 1996 and the first quarter of 1997 totalled approximately $2.3
million.
There can be no assurance that the Bank's estimates used to determine the
fair value of mortgage servicing rights will remain appropriate for the life
of the loans sold or the securitizations. If actual loan prepayments or
delinquencies exceed the Bank's estimates, the carrying value of the Bank's
mortgage servicing rights may have
16
<PAGE>
to be written down through a charge against earnings. The Bank cannot write up
such assets to reflect slower than expected prepayments, although slower
prepayments may increase future earnings as the Bank will receive cash flows
in excess of those anticipated. Fluctuations in interest rates may also result
in a write-down of the Bank's mortgage servicing rights in subsequent periods.
COMPETITION
As a purchaser and originator of mortgage loans, the Bank faces intense
competition, primarily from mortgage banking companies, commercial banks,
credit unions, thrift institutions, credit card issuers and finance companies.
Many of these competitors in the financial services business are substantially
larger and have more capital and other resources than the Bank. Certain large
national finance companies and conforming mortgage originators have announced
their intention to adapt their conforming origination programs and allocate
resources to the origination of non-conforming loans. Certain of these larger
mortgage companies and commercial banks have begun to offer products similar
to those offered by the Bank, targeting customers similar to those of the
Bank. In addition, it is anticipated that the participation of government-
sponsored entities with substantial capital resources in the origination of
non-conforming loans will further intensify competition. The FHLMC recently
announced its intention to support such originations by purchasing,
guaranteeing and securitizing non-conforming loans originated by qualified
institutions. Other government-sponsored entities, such as the FNMA or GNMA,
may also enter into the market for non-conforming loans. The offering by these
competitors, some of which are anticipated to receive support from government-
sponsored entities, of products similar to those of the Bank's could have a
material adverse effect on the Bank's results of operations and financial
condition. The Bank depends largely on Originators with whom the Bank's
competitors also seek to establish relationships. The Bank's future results
may become increasingly sensitive to fluctuations in the volume and cost of
its wholesale loan purchases resulting from competition from other purchasers
for such loans. In addition, as the Bank expands into new geographic markets,
it will face competition from lenders with established positions in these
locations. There can be no assurance that the Bank will be able to continue to
compete successfully in the markets it serves. See "Business--Competition."
AVAILABILITY OF FUNDING SOURCES
The Bank funds substantially all of the loans which it originates or
purchases through deposits, internally generated funds or FHLB advances. The
Bank competes for deposits primarily on the basis of rates, and as a
consequence the Bank could experience difficulties in attracting deposits to
fund its operations if it does not continue to offer deposit rates at levels
that are competitive with other financial institutions. Certificate of deposit
accounts constituted $113.5 million or 86.7% of total deposits at March 31,
1997, of which $103.5 million mature in one year or less. Further increases in
short-term certificate accounts, which tend to be more sensitive to movements
in market interest rates than core deposits, may result in the Bank's deposit
base being less stable than if it had a large amount of core deposits which,
in turn, may result in further increases in the Bank's cost of deposits. The
Bank also uses the cash proceeds generated by the Bank in selling loans in the
secondary market or pools of loans in asset securitizations to fund subsequent
originations or purchases. On an ongoing basis, the Bank explores
opportunities to access credit lines as an additional source of funds and
recently entered into a line of credit with a national investment banking firm
in the amount of $50.0 million to fund loan originations. See "Business--
Sources of Funds--Borrowings." To the extent that the Bank is not able to
maintain its currently available funding sources or to access new funding
sources, it would have to curtail its loan production activities or sell loans
earlier than is optimal. Any such event would have a material adverse effect
on the Bank's results of operations and financial condition. See "Business--
Sources of Funds."
MULTI-FAMILY AND COMMERCIAL REAL ESTATE RISKS
As part of its lending strategy, the Bank has targeted borrowers seeking
loans secured by multi-family properties or properties used for commercial
business purposes such as small office buildings or light industrial or retail
facilities. Although such loans are generally originated for sale, the Bank
anticipates that its multi-family
17
<PAGE>
and commercial real estate portfolios will increase as a percentage of total
assets in future periods. Multi-family and commercial real estate loans are
generally considered to involve a higher degree of credit risk, be more
vulnerable to deteriorating economic conditions and involve higher loan
principal amounts than one- to four-family residential mortgage loans. Income
producing property values are also subject to greater volatility than owner-
occupied residential property values. Economic events and government
regulations, which are outside the control of the borrower or lender, could
impact the value of the security for such loans or the future cash flows of
the affected properties. Further, any material decline in real estate values,
such as the declines experienced in southern California in recent years,
generally reduces the ability of borrowers to use home equity to support
borrowings and increases the loan-to-value ratios of loans previously made,
thereby weakening collateral coverage and increasing the possibility of a loss
in the event of a borrower default.
POTENTIAL IMPACT OF CHANGES IN INTEREST RATES
The Bank's profitability is dependent to a certain extent upon its net
interest income, which is the difference between its interest income on
interest-earning assets, such as loans and investments, and its interest
expense on interest-bearing liabilities, such as deposits and borrowings. The
Bank's ability to originate, purchase and sell loans through its mortgage
financing operations is significantly impacted by changes in interest rates.
Increases in interest rates may also reduce the amount of loan and commitment
fees received by the Bank. A significant decline in interest rates could also
decrease the size of the Bank's servicing portfolio and the related servicing
income by increasing the level of loan prepayments. Additionally, the interest
rate adjustments with respect to the Bank's investment securities lag rate
adjustments to the Bank's deposit accounts. Accordingly, the yield on the
Bank's investment securities may adjust more slowly than the cost of the
Bank's interest-bearing liabilities in a rising interest rate environment. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Management of Interest Rate Risk."
ABSENCE OF MARKET FOR COMMON STOCK
The Company, as a newly organized company, has never issued common stock.
Consequently, the initial public offering price will be determined through
negotiations between the Company and the Underwriter. See "Underwriting" for
factors to be considered in determining the initial public offering price. The
Company Common Stock has been approved for quotation on the National Market
System of the Nasdaq Stock Market under the symbol "LFCO." However, there can
be no assurance that an active and liquid trading market for the Common Stock
will develop, or, once developed, will continue, nor can there be any
assurances that holders of the Common Stock will be able to sell their shares
at or above the price per share in the Public Offering. The absence or
discontinuance of a market for the Common Stock may have an adverse effect on
both the price and liquidity of the Common Stock. In addition, the stock
market has on occasion experienced extreme price and volume fluctuations.
These broad market fluctuations may adversely affect the market price for the
Company's Common Stock. See "Market for the Common Stock of the Company."
CERTAIN ANTI-TAKEOVER PROVISIONS
Provisions in the Company's Governing Instruments. Certain provisions of the
Company's Certificate of Incorporation and Bylaws, particularly a provision
limiting voting rights, as well as certain federal regulations, assist the
Company in maintaining its status as an independent publicly owned
corporation. These provisions provide for, among other things, supermajority
voting on certain matters, staggered elections of the board of directors, non-
cumulative voting for directors, limits on the calling of special meetings,
limits on voting shares in excess of 10% of the outstanding shares, and
certain uniform price provisions for certain business combinations. These
provisions in the Company's governing instruments may discourage potential
proxy contests and other potential takeover attempts, particularly those which
have not been negotiated with the Board of Directors, and thus, generally may
serve to perpetuate current management. For a more detailed discussion of
these provisions, see "Restrictions on Acquisition of the Company."
18
<PAGE>
Voting Control of Officers and Directors. Directors and executive officers
of the Company are expected to own approximately 13.0% of the shares of common
stock of the Company following the Reorganization and the Public Offering,
including shares purchased by directors and executive officers in the Public
Offering. Options for an additional 434,840 shares of Common Stock, or 7.1% of
the shares of Common Stock to be issued and outstanding after the
Reorganization and the Public Offering and the exercise of such options, may
be attributable to directors and executive officers through the Option Plans.
Accordingly, management's potential voting control could, together with
additional stockholder support, defeat stockholder proposals requiring 80%
approval of stockholders and will continue to have a significant influence
over the affairs of the Company and the Bank. Such concentration of ownership
may have the effect of delaying, deferring or preventing takeover attempts
that certain stockholders deem to be in their best interest and may tend to
perpetuate existing management. See "Restrictions on Acquisition of the
Company--Restrictions in the Company's Certificate of Incorporation and
Bylaws" and "The Board of Directors and Management of the Bank--Stock Option
Plans."
Employment Agreement. Daniel L. Perl, the President and Chief Executive
Officer, is subject to a letter agreement with the Bank from January 1, 1997
until the consummation of the Reorganization (the "Letter Agreement"). At such
time, the Bank and the Company intend to enter into written employment
agreements with Mr. Perl. Such employment agreements provide for benefits and
cash payments in the event of a change in control of the Company or the Bank.
These provisions may have the effect of increasing the cost of acquiring the
Company, thereby discouraging future attempts to take over the Company or the
Bank. See "The Board of Directors and Management of the Bank--Employment
Agreements." Based on current salary and cash bonus, payments to be paid in
the event of a change in control pursuant to the Employment Agreements would
be approximately $3.0 million. However, the actual amount to be paid in the
event of a change in control of the Company or the Bank cannot be estimated at
this time because the actual amount is based on the average salary of the
employee and other factors existing at the time of the change in control which
cannot be determined at this time.
FINANCIAL INSTITUTION REGULATION AND POSSIBLE LEGISLATION
The Company, as a savings and loan holding company, will be, and the Bank,
as a federal savings association, is subject to extensive federal law,
regulations and supervision. Such law and regulations, which affect operations
on a daily basis, may be changed at any time, and the interpretation of the
relevant existing law and regulations is also subject to change by the federal
regulatory authorities. Any failure of the Bank to comply with any of the laws
and regulations to which it is subject or any change in the regulatory
structure or the applicable statutes, regulations or interpretations, whether
by the OTS, the FDIC or the Congress, could have a material adverse impact on
the Company, the Bank, their respective operations or the Reorganization. See
"Regulation."
Recently enacted legislation provides that the Bank Insurance Fund ("BIF")
and the SAIF will merge on January 1, 1999 if there are no more savings
associations as of that date. Such legislation also requires that the
Department of Treasury submit a report to Congress that makes recommendations
regarding a common financial institutions charter, including whether the
separate charters for thrifts and banks should be abolished. Various proposals
to eliminate the federal thrift charter and create a uniform financial
institutions charter were introduced in the 105th Congress. Such legislative
proposals would also abolish the OTS and transfer its functions to three
federal bank regulators and to the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") with respect to the regulation of holding
companies which could limit the activities permissible for the Company to
activities that are financial in nature. While such legislation was not acted
upon by the past session of Congress, no assurances can be made that similar
legislation will not be enacted by the current session of Congress. The Bank
is unable to determine the extent to which such legislation, if enacted, would
affect its business.
Recent federal legislation known as the Riegle Community Development and
Regulatory Improvement Act (the "Riegle Act"), imposed additional regulatory
requirements on mortgage loans having relatively higher origination fees and
interest rates, such as those made by the Bank, and the Bank expects its
business to be the focus of additional federal and state legislation, and
regulation in the future.
19
<PAGE>
IMPACT OF LAWS AND REGULATIONS AFFECTING CERTAIN LENDING OPERATIONS
In addition to federal regulations on its banking operations, the Bank's
consumer lending activities are subject to consumer protection and other
statutes including the Federal Truth-in-Lending Act and Regulation Z
(including the Home Ownership and Equity Protection Act of 1994), the Federal
Equal Credit Opportunity Act and Regulation B, as amended, the Fair Credit
Reporting Act of 1970, as amended, the Federal Real Estate Settlement
Procedures Act of 1974, as amended ("RESPA"), and Regulation X, the Fair
Housing Act, the Home Mortgage Disclosure Act and Regulation C and the Federal
Debt Collection Practices Act.
These rules and regulations, among other things, establish eligibility
criteria for mortgage loans, prohibit discrimination, provide for inspections
and appraisals of properties, require credit reports on loan applicants,
regulate assessment, collection, foreclosure and claims handling, investment
and interest payments on escrow balances and payment features, mandate certain
disclosures and notices to borrowers and, in some cases, fix maximum interest
rates, fees and mortgage loan amounts. Failure to comply with these
requirements can lead to loss of approved status, termination or suspension of
servicing contracts without compensation to the servicer, demands for
indemnifications or mortgage loan repurchases, certain rights of rescission
for borrowers, class action lawsuits and administrative enforcement actions.
Although the Company believes that it has systems and procedures to
facilitate compliance with these requirements and believes that it is in
compliance in all material respects with applicable local, state and federal
laws, rules and regulations, in the future more restrictive laws, rules and
regulations or the judicial interpretation of existing laws, rules and
regulations could make compliance more difficult or expensive. See
"Regulation."
ELIMINATION OF LENDER PAYMENTS TO BROKERS COULD ADVERSELY AFFECT RESULTS OF
OPERATIONS
Lawsuits have been filed against several mortgage lenders alleging that such
lenders have made certain payments to independent mortgage brokers in
violation of RESPA. These lawsuits have generally been filed on behalf of a
purported nationwide class of borrowers alleging that payments made by a
lender to a broker in addition to payments made by the borrower to a broker
are prohibited by RESPA and are therefore illegal. If these cases are resolved
against the lenders, it may cause an industry-wide change in the way
independent mortgage brokers are compensated. The Bank's broker compensation
programs permit such payments. Although the Bank believes that its broker
compensation programs comply with all applicable laws and are consistent with
long-standing industry practice and regulatory interpretations, in the future
new regulatory interpretations or judicial decisions may require the Bank to
change its broker compensation practices. Such a change may have a material
adverse effect on the Bank and the entire mortgage lending industry.
DILUTION
Upon completion of the Public Offering, there will be an immediate dilution
to investors in the Public Offering of the net tangible book value per share
of Common Stock of $4.42 per share based on the offering price of $11.00 per
share. On an as adjusted basis, the offering price is substantially greater
than the effective price at which the existing stockholders purchased their
shares and the effective exercise price of the outstanding stock options. See
"Dilution."
NO CASH DIVIDENDS
Following the Reorganization and the Public Offering, the Company intends to
retain its earnings, if any, for use in its business and does not anticipate
declaring or paying any cash dividends in the foreseeable future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Dividend Policy." In
addition, the Company's ability to pay dividends at any time may be limited by
the Bank's ability to pay dividends to its sole stockholder, the Company. See
"Regulation-- Federal Savings Institution Regulation--Limitation on Capital
Distributions."
20
<PAGE>
ENVIRONMENTAL RISKS
In the course of its business, the Bank has acquired, and may acquire in the
future, properties securing loans that are in default. There is a risk that
hazardous substances or waste, contaminants, pollutants or sources thereof
could be discovered on such properties after acquisition by the Bank. In such
event, the Bank may be required by law to remove such substances from the
affected properties at its sole cost and expense. There can be no assurance
that (i) the cost of such removal would not substantially exceed the value of
the affected properties or the loans secured by the properties, (ii) the Bank
would have adequate remedies against the prior owner or other responsible
parties or (iii) the Bank would not find it difficult or impossible to sell
the affected properties either prior to or following such removal.
21
<PAGE>
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of 2,900,000
shares of Common Stock offered in the Public Offering based on an offering
price of $11.00 per share after deducting estimated underwriting commissions
and expenses are estimated to be $28.7 million ($33.2 million, if the
Underwriters' overallotment option is exercised in full). Such net proceeds
will be used to (i) pay $9.8 million in cash to the Bank, which together with
the assumption of the Bank's $9.6 million, net, subordinated debt liability,
will be used to acquire residual assets of approximately $12.5 million and
restricted cash of $6.9 million resulting from the Bank's securitizations, see
"Business--Sources of Funds--Borrowings"; (ii) downstream proceeds to the Bank
if necessary to fund additional purchases of loans; (iii) acquire an interest
in or pay the startup costs to establish a subsidiary for the purpose of
providing short term warehouse lines of credit; and (iv) fund general business
activities, including expansion of existing mortgage financing operations,
possible acquisitions or development costs of related businesses as
opportunities arise. However, the Company has not entered into any
arrangement, agreement or understanding with respect to future acquisitions
and there can be no assurance that it will do so in the future. No
determination has been made as to the amount of proceeds that will be
allocated to each use, with the exception of the acquisition of the residual
assets and Reserve Account. The Company, upon the Reorganization, will be a
unitary savings and loan holding company, which under existing laws would
generally not be restricted as to the types of business activities in which it
may engage, provided that the Bank continues to be a qualified thrift lender
("QTL"). See "Regulation--Holding Company Regulation" for a description of
certain regulations and proposed regulations applicable to the Company.
DIVIDEND POLICY
The Company presently intends to retain all future earnings, if any, for use
in its business and does not anticipate declaring or paying any cash dividends
on its Common Stock in the foreseeable future. In the event that the Board of
Directors does determine to pay dividends in the future, any such payment will
depend upon a number of factors, including investment opportunities available
to the Company or the Bank, capital requirements, regulatory limitations, the
Company's or the Bank's financial condition and results of operations, tax
considerations and general economic conditions. For information concerning
federal regulations regarding the Bank's ability to make capital distributions
to the Company, see "Regulation--Federal Savings Institution Regulation--
Limitation on Capital Distributions."
The Company is subject to the requirements of Delaware law, which generally
limit dividends to an amount equal to the excess of the net assets of the
Company (the amount by which total assets exceed total liabilities) over its
statutory capital, or if there is no such excess, to its net profits for the
current and/or immediately preceding fiscal year. For a discussion of certain
circumstances under which the Company may become subject to certain provisions
of the California Corporation Code, see "Restrictions on Acquisition of the
Company-- General."
MARKET FOR THE COMMON STOCK OF THE COMPANY
The Company was recently formed and has never issued capital stock. The
Common Stock has been approved for quotation on the National Market System of
the Nasdaq Stock Market under the symbol "LFCO". KBW has indicated its
intention to make a market in the Company's Common Stock. KBW is not
obligated, however, to make a market in the Common Stock and any market making
may be discontinued at any time. Upon completion of the Public Offering, the
Company will have at least three market makers making a market in its Common
Stock. Making a market involves maintaining bid and ask quotations and being
able, as principal, to effect transactions in reasonable quantities at those
quoted prices, subject to various securities laws and other regulatory
requirements. There can be no assurance that the Common Stock will be able to
meet the applicable listing criteria in order to maintain its quotation on the
Nasdaq Stock Market or that an active and liquid trading market will develop
or, if developed, will be maintained. A public market having the desirable
characteristics of
22
<PAGE>
depth, liquidity and orderliness, however, depends upon the presence in the
marketplace of both willing buyers and sellers of Common Stock at any given
time, which is not within the control of the Company. No assurance can be
given that an investor will be able to resell the Common Stock at or above the
price to the public of the Common Stock after the Public Offering. See "Risk
Factors--Absence of Market for Common Stock."
MARKET FOR THE COMMON STOCK OF THE BANK
There is no established market for the common stock of the Bank. As of April
22, 1997, the Bank's common stock was held by approximately 406 holders of
record. The Bank has not paid cash dividends on its common stock. The Board of
Directors declared a 100% stock dividend to stockholders of record as of
February 28, 1996, payable as of March 31, 1996. For a description of
regulatory restrictions on the payment of cash dividends and other capital
distributions by the Bank, see "Regulation--Federal Savings Institution
Regulation--Limitation on Capital Distributions."
DILUTION
The pro forma net tangible book value of the Common Stock of the Bank at
March 31, 1997, was $3.59 per share. Net tangible book value per share
represents the amount of total tangible assets less total liabilities, divided
by the number of shares of Common Stock outstanding. After giving effect to
the Public Offering and the application of the net proceeds therefrom, at an
initial public offering price of $11.00 per share, the net tangible book value
of the Company at March 31, 1997 would have been $40.2 million, or $6.58 per
share of Common Stock. This represents an immediate increase in net tangible
book value of $2.99 per share to the existing stockholders of the Bank and an
immediate dilution in net tangible book value of $4.42 per share to new
investors at the assumed initial public offering price. The following
illustrates this dilution per share:
<TABLE>
<S> <C> <C>
Initial public offering price per share........................ $11.00
Pro forma net tangible book value per share as of March 31,
1997, as adjusted for the Reorganization.................... 3.59
Increase in net tangible book value per share attributable to
new investors............................................... 2.99
----
Pro forma net tangible book value after the Public Offering.... 6.58
------
Dilution per share to new investors............................ $ 4.42
======
</TABLE>
The following table summarizes, on a pro forma basis, as of March 31, 1997,
the relative investments of the existing stockholders of the Bank and new
investors in the Company, with respect to the number of shares of Common Stock
purchased from the Company, the total consideration paid and the average price
per share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
----------------- --------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ---------- ---------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Existing stockholders... 3,211,716 52.6% $ 11,515 26.5% $ 3.59
New investors........... 2,900,000 47.4 31,900 73.5% 11.00
--------- ----- ---------- --------
Total................. 6,111,716 100.0% $ 43,415 100.0%
========= ===== ========== ========
</TABLE>
23
<PAGE>
CAPITALIZATION
The following table sets forth, at March 31, 1997, the actual capitalization
of the Bank, the pro forma capitalization of the Company giving effect to the
Reorganization, and the pro forma capitalization of the Company as adjusted to
give effect to the Reorganization and the sale by the Company of 2,900,000
shares of Common Stock at the initial public offering price of $11.00 per
share (net of underwriting discount and estimated offering expenses). The
information below should be read in conjunction with the Financial Statements
and the Notes thereto which are included elsewhere herein.
<TABLE>
<CAPTION>
AT MARCH 31, 1997
----------------------------------
PRO FORMA
PRO FORMA COMPANY AS
BANK ACTUAL COMPANY ADJUSTED(1)
----------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Deposits..................................... $130,808 $130,808 $130,808
Subordinated debt............................ 10,000 10,000 10,000
-------- -------- --------
Total deposits and borrowed funds.......... $140,808 $140,808 $140,808
======== ======== ========
Common Stock of the Bank, $8.00 stated value
(10,000,000 shares authorized, 1,070,572
shares issued and outstanding).............. 8,565 -- --
Common stock of the Company, $0.01 par value
(25,000,000 shares authorized, 3,211,716
shares issued and outstanding, as adjusted
to reflect the Reorganization, and 6,111,716
shares issued and outstanding, as adjusted
to reflect the Reorganization and the Public
Offering)................................... -- 32 61
Additional paid-in capital................... 825 9,358 38,036
Retained earnings............................ 2,125 2,125 2,125
-------- -------- --------
Total stockholders' equity................. $ 11,515 $ 11,515 $ 40,222
======== ======== ========
Bank Regulatory Capital Ratios:
Tangible Capital........................... 7.19% 7.19% 7.66%
Core (leverage) capital.................... 7.19 7.19 7.66
Total risk-based capital................... 10.51 10.51 17.11
Stockholders' equity to total assets......... 7.30 7.30 21.58
</TABLE>
- --------
(1) Adjustment also reflects the transfer of the residuals, restricted cash
and subordinated debt to the Company.
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The condensed operating data presented below is derived in part from, and
should be read in conjunction with, the Financial Statements and related notes
of Life Savings Bank, Federal Savings Bank, presented elsewhere in this
Prospectus. The condensed operating data for the three-month periods ended
March 31, 1997 and 1996 is derived from unaudited financial data, but, in the
opinion of management reflects all adjustments (consisting of only normal
recurring adjustments) which are necessary to present fairly the results for
such interim periods. The results of operations for the three months ended
March 31, 1997 are not necessarily indicative of the results of operations
that may be expected for the year ending December 31, 1997.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
--------------- -----------------------
1997 1996 1996 1995 1994
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C> <C>
Interest income:
Loans............................... $ 1,872 $ 1,598 $ 6,542 $ 5,433 $ 4,530
Securities held to maturity......... 106 25 56 159 138
Other interest-earning assets....... 326 39 331 233 156
------- ------- ------- ------- -------
Total interest income............. 2,304 1,662 6,929 5,825 4,824
------- ------- ------- ------- -------
Interest expense:
Deposit accounts.................... 1,317 826 3,514 3,192 2,534
FHLB advances and other borrowings.. 173 103 252 256 187
Subordinated debentures............. 71 -- -- -- --
------- ------- ------- ------- -------
Total interest expense............ 1,561 929 3,766 3,448 2,721
------- ------- ------- ------- -------
Net interest income before
provision for estimated loan
losses......................... 743 733 3,163 2,377 2,103
Provision for estimated loan losses... 500 68 963 1,194 1,306
------- ------- ------- ------- -------
Net interest income after
provision for estimated loan
losses......................... 243 665 2,200 1,183 797
------- ------- ------- ------- -------
Non-interest income:
Loan servicing and other fees....... 120 101 496 231 164
Service charges on deposit
accounts........................... 30 33 128 111 84
Net gains from mortgage financing
operations......................... 5,877 887 8,352 3,575 1,428
Other income........................ 58 19 136 103 12
------- ------- ------- ------- -------
Total non-interest income......... 6,085 1,040 9,112 4,020 1,688
------- ------- ------- ------- -------
Non-interest expense:
Compensation and benefits........... 1,582 814 5,233 2,544 1,575
Premises and occupancy.............. 223 166 746 471 418
Data processing..................... 135 87 390 208 167
Net loss on foreclosed real estate.. 63 91 158 53 280
FDIC insurance premiums............. 18 44 174 184 186
SAIF special assessment............. -- -- 448 -- --
Marketing........................... 68 39 189 65 55
Telephone........................... 85 40 246 143 128
Professional services............... 58 27 218 92 86
Other expense....................... 260 213 879 629 561
------- ------- ------- ------- -------
Total non-interest expense........ 2,492 1,521 8,681 4,389 3,456
------- ------- ------- ------- -------
Income (loss) before income tax
provision (benefit).................. 3,836 184 2,631 814 (971)
Income tax provision (benefit)........ 1,594 79 1,126 294 (300)
------- ------- ------- ------- -------
Net income (loss)................... $ 2,242 $ 105 $ 1,505 $ 520 $ (671)
======= ======= ======= ======= =======
Earnings (loss) per share (pro
forma)(1)............................. $ 0.70 $ 0.06 $ 0.63 $ 0.28 $ (0.36)
======= ======= ======= ======= =======
</TABLE>
- -------
(1) Earnings per share is based on the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred
during 1996. Earnings per share (pro forma) is then adjusted for the
exchange of three shares of Company Common Stock for one share of Bank
common stock in the Reorganization.
25
<PAGE>
AVERAGE BALANCE SHEETS
The following tables set forth certain information relating to the Bank at
March 31, 1997, and for the three months ended March 31, 1997 and 1996 and for
the years ended December 31, 1996, 1995 and 1994. The yields and costs are
derived by dividing income or expense by the average balance of assets or
liabilities, respectively, for the periods shown. Unless otherwise noted,
average balances are measured on a daily basis. The yields and costs include
fees which are considered adjustments to yields.
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
AT MARCH 31, 1997 MARCH 31, 1997 MARCH 31, 1996
------------------- ---------------------------- ---------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE YIELD/COST BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
-------- ---------- -------- -------- ---------- ------- -------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Interest-earning
deposits and short-
term investments...... $ 43,551 5.29% $ 8,914 $ 139 6.24% $ 3,318 $ 34 4.10%
Investment
securities(1)......... 9,012 5.65 8,628 120 5.56 2,689 30 4.46
Loans receivable,
net(2)................ 72,967 10.04 98,890 1,872 7.57 72,916 1,598 8.77
Mortgage-backed
securities(1)......... 9 6.88 10 -- -- 11 -- --
Residual assets........ 12,519 13.50 5,131 173 13.49 -- -- --
-------- -------- ----- ------- -----
Total interest-earning
assets................ 138,058 8.57 121,573 2,304 7.58 78,934 1,662 8.42
----- -----
Non-interest-earning
assets(3).............. 19,649 20,317 8,365
-------- -------- -------
Total assets(3)...... $157,707 $141,890 $87,299
======== ======== =======
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Passbook accounts...... $ 4,115 2.10 $ 3,959 20 2.02 $ 4,640 24 2.07
Money market
accounts.............. 3,032 2.98 3,025 23 3.04 3,871 29 3.00
Checking accounts...... 10,209 2.63 10,006 61 2.44 6,980 24 1.38
Certificate accounts... 113,452 5.83 86,348 1,213 5.62 53,434 749 5.61
-------- -------- ----- ------- -----
Total deposit
accounts............ 130,808 5.39 103,338 1,317 5.10 68,925 826 4.79
Borrowings............. 10,000 13.50 15,350 244 6.36 6,889 103 5.98
-------- -------- ----- ------- -----
Total interest-
bearing
liabilities......... 140,808 5.97 118,688 1,561 5.26 75,814 929 4.90
----- -----
Non-interest-bearing
liabilities(3)......... 5,384 13,290 7,168
-------- -------- -------
Total
liabilities(3)...... 146,192 131,978 82,982
Equity(3)............... 11,515 9,912 4,317
-------- -------- -------
Total liabilities and
equity(3)........... $157,707 $141,890 $87,299
======== ======== =======
Net interest income
before provision for
estimated loan losses.. $ 743 $ 733
===== =====
Net interest rate
spread(4).............. 2.60 2.32 3.52
Net interest margin(5).. 2.44 3.71
Ratio of interest-
earning assets to
interest-bearing
liabilities............ 98.05 102.43 104.12
</TABLE>
- -------
(1) Includes unamortized discounts and premiums and certificates of deposit.
(2) Amount is net of deferred loan origination fees, unamortized discounts,
premiums and allowance for estimated loan losses and includes loans held
for sale and non-performing loans. See "Business--Lending Overview."
(3) Average balances are measured on a month-end basis.
(4) Net interest rate spread represents the difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income divided by average
interest-earning assets.
26
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1996 1995 1994
------------------------ ------------------------ ------------------------
AVERAGE AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------- ------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning
assets:
Interest-earning
deposits and short-
term investments...... $ 5,618 $ 257 4.57% $ 4,225 $ 203 4.80% $ 3,736 $ 124 3.32%
Investment
securities(1)......... 1,912 100 5.23 3,458 188 5.44 3,763 169 4.49
Loans receivable,
net(2)................ 72,556 6,542 9.02 65,521 5,433 8.29 65,566 4,530 6.91
Mortgage-backed
securities(1)......... 11 1 9.09 12 1 8.33 14 1 7.14
Residual assets........ 199 29 14.57 -- -- -- -- -- --
------- ------ ------- ------ ------- ------
Total interest-
earning assets...... 80,296 6,929 8.63 73,216 5,825 7.96 73,079 4,824 6.60
------ ------ ------
Non-interest-earning
assets(3)............. 6,035 2,465 2,517
------- ------- -------
Total assets(3)...... $86,331 $75,681 $75,596
======= ======= =======
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Passbook accounts...... $ 4,401 92 2.09 $ 5,090 127 2.50 $ 7,048 157 2.23
Money market
accounts.............. 4,233 118 2.79 5,493 144 2.62 6,512 163 2.50
Checking accounts...... 7,048 112 1.59 6,434 92 1.43 6,180 95 1.54
Certificate accounts... 57,333 3,192 5.57 50,608 2,829 5.59 49,851 2,119 4.25
------- ------ ------- ------ ------- ------
Total deposit
accounts............ 73,015 3,514 4.81 67,625 3,192 4.72 69,591 2,534 3.64
Borrowings(4).......... 4,268 252 5.90 3,112 256 8.23 1,863 187 10.04
------- ------ ------- ------ ------- ------
Total interest-
bearing
liabilities......... 77,283 3,766 4.87 70,737 3,448 4.87 71,454 2,721 3.81
------ ------ ------
Non-interest-bearing
liabilities(3)........ 3,026 1,131 197
------- ------- -------
Total
liabilities(3)...... 80,309 71,868 71,651
Equity(3).............. 6,022 3,813 3,945
------- ------- -------
Total liabilities and
equity(3)........... $86,331 $75,681 $75,596
======= ======= =======
Net interest income
before provision for
estimated loan
losses................ $3,163 $2,377 $2,103
====== ====== ======
Net interest rate
spread(5)............. 3.76 3.09 2.79
Net interest
margin(6)............. 3.94 3.25 2.88
Ratio of interest-
earning assets to
interest-bearing
liabilities........... 103.90 103.50 102.27
</TABLE>
- -------
(1) Includes unamortized discounts and premiums and certificates of deposit.
(2) Amount is net of deferred loan origination fees, unamortized discounts,
premiums and allowance for estimated loan losses and includes loans held
for sale and non-performing loans. See "Business--Lending Overview."
(3) Average balances are measured on a month-end basis.
(4) The average yield on borrowings for the years ending December 31, 1995 and
1994 included the effects of $52,000 and $96,000, respectively, in
interest expense on swap transactions with a notional principal balance of
$2.0 million in 1995 and 1994. Without this added expense, the average
yield on borrowings for the years ending December 31, 1995 and 1994 would
have been 6.56% and 4.88%, respectively. The yield on total interest-
bearing liabilities for the years ending December 31, 1995 and 1994 would
have been 4.80% and 3.67%, respectively. The $2.0 million in swap
contracts matured on November 7, 1995.
(5) Net interest rate spread represents the difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average
interest-earning assets.
27
<PAGE>
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected the Bank's interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to: (i) changes attributable to changes in volume
(changes in volume multiplied by prior rate); (ii) changes attributable to
changes in rate (changes in rate multiplied by prior volume); and (iii) the
net change. The changes attributable to the combined impact of volume and rate
have been allocated proportionately to the changes due to volume and the
changes due to rate.
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED YEAR ENDED
MARCH 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
COMPARED TO COMPARED TO COMPARED TO
THREE MONTHS ENDED YEAR ENDED YEAR ENDED
MARCH 31, 1996 DECEMBER 31, 1995 DECEMBER 31, 1994
---------------------------- ----------------------------- -----------------------------
INCREASE (DECREASE) INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO DUE TO
---------------------- --------------------- ---------------------
VOLUME RATE NET VOLUME RATE NET VOLUME RATE NET
---------- ---------- ---- ---------- --------- ------ ---------- --------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Interest-earning
deposits and short-
term investments...... $ 80 $ 25 $105 $ 64 $ (10) $ 54 $ 18 $ 60 $ 78
Investment securities,
net................... 81 9 90 (81) (7) (88) (14) 34 20
Loans receivable,
net(1)................ 513 (239) 274 609 500 1,109 (2) 905 903
Residual assets........ 173 -- 173 29 -- 29 -- -- --
Mortgage-backed
securities............ -- -- -- -- -- -- -- -- --
--------- ---------- ---- --------- --------- ------ --------- --------- ------
Total interest-earning
assets................ 847 (205) 642 621 483 1,104 2 999 1,001
INTEREST-BEARING
LIABILITIES:
Money market accounts.. (7) 1 (6) (35) 9 (26) $ (27) 8 (19)
Passbook accounts...... (3) (1) (4) (16) (19) (35) (47) 17 (30)
Checking accounts...... 13 24 37 9 11 20 4 (7) (3)
Certificate accounts... 462 2 464 374 (11) 363 33 677 710
Borrowings............. 134 7 141 80 (84) (4) 108 (39) 69
--------- ---------- ---- --------- --------- ------ --------- --------- ------
Total interest-bearing
liabilities........... 599 33 632 412 (94) 318 71 656 727
--------- ---------- ---- --------- --------- ------ --------- --------- ------
Change in net interest
income................. $ 248 $ (238) $ 10 $ 209 $ 577 $ 786 $ (69) $ 343 $ 274
========= ========== ==== ========= ========= ====== ========= ========= ======
</TABLE>
- --------
(1) Includes interest on loans held for sale.
SUMMARY
The Bank is involved in the origination, purchase, sale and servicing of
non-conventional mortgage loans principally secured by first and second
mortgage loans on one- to four-family residences. The Bank has focused on
Liberator Series loans which are for the purchase or refinance of residential
real property by borrowers who may have had prior credit problems or who do
not have an adequate credit history, are considered "sub-prime borrowers," or
loans which have other non-conforming features. In addition, the Bank has
originated a substantial number of Portfolio Series loans which are debt
consolidation loans for Agency Qualified Borrowers. The Bank purchases and
originates mortgage loans and other real estate secured loans through a
network of Originators throughout the country. The Bank funds substantially
all of the loans which it originates or purchases through deposits, internally
generated funds and FHLB advances. In the immediate and foreseeable future,
the Bank will also fund loans from the cash proceeds, if any, received from
securitizations. Deposit flows and cost of funds are influenced by prevailing
market rates of interest primarily on competing investments, account
maturities and the levels of savings in the Bank's market area. The Bank's
ability to purchase or sell loans is influenced by the general level of
product available from its correspondent relationships and the willingness of
investors to purchase the loans at an acceptable price to the Bank. Due to
substantial activity in the purchase and sale of loans in recent years, the
net gains from mortgage financing operations have been significant. The
28
<PAGE>
Company anticipates utilizing a portion of the net proceeds from the Public
Offering to continue to expand the Bank's mortgage financing operations. See
"Business" and "Use of Proceeds." The Bank's results of operations are also
affected by the Bank's provision for loan losses and the level of operating
expenses. The Bank's operating expenses primarily consist of employee
compensation and benefits, premises and occupancy expenses, and other general
expenses. The Bank's results of operations are also affected by prevailing
economic conditions, competition, government policies and actions of
regulatory agencies. See "Regulation."
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND
MARCH 31, 1996
GENERAL
Net income increased from $105,000 for the three months ended March 31, 1996
to $2.2 million for the three months ended March 31, 1997. The increase was
due to the expansion of the mortgage financing operations and the increase in
gains with respect to such operations. The increase was partially offset by an
increase in non-interest expense, which was also a result of the expansion of
the mortgage financing operations.
Net gains from mortgage financing operations for the three months ended
March 31, 1996 totalled $887,000, compared to $5.9 million for the three
months ended March 31, 1997, due to the expansion of the mortgage financing
operations and increased marketing effort therefrom, along with the
securitization of $83.2 million in loans which occurred during the three
months ended March 31, 1997. The expansion of the mortgage financing
operations resulted in an increase in loan originations and purchases from
$50.9 million for the three months ended March 31, 1996 to $92.2 million for
the three months ended March 31, 1997. The related sales and securitization of
loans increased from $37.8 million for the three months ended March 31, 1996
to $83.2 million for the three months ended March 31, 1997. See "Business--
Loan Sales and Asset Securitizations."
Although the Bank will not complete a securitization in the second quarter
of 1997, the Company currently intends to conduct securitizations on a regular
basis either through private placements or public offerings. There can be no
assurance, however, that the Company will be able to successfully implement
this strategy. See "Risk Factors--Dependence on Asset Securitizations and
Impact on Quarterly Operating Results."
INTEREST INCOME
Interest income increased from $1.7 million for the three months ended March
31, 1996 to $2.3 million for the three months ended March 31, 1997 due
primarily to an increase in the average balance of interest earning assets
offset in part by a decrease in the average yield on such assets. Average
interest earning assets increased from $78.9 million for the three months
ended March 31, 1996 to $121.6 million for the three months ended March 31,
1997. The yield on interest earning assets decreased from 8.42% for the three
months ended March 31, 1996 to 7.58% for the three months ended March 31,
1997. The largest single component of interest earning assets was loans
receivable, net, which increased from $72.9 million with a yield of 8.77% for
the three months ended March 31, 1996 to $98.9 million with a yield of 7.57%
for the three months ended March 31, 1997. The decline in yield is a result of
the securitization of assets which occurred at the end of the three months
ended December 31, 1996. The loans securitized at the end of December 1996 had
a weighted average interest rate of 13.32%, which led to an immediate decline
in the yield on loans receivable, net, following the sale of these assets. The
increase in loans receivable was a result of an increase in loans held for
sale, which increased from $32.8 million as of March 31, 1996 to $37.8 million
as of March 31, 1997. Loans held for investment decreased from $41.9 million
as of March 31, 1996 to $36.5 million as of March 31, 1997. Generally, all
loans are originated or purchased for sale in the secondary market or through
securitizations. See "Business--Core Lending Products" and "--Loan Sales and
Asset Securitizations."
Other components of interest earning assets increased as well. Interest
earning deposits and short term investments increased from $3.3 million with a
yield of 4.10% for the three months ended March 31, 1996 to $8.9 million with
a yield of 6.24% for the three months ended March 31, 1997. Investment
securities increased from $2.7 million with a yield of 4.46% for the three
months ended March 31, 1996 to $8.6 million with a yield
29
<PAGE>
of 5.56% for the three months ended March 31, 1997. Finally, the residual
asset of $5.1 million resulting from the Bank's securitization activities
during the three months ended March 31, 1997 yielded 13.49% for the three
months. The Bank held no residual assets for the three months ended March 31,
1996.
INTEREST EXPENSE
Interest expense increased from $929,000 for the three months ended March
31, 1996 to $1.6 million for the three months ended March 31, 1997 due to an
increase in the average total interest bearing liabilities and the composition
of the liabilities. Average total interest bearing liabilities increased from
$75.8 million with a yield of 4.90% for the three months ended March 31, 1996
to $118.7 million with a yield of 5.26% for the three months ended March 31,
1997. The largest component of average interest bearing liabilities was
certificate accounts, which increased from an average balance of $53.4 million
with a yield of 5.61% for the three months ended March 31, 1996 to an average
balance of $86.3 million with a yield of 5.62% for the three months ended
March 31, 1997. This increase in yield reflects the increased use of wholesale
deposits to fund the mortgage financing operations.
The second largest component of average interest bearing liabilities is
borrowings, which increased from an average balance of $6.9 million with a
yield of 5.98% for the three months ended March 31, 1996 to an average balance
of $15.4 million with a yield of 6.36% for the three months ended March 31,
1997. In addition, during the three months ended March 31, 1997, the Bank
issued Subordinated Debentures totalling $10.0 million with a coupon of 13.5%.
No Subordinated Debentures were outstanding for the three months ended March
31, 1996. See "Risk Factors--Risks Related to Debentures" and "Business--
Sources of Funds--Borrowings."
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN LOSSES
Net interest income before provision for estimated loan losses for the three
months ended March 31, 1996 was $733,000, compared to $743,000 for the three
months ended March 31, 1997. This increase is the net effect of an increase in
average interest earning assets and average interest bearing liabilities,
offset by a decline in the net interest margin and a decrease in the ratio of
interest earning assets to interest bearing liabilities. Average interest
earnings assets increased from $78.9 million with a yield of 8.42% for the
three months ended March 31, 1996 to $121.6 million with a yield of 7.58% for
the three months ended March 31, 1997. The ratio of interest earning assets to
interest bearing liabilities decreased from 104.12% for the three months ended
March 31, 1996 to 102.43% for the three months ended March 31, 1997.
PROVISION FOR ESTIMATED LOAN LOSSES
Provision for estimated loan losses increased from $68,000 for the three
months ended March 31, 1996 to $500,000 for the three months ended March 31,
1997 due to an increase in the size of the Bank's loan portfolio, a change in
the composition of loans receivable from December 31, 1996 to March 31, 1997
and an increase in charge-offs. The increase in the provision resulted from
the Bank's quarterly analysis of its loan portfolio and the change in the
composition of the loan portfolio during the three months ended March 31,
1997.
During the three months ended March 31, 1997, the Bank purchased consumer
loans totalling $3.3 million, which increased the Bank's investment in
consumer loans from $65,000 as of December 31, 1996 to $3.3 million as of
March 31, 1997. In addition, multi-family real estate loans increased from
$4.8 million as of December 31, 1996 to $9.9 million as of March 31, 1997, and
commercial real estate and land loans increased from $9.7 million as of
December 31, 1996 to $10.3 million as of March 31, 1997. Non-performing loans
declined from $2.2 million, or 2.98% of gross loans receivable, as of March
31, 1996 to $1.7 million, or 2.34% of gross loans receivable, as of March 31,
1997. Allowance for estimated loan losses as a percent of gross loans
receivable increased from 2.36% as of December 31, 1996 to 2.42% as of March
31, 1997.
Loan charge-offs increased from $73,000 for the three months ended March 31,
1996 to $332,000 for the three months ended March 31, 1997 as $846,000 of
loans were transferred to REO and written down to fair
30
<PAGE>
value at the time of transfer during this period. In addition, the ratio of
net charge-offs to average net loans outstanding increased from 0.10% for the
three months ended March 31, 1996 to 0.33% for the three months ended March
31, 1997. While management believes it has adequately provided for losses and
does not expect any material loss on its loans in excess of allowances already
recorded, no assurance can be given that additional loans will not become
delinquent or that the collateral for such loans will be sufficient to prevent
losses in the event of foreclosure. Management believes that the allowance for
loan losses at March 31, 1997 was adequate to absorb known and inherent risks
in the Bank's loan portfolio. No assurance can be given, however, that
economic conditions which may adversely affect the Company's or the Bank's
service areas or other circumstances will not be reflected in increased losses
in the loan portfolio. In addition, regulatory agencies, as an integral part
of their examination process, periodically review the Bank's allowance for
loan losses. Such agencies may require the Bank to recognize additions to the
allowance or to take charge-offs resulting in reductions in the allowance in
anticipation of losses. See "Business--Lending Overview--Delinquencies and
Classified Assets" and "--Lending Overview--Allowance for Loan Losses."
NON-INTEREST INCOME
Net gains from mortgage financing operations for the three months ended
March 31, 1996 were $887,000 compared to $5.9 million for the three months
ended March 31, 1997. This increase was attributable to the increase in the
level of mortgage financing operations, with loans sold and securitized
totalling $37.8 million for the three months ended March 31, 1996 compared to
$83.2 million for the three months ended March 31, 1997, combined with the
effect of the securitization of assets as compared to whole loans sales of
assets. Net gains from mortgage financing operations as a percent of loans
sold increased from 2.34% for the three months ended March 31, 1996, compared
to 7.07% for the three months ended March 31, 1997. All loans sold during the
three months ended March 31, 1996 were sold as whole loans, generally with
servicing retained, while all loans sold during the three months ended
March 31, 1997 were sold through securitization. Loans originated and
purchased totalled $50.9 million for the three months ended March 31, 1996
compared to $92.2 million for the three months ended March 31, 1997, which
also resulted in an increase in loan servicing and other fees from $101,000
for the three months ended March 31, 1996 to $120,000 for the three months
ended March 31, 1997. Consistent with management's business strategy, it is
anticipated that mortgage financing operations will constitute an even greater
portion of the Company's business in future periods. The inability of the
Company to implement its business strategy would have a material adverse
effect on the Company's financial condition and results of operations. See
"Risk Factors--Ability of the Bank to Implement its Business Strategy,"
"Business--Background of the Bank" and "--Growth and Operating Strategies."
NON-INTEREST EXPENSE
Non-interest expense was $1.5 million for the three months ended March 31,
1996, compared to $2.5 million for the three months ended March 31, 1997. The
increase was due primarily to the expansion of the mortgage financing
operations. New loans originated and purchased increased from $50.9 million
for the three months ended March 31, 1996 to $92.2 million for the three
months ended March 31, 1997, which resulted in increased compensation and
benefits and other operating expenses.
Compensation and benefits increased from $814,000 for the three months ended
March 31, 1996 to $1.6 million for the three months ended March 31, 1997.
These costs are directly related to the expansion of the mortgage financing
operations and the corresponding increase in personnel, from an average of 87
for the three months ended March 31, 1996 to 161 for the three months ended
March 31, 1997.
Premises and occupancy expense increased from $166,000 for the three months
ended March 31, 1996 to $223,000 for the three months ended March 31, 1997,
due to the expansion of the mortgage financing operations. During the three
months ended March 31, 1997, the Company opened its regional operating center
in the Denver, Colorado metropolitan area, and also leased temporary space on
a month to month basis in Corona, California. The Corona facility lease will
be terminated upon completion of the new executive offices. As a result of
leasing
31
<PAGE>
office space for the Company's and the Bank's executive offices and the
western regional office of Life Financial Services, premises and occupancy
expenses are expected to increase to approximately $400,000 per quarter. See
"Business--Properties."
As a result of the expansion of the mortgage financing operations, other
operating expenses increased as well. Data processing increased from $87,000
for the three months ended March 31, 1996 to $135,000 for the three months
ended March 31, 1997. Marketing, telephone, professional services and other
expense increased from $39,000, $40,000, $27,000 and $213,000, respectively,
for the three months ended March 31, 1996 to $68,000, $85,000, $58,000 and
$260,000 for the three months ended March 31, 1997.
FDIC insurance premiums declined from $44,000 for the three months ended
March 31, 1996 to $18,000 for the three months ended March 31, 1997. During
the three months ended September 30, 1996, the FDIC assessed a one time
special assessment in order to recapitalize the SAIF insurance fund. As a
result of this recapitalization, the FDIC reduced the insurance premiums to
most SAIF insured institutions, including the Bank.
INCOME TAXES
The provision for income taxes increased from $79,000 for the three months
ended March 31, 1996 to $1.6 million for the three months ended March 31, 1997
due to an increase in income before income tax provision. Income before income
tax provision increased from $184,000 for the three months ended March 31,
1996 to $3.8 million for the three months ended March 31, 1997. The effective
tax rate decreased from 42.9% for the three months ended March 31, 1996 to
41.6% for the three months ended March 31, 1997.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 1997 AND DECEMBER 31, 1996
Total assets increased from $104.0 million as of December 31, 1996 to $157.7
million as of March 31, 1997. Cash and cash equivalents increased from $13.3
million as of December 31, 1996 to $46.0 million as of March 31, 1997 due to
an increase in deposit accounts used to fund loans during the quarter which
were sold immediately prior to the end of the quarter.
Loans held for sale increased from $31.0 million as of December 31, 1996 to
$38.3 million as of March 31, 1997. During the three months ended March 31,
1997, the Bank funded $92.2 million in loans, which was offset by
securitizations of $83.2 million, and to a lesser extent principal repayments
and foreclosures. As a result of the securitization, residual assets and
restricted cash increased from $5.7 million and $1.6 million, respectively, as
of December 31, 1996 to $12.5 million and $6.9 million as of March 31, 1997.
Mortgage servicing rights increased from $2.6 million as of December 31, 1996
to $4.1 million as of March 31, 1997 due to the securitization of loans during
the three months ended March 31, 1997. See "Business--Loan Sales and Asset
Securitizations" and "Risk Factors--Dependence on Asset Securitizations and
Impact on Quarterly Operating Results" and "--Risks Related to Mortgage
Servicing Rights."
Foreclosed real estate, net increased from $561,000 as of December 31, 1996
to $1.2 million as of March 31, 1997 due to the transfer to REO of $846,000 in
mortgage loans during the three months ended March 31, 1997. As a result of
this transfer, non-accrual loans decreased from $2.4 million as of December
31, 1996 to $1.7 million as of March 31, 1997. Non-performing loans as a
percent of gross loans receivable decreased from 3.50% as of December 31, 1996
to 2.34% as of March 31, 1997. Allowance for estimated loan losses increased
from $1.6 million, or 2.36% of gross loans receivable, as of December 31, 1996
to $1.8 million, or 2.42% of gross loans receivable, as of March 31, 1997.
Allowance for estimated loan losses as a percent of total non-performing loans
increased from 67.3% as of December 31, 1996 to 103.6% as of March 31, 1997.
Classified assets, gross, decreased from $4.8 million as of December 31, 1996
to $4.5 million as of March 31, 1997.
During the three months ended March 31, 1997, the Bank issued $10.0 million
in Subordinated Debentures in order to increase its risk based capital. The
additional funds, net of debt issuance costs, were used to fund loans during
the three months ended March 31, 1997. In addition, the Bank increased its
liabilities by increasing
32
<PAGE>
deposit accounts from $85.7 million as of December 31, 1996 to $130.8 million
as of March 31, 1997. The major component of the increase in deposits was
certificate accounts, which increased from $69.4 million as of December 31,
1996 to $113.5 million as of March 31, 1997. In addition, checking accounts
increased from $8.9 million as of December 31, 1996 to $10.2 million as of
March 31, 1997.
Stockholder's equity increased from $9.3 million as of December 31, 1996 to
$11.5 million as of March 31, 1997 due to an increase in retained earnings.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND
DECEMBER 31, 1995
GENERAL
Net income increased by $985,000 from $520,000 for the year ended December
31, 1995 to $1.5 million for the year ended December 31, 1996. Net income for
the year ended December 31, 1996 was adversely impacted by a non-recurring
expense for compensation and benefits of $354,000 which was incurred during
the quarter ended June 30, 1996, and a non-recurring SAIF special assessment
of $448,000 which was incurred during the quarter ended September 30, 1996.
The non-recurring expense for compensation and benefits is an accrual of the
present value of a portion of the future payments due pursuant to a consulting
agreement entered into with a former officer of the Bank. See "The Board of
Directors and Management of the Bank--Consultation Agreement." Net income for
the year ended December 31, 1996 would have been $2.0 million if these charges
had not been incurred.
Net gains from mortgage financing operations for the year ended December 31,
1995 totaled $3.6 million compared to $8.4 million for the year ended December
31, 1996 due to the expansion of the mortgage financing operations and
increased marketing effort therefrom, along with the completion of the Bank's
first securitization during the quarter ended December 31, 1996. The expansion
of the mortgage financing operations resulted in an increase in loan
originations and purchases from $134.8 million for the year ended December 31,
1995 to $222.6 million for the year ended December 31, 1996. The related sales
of loans increased from $126.9 million for the year ended December 31, 1995 to
$206.6 million (including $51.9 million sold through the fourth quarter
securitization) for the year ended December 31, 1996. As a result of this
securitization, the Bank recognized a gain on sale of $4.3 million. See
"Business--Loan Sales and Asset Securitizations."
The Company currently intends to conduct securitizations on a regular basis
either through private placements or public offerings. There can be no
assurance, however, that the Company will be able to successfully implement
this strategy. See "Risk Factors--Dependence on Asset Securitizations and
Impact on Quarterly Operating Results."
In addition, during the year ended December 31, 1996, the Bank acquired the
Riverside, California property it had been leasing by exercising its lease
option at a price of $375,000. The Bank also increase its personnel from an
average of 50 for the year ended December 31, 1995 to an average of 97 for the
year ended December 31, 1996. The additional staff allowed for increased
marketing, processing and underwriting efforts and the ability to increase the
number of broker and correspondent relationships, but also added to non-
interest expense for the period.
INTEREST INCOME
Interest income increased from $5.8 million for the year ended December 31,
1995 to $6.9 million for the year ended December 31, 1996, due to an increase
in the yield on interest-earning assets as well as in the average balances of
those assets. The Bank's yield on average interest-earning assets increased
from 7.96% for the year ended December 31, 1995 to 8.63% for the year ended
December 31, 1996. Total average interest-earning assets increased from $73.2
million for the year ended December 31, 1995 to $80.3 million for the year
ended December 31, 1996. The largest single component of interest-earning
assets was loans receivable, net, which increased from an average of $65.5
million for the year ended December 31, 1995 to $72.6 million for the year
33
<PAGE>
ended December 31, 1996. The increase in average loans receivable, net was due
to an increase in loans held for sale from the expansion of the mortgage
financing operations. Loans held for sale increased from $21.7 million at
December 31, 1995 to $31.0 million at December 31, 1996, while loans held for
investment, net decreased from $41.7 million at December 31, 1995 compared to
$36.9 million at December 31, 1996. Generally, all loans are originated or
purchased for sale in the secondary market or through securitizations. See
"Business--Core Lending Products" and "--Loan Sales and Asset
Securitizations." The yield on loans receivable increased from 8.29% for the
year ended December 31, 1995 to 9.02% for the year ended December 31, 1996.
INTEREST EXPENSE
Interest expense increased from $3.4 million for the year ended December 31,
1995 to $3.8 million for the year ended December 31, 1996 due to an increase
in average interest-bearing liabilities. Average interest-bearing liabilities
increased from $70.7 million for the year ended December 31, 1995 to $77.3
million for the year ended December 31, 1996. Interest expense for the year
ended December 31, 1995 was adversely impacted by the effects of an interest
rate swap which matured on November 7, 1995 which resulted in an increase in
interest expense on borrowings of $52,000 for the year ended December 31,
1995. Without this expense, average yield on borrowings for the year ended
December 31, 1995 would have been 6.56%, and the average yield on total
interest-bearing liabilities would have been 4.80%. The increase in interest
expense also reflects a change in the composition of interest-bearing
liabilities. Average certificate accounts increased from $50.6 million for the
year ended December 31, 1995 to $57.3 million for the year ended December 31,
1996. Average borrowings increased from $3.1 million for the year ended
December 31, 1995 to $4.3 million for the year ended December 31, 1996.
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN LOSSES
Net interest income before provision for estimated loan losses for the year
ended December 31, 1995 was $2.4 million compared to $3.2 million for the year
ended December 31, 1996. This increase was primarily due to the increase in
the net interest margin from 3.25% for the year ended December 31, 1995 to
3.94% for the year ended December 31, 1996, and an increase in the ratio of
average interest-earning assets to average interest-bearing liabilities from
103.50% for the year ended December 31, 1995 to 103.90% for the year ended
December 31, 1996.
PROVISION FOR ESTIMATED LOAN LOSSES
The provision for estimated loan losses was $963,000 for the year ended
December 31, 1996 compared to $1.2 million for the year ended December 31,
1995. The decrease in the provision resulted from the Bank's quarterly
analysis of its loan portfolio, the decrease in charge-offs of loans and the
increase in recoveries and management's belief that property values in the
southern California market had stopped deteriorating.
Charge-offs for the year ended December 31, 1995 were $914,000 compared to
$734,000 for the year ended December 31, 1996. For the year ended December 31,
1995, the ratio of net charge-offs to average loans outstanding was 1.30%
compared to 0.71% for the year ended December 31, 1996. Recoveries increased
from $65,000 for the year ended December 31, 1995 to $219,000 for the year
ended December 31, 1996. Non-performing assets as a percent of total assets
decreased from 3.0% at December 31, 1995 to 2.86% at December 31, 1996. At
December 31, 1995 the allowance for estimated loan losses was $1.2 million
compared to $1.6 million at December 31, 1996. The allowance for estimated
loan losses as a percent of non-performing loans was 84.25% at December 31,
1995 compared to 67.26% at December 31, 1996. While management believes it has
adequately provided for losses and does not expect any material loss on its
loans in excess of allowances already recorded, no assurance can be given that
additional loans will not become delinquent or that the collateral for such
loans will be sufficient to prevent losses in the event of foreclosure.
Management believes that the allowance for loan losses at December 31, 1996
was adequate to absorb known and inherent risks in the Bank's loan portfolio.
No assurance can be given, however, that economic conditions which may
adversely affect the Company's or the Bank's service areas or other
circumstances will not be reflected in increased losses in the loan portfolio.
In addition, regulatory agencies, as an integral part of their examination
process, periodically
34
<PAGE>
review the Bank's allowance for loan losses. Such agencies may require the
Bank to recognize additions to the allowance or to take charge-offs
(reductions in the allowance) in anticipation of losses. See "Business--
Lending Overview--Delinquencies and Classified Assets" and "--Lending
Overview--Allowance for Loan Losses."
NON-INTEREST INCOME
Gains from mortgage financing operations for the year ended December 31,
1995 were $3.6 million compared to $8.4 million for the year ended December
31, 1996. This increase was attributable to the increase in the level of
mortgage financing operations, with loans sold totaling $126.9 million for the
year ended December 31, 1995 compared to $206.6 million (including $51.9
million sold through the securitization completed in the quarter ended
December 31, 1996) for the year ended December 31, 1996. Loans originated and
purchased totalled $134.8 million for the year ended December 31, 1995
compared to $222.6 million for the year ended December 31, 1996, which also
resulted in an increase in loan servicing and other fees from $231,000 for the
year ended December 31, 1995 to $496,000 for the year ended December 31, 1996.
Gains from mortgage financing operations as a percent of loans sold and
securitized increased from 2.82% for the year ended December 31, 1995 to 4.04%
for the year ended December 31, 1996. This increase is a direct result of the
Bank's securitization during the quarter ended December 31, 1996. As a result
of this securitization, the Bank generated a gain on sale of $4.3 million.
Consistent with management's business strategy, it is anticipated that
mortgage financing operations will constitute an even greater portion of the
Company's business in future periods. The inability of the Company to
implement its business strategy would have a material adverse effect on the
Company's financial condition and results of operations. See "Risk Factors--
Ability of the Bank to Implement its Business Strategy" and "Business--
Background of the Bank" and "--Growth and Operating Strategies."
NON-INTEREST EXPENSE
Non-interest expense was $4.4 million for the year ended December 31, 1995
compared to $8.7 million for the year ended December 31, 1996. The increase
was due primarily to the expansion of the mortgage financing operations, a
non-recurring increase in compensation and benefits and the non-recurring SAIF
special assessment. New loans originated and purchased increased from $134.8
million for the year ended December 31, 1995 to $222.6 million for the year
ended December 31, 1996, which resulted in increased employee commissions and
bonuses.
Compensation and benefits increased from $2.5 million for the year ended
December 31, 1995 to $5.2 million for the year ended December 31, 1996. These
costs are directly related to the expansion of the mortgage financing
operations and the corresponding increase in personnel, from an average of 50
for the year ended December 31, 1995 to 97 for the year ended December 31,
1996, combined with a non-recurring expense for compensation and benefits of
$354,000 during the quarter ended June 30, 1996. The non-recurring expense for
compensation and benefits is an accrual of the present value of a portion of
the future payments due pursuant to a consulting agreement entered into with a
former officer of the Bank. See "The Board of Directors and Management of the
Bank--Consultation Agreement."
Premises and occupancy increased from $471,000 for the year ended December
31, 1995 to $746,000 for the year ended December 31, 1996 due to the addition
of the Riverside, California mortgage financing office. The financing office
is approximately 7,500 square feet, with additional space being utilized for
the increase in personnel and the expansion of the mortgage financing
operations. With the increase in loans originated and purchased, combined with
the increase in personnel, data processing expense increased from $208,000 for
the year ended December 31, 1995 to $390,000 for the year ended December 31,
1996.
As a result of the expansion of the mortgage financing operations, marketing
expense increased from $65,000 for the year ended December 31, 1995 to
$189,000 for the year ended December 31, 1996. In addition, telephone expense
increased from $143,000 for the year ended December 31, 1995 to $246,000 for
the year
35
<PAGE>
ended December 31, 1996, and professional services increased from $92,000 for
the year ended December 31, 1995 to $218,000 for the year ended December 31,
1996.
The Bank incurred a charge of $448,000 due to the non-recurring SAIF special
assessment during the year ended December 31, 1996. No similar charge was
assessed for the year ended December 31, 1995. In addition, other expenses
also increased due to the expansion of the mortgage financing operations,
although no single item exceeded 1.0% of gross income.
INCOME TAXES
The provision for income taxes increased from $294,000 for the year ended
December 31, 1995 to $1.1 million for the year ended December 31, 1996. The
increase in income taxes is the result of the increase in income before tax,
which increased from $814,000 for the year ended December 31, 1995 to $2.6
million for the year ended December 31, 1996. The effective tax rate increased
from 36.1% for the year ended December 31, 1995 to 42.8% for the year ended
December 31, 1996. The change in effective tax rate is due to a reduction in
the deferred tax valuation allowance for state tax purposes in 1995.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1996 AND DECEMBER 31, 1995
Total assets increased from $74.1 million as of December 31, 1995 to $104.0
million as of December 31, 1996, which was attributable to an increase in
loans held for sale, an increase in cash and cash equivalents, an increase in
securities held-to-maturity and FHLB stock and an investment in residuals and
restricted cash created as a result of the securitization completed in the
quarter ended December 31, 1996. Loans held for sale, net, increased from
$21.7 million as of December 31, 1995 to $31.0 million as of December 31,
1996, which was partially offset by a decrease in loans held for investment
from $41.7 million as of December 31, 1995 to $36.9 million as of December 31,
1996. During the year ended December 31, 1996, the Bank originated and
purchased $222.6 million in loans, which were offset by prepayments, sales and
securitizations totaling $206.6 million. Cash and cash equivalents were $3.9
million at December 31, 1995, compared to $13.3 million at December 31, 1996
due to an increase in deposits from $67.5 million at December 31, 1995 to
$85.7 million at December 31, 1996. Securities held-to-maturity and FHLB stock
increased from $2.7 million at December 31, 1995 to $8.8 million at December
31, 1996. Securities held-to-maturity consist of U.S. Treasury bills and U.S.
Treasury notes with staggered maturities ranging from three months to 24
months. During the quarter ended December 31, 1996, the Bank securitized $51.9
million in loans. This was the first loan securitization completed by the
Bank, which recorded a gain on sale of $4.3 million.
Deposit accounts increased from $67.5 million as of December 31, 1995 to
$85.7 million as of December 31, 1996 due to an increased use of wholesale
deposits to fund lending activity. While core deposits remained fairly stable,
certificates of deposits increased from $51.8 million at December 31, 1995 to
$69.4 million at December 31, 1996.
Stockholders' equity increased from $4.3 million at December 31, 1995 to
$9.3 million at December 31, 1996 due to net income of $1.5 million for the
year ended December 31, 1996 and due to proceeds from the issuance of common
stock in a private placement offering (the "Private Placement") during the
third quarter of 1996 totaling $3.5 million.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1995 AND
DECEMBER 31, 1994
GENERAL
The Bank reported net income of $520,000 for the year ended December 31,
1995, which represented a $1.2 million increase from the net loss of $671,000
for the year ended December 31, 1994. The increase in net income for the year
ended December 31, 1995 compared to the year ended December 31, 1994 was
attributable to the increase in mortgage financing operations and an increase
in net interest income. Loans originated and
36
<PAGE>
purchased totalled $134.8 million for the year ended December 31, 1995
compared to $72.8 million for the year ended December 31, 1994. The increase
in loans originated and purchased is due to the restructuring and expansion of
the mortgage financing operations during 1994 and 1995.
During 1994, the Bank hired new management to restructure the mortgage
financing operations, changing the lending strategy from traditional mortgage
banking and portfolio lending to focusing on sub-prime mortgage financing.
During the period of restructuring in the first half of 1994, loan
originations and purchases declined as new lending products were being
developed and new personnel skilled in originating, processing underwriting
and servicing the new products were being hired. Loan originations and
purchases increased during the latter half of 1994 and 1995 as a result of the
restructuring.
Gains from mortgage financing operations were $3.6 million for the year
ended December 31, 1995 compared to $1.4 million for the year ended December
31, 1994 due to the expansion of the mortgage financing operations and the
increase in sales of loans which were generated as a result of this expansion.
Loan sales were $126.9 million for the year ended December 31, 1995 compared
to $65.7 million for the year ended December 31, 1994. In addition, based on
the change in the loans generated and therefore the change in the market
demand for these loans, gains on sale as a percentage of loans sold increased
from 2.17% for the year ended December 31, 1994 to 2.82% for the year ended
December 31, 1995.
In addition, interest income increased due to the types of loans being
generated. Net interest income before provision for estimated loan losses for
the year ended December 31, 1995 was $2.4 million compared to $2.1 million for
the year ended December 31, 1994. The Bank's net interest margin increased to
3.25% for the year ended December 31, 1995 compared to 2.88% for the year
ended December 31, 1994. The Bank's yield on loans receivable, the single
largest component of interest-earning assets, increased from 6.91% for the
year ending December 31, 1994 to 8.29% for the year ending December 31, 1995.
As a result of these events, the Bank's return on average assets and return
on average equity increased to 0.69% and 13.64%, respectively, for the year
ended December 31, 1995, compared to (0.89%) and (17.01%), respectively, for
the year ended December 31, 1994.
INTEREST INCOME
Interest income increased from $4.8 million for the year ended December 31,
1994 to $5.8 million for the year ended December 31, 1995 due to an increase
in the yield on interest earning assets as well as the average balances of
those assets. The Bank's yield on average interest earning assets increased to
7.96% for the year ended December 31, 1995 compared to 6.60% for the year
ended December 31, 1994 due to the increase in loans held for sale from $17.1
million at December 31, 1994 to $21.7 million at December 31, 1995 as compared
to loans held for investment which decreased from $47.1 million at December
31, 1994 to $41.7 million at December 31, 1995. The total average interest
earning assets increased from $73.1 million for the year ended December 31,
1994 to $73.2 million for the year ended December 31, 1995. The largest single
component of interest-earning assets was loans receivable, net. The yield on
loans receivable increased from 6.91% for the year ended December 31, 1994 to
8.29% for the year ended December 31, 1995. Except for loans specifically
originated to be held for investment, all loans are originated or purchased
for sale in the secondary market or through securitizations.
INTEREST EXPENSE
Interest expense increased from $2.7 million for the year ended December 31,
1994 to $3.4 million for the year ended December 31, 1995. Total average
interest-bearing liabilities decreased from $71.5 million with an average
yield of 3.81% for the year ended December 31, 1994 to $70.7 million with an
average yield of 4.87% for the year ended December 31, 1995. The yield on
certificate accounts increased from 4.25% for the year ended December 31, 1994
to 5.59% for the year ended December 31, 1995. The level of certificate
accounts averaged $50.6 million for the year ended December 31, 1995 compared
to $49.9 million for the year ended December 31,
37
<PAGE>
1994. The interest expense increase also reflects the rise in average
borrowings, which were $3.1 million for the year ended December 31, 1995,
compared to $1.9 million for the year ended December 31, 1994. The yield on
borrowings was adversely affected by interest rate swaps which matured on
November 7, 1995. During the years ended December 31, 1995 and December 31,
1994, the interest on swaps totalled $52,000 and $96,000, respectively, which
increased the yield on borrowings for the years ended December 31, 1995 and
December 31, 1994 to 8.23% and 10.04%, respectively. Without the interest on
the swaps, the yield on borrowings would have been 6.56% for the year ended
December 31, 1995 and 4.88% for the year ended December 31, 1994. Furthermore,
the yield on total interest-bearing liabilities for the years ended December
31, 1995 and December 31, 1994 would have been 4.80% and 3.67% without the
interest on the swaps.
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN LOSSES
Net interest income before provision for estimated loan losses for the year
ended December 31, 1995 was $2.4 million compared to $2.1 million for the year
ended December 31, 1994. The Bank's net interest margin increased to 3.25% for
the year ended December 31, 1995 compared to 2.88% for the year ended December
31, 1994. Average interest-earning assets to interest-bearing liabilities
increased from 102.27% at December 31, 1994 to 103.50% at December 31, 1995.
PROVISION FOR ESTIMATED LOAN LOSSES
The provision for estimated loan losses was $1.2 million for the year ended
December 31, 1995 compared to $1.3 million for the year ended December 31,
1994. The decrease in the provision resulted from the Bank's analysis of its
loan portfolio and an increase in the recoveries of the loans previously
charged off. Recoveries for the year ended December 31, 1995 were $65,000
compared to $3,000 for the year ended December 31, 1994.
Charge-offs for the 1995 and 1994 periods remained relatively constant as
management continued to charge-off problem assets and improve its collection
procedures pursuant to its strategy which was revised during the year ended
December 31, 1994. See "Business--Background of the Bank." Charge-offs net of
recoveries, however, totalled $849,000 for the year ended December 31, 1995
exceeding the Bank's allowance for estimated loan losses of $832,000
established at December 31, 1994, which reflected management's loss
expectation for the year ended December 31, 1995.
Non-performing assets as a percent of total assets declined from 3.42% at
December 31, 1994 to 3.00% at December 31, 1995. The Bank's allowance for
estimated loan losses increased from $832,000 at December 31, 1994 to $1.2
million at December 31, 1995. The allowance for estimated loan losses as a
percent of non-performing loans increased to 84.25% at December 31, 1995
compared to 44.04% at December 31, 1994.
NON-INTEREST INCOME
Gains from mortgage financing operations for the year ended December 31,
1995 were $3.6 million compared to $1.4 million for the year ended December
31, 1994. This increase was attributable to the increase in the level of
mortgage financing operations, with loans sold totaling $126.9 million for the
year ended December 31, 1995 compared to $65.7 million for the year ended
December 31, 1994. Loans originated and purchased totaled $134.8 million for
the year ended December 31, 1995 compared to $72.8 million for the year ended
December 31, 1994. During 1994, the Bank hired new management to restructure
the mortgage financing operations, changing the lending strategy from a
traditional mortgage banking and portfolio lending operation to a strategy of
a sub-prime mortgage financing operations. During the period of restructuring
in the first six months of 1994, loan originations and purchases declined as
new lending products were being developed and new personnel skilled in
originating, processing, underwriting and servicing the new products were
being hired. Loan originations and purchases increased during the latter half
of 1994 and 1995 as a result of the restructuring.
Loan servicing and other fees were $231,000 for the year ended December 31,
1995 compared to $164,000 for the year ended December 31, 1994 due to the
expansion of the mortgage financing operations and the increase
38
<PAGE>
in the loan servicing portfolio. With the adoption of SFAS No. 122 in July of
1995, the Bank retained a greater portion of its servicing, which resulted in
an increase in servicing for other investors from $48.2 million as of December
31, 1994 to $189.5 million as of December 31, 1995. See "--Impact of New
Accounting Standards."
NON-INTEREST EXPENSE
Total non-interest expense totalled $4.4 million for the year ended December
31, 1995 compared to $3.5 million for the year ended December 31, 1994. This
increase is primarily attributable to the expenses related to compensation and
benefits increasing from $1.6 million for the year ended December 31, 1994 to
$2.5 million for the year ended December 31, 1995. These costs are directly
related to the expansion of the mortgage financing operations and the
corresponding increase in personnel. Loans originated and purchased increased
from $72.8 million for the year ended December 31, 1994 to $134.8 million for
the year ended December 31, 1995, which resulted in increased employee
commissions.
Premises and occupancy, data processing and other expense increased as a
result of the addition of the Riverside loan center in November 1995 and the
increased loan activity during the year ended December 31, 1995 compared to
the year ended December 31, 1994.
INCOME TAXES
The provision for income taxes increased from a benefit of $300,000 for the
year ended December 31, 1994 to an expense of $294,000 for the year ended
December 31, 1995. This increase is a result of income before income taxes of
$814,000 for the year ended December 31, 1995 compared to a loss before income
taxes of $971,000 for the year ended December 31, 1994 and the resulting
increase in the Bank's effective rate from 30.9% to 36.1% for the year ended
December 31, 1995.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1995 AND DECEMBER 31, 1994
Total assets increased from $71.4 million as of December 31, 1994 to $74.1
million as of December 31, 1995, which was directly attributable to loans held
for sale. Loans held for sale increased to $21.7 million at December 31, 1995
compared to $17.1 million at December 31, 1994, which was offset by a decrease
in loans held for investment from $47.1 million at December 31, 1994 to $41.7
million at December 31, 1995. During the year ended December 31, 1995 the Bank
originated and purchased $134.8 million in loans, which were offset by sales
totalling $126.9 million. Cash and cash equivalents also increased during the
year ended December 31, 1995 to $3.9 million from $1.5 million at December 31,
1994 due to the increase in deposits from $65.7 million at December 31, 1994
to $67.5 million at December 31, 1995.
The increase in assets were funded by an increase in deposits and other
liabilities. Borrowings totalled $1.3 million as of December 31, 1994 compared
to zero at December 31, 1995. Deposits slightly increased from $65.7 million
at December 31, 1994 to $67.5 million at December 31, 1995. Other liabilities
increased as a result of an increase in loans serviced for others and the
corresponding impounds thereon. With earnings of $520,000 for the year ended
December 31, 1995, total stockholders' equity increased from $3.7 million for
the year ended December 31, 1994 to $4.3 million for the year ended December
31, 1995.
Tangible, core and risk based capital ratios increased from 5.25%, 5.25% and
10.00% as of December 31, 1994, to 5.68%, 5.68% and 10.17% as of December 31,
1995, respectively. During the same period, non-performing loans as a percent
of gross loans decreased from 2.90% as of December 31, 1994 to 2.17% as of
December 31, 1995. Non-performing assets as a percent of total assets
decreased from 3.42% to 3.00% as of December 31, 1994 and December 31, 1995,
respectively. See "Business--Lending Overview--Delinquencies and Classified
Assets."
39
<PAGE>
MANAGEMENT OF INTEREST RATE RISK
The principal objective of the Bank's interest rate risk management function
is to evaluate the interest rate risk included in certain balance sheet
accounts, determine the level of appropriate risk given the Bank's business
focus, operating environment, capital and liquidity requirements and
performance objectives and manage the risk consistent with Board approved
guidelines through the establishment of prudent asset concentration
guidelines. Through such management, management of the Bank seeks to reduce
the vulnerability of the Bank's operations to changes in interest rates.
Management of the Bank monitors its interest rate risk as such risk relates to
its operational strategies. The Bank's Board of Directors reviews on a
quarterly basis the Bank's asset/liability position, including simulations of
the effect on the Bank's capital of various interest rate scenarios. The
extent of the movement of interest rates, higher or lower, is an uncertainty
that could have a negative impact on the earnings of the Bank.
Between the time the Bank originates loans and purchase commitments are
issued, the Bank is exposed to both upward and downward movements in interest
rates which may have a material adverse effect on the Bank. The Board of
Directors of the Bank recently implemented a hedge management policy primarily
for the purpose of hedging the risks associated with loans held for sale in
the Bank's mortgage pipeline. In a flat or rising interest rate environment,
this policy enables management to utilize mandatory forward commitments to
sell fixed rate assets as the primary hedging vehicles to shorten the maturity
of such assets. In a declining interest rate environment, the policy enables
management to utilize put options. The hedge management policy also permits
management to extend the maturity of its liabilities through the use of short
financial futures positions, purchase of put options, interest rate caps or
collars, and entering into "long" interest rate swap agreements. Management
may also utilize "short" interest rate swaps to shorten the maturity of long-
term liabilities when the net cost of funds raised by using such a strategy is
attractive, relative to short-term CD's or borrowings. Since this policy was
implemented after March 31, 1997, the Bank has little historical experience to
determine whether or not its hedging policies will act to reduce the risks
associated with loans held for sale. See "Risk Factors--Risks Associated with
Mortgage Origination, Repurchase and Sales Activities."
Net Portfolio Value. The Bank's interest rate sensitivity is monitored by
management through the use of a model which estimates the change in net
portfolio value ("NPV") over a range of interest rate scenarios. NPV is the
present value of expected cash flows from assets, liabilities and off-balance
sheet contracts. An NPV Ratio, in any interest rate scenario, is defined as
the NPV in that scenario divided by the market value of assets in the same
scenario. The sensitivity measure is the decline in the NPV Ratio, in basis
points, caused by a 2% increase or decrease in rates, whichever produces a
larger decline (the "Sensitivity Measure"). The higher an institution's
Sensitivity Measure is, the greater its exposure to interest rate risk is
considered to be. The Bank utilizes a market value model prepared by the OTS
(the "OTS NPV model"), which is prepared quarterly, based on the Bank's
quarterly Thrift Financial Reports filed with the OTS. The OTS NPV model
measures the Bank's interest rate risk by approximating the Bank's NPV, which
is the net present value of expected cash flows from assets, liabilities and
any off-balance sheet contracts, under various market interest rate scenarios
which range from a 400 basis point increase to a 400 basis point decrease in
market interest rates. The interest rate risk policy of the Bank provides that
the maximum permissible change at a 400 basis point increase or decrease in
market interest rates is a 45% change in the net portfolio value. The OTS has
incorporated an interest rate risk component into its regulatory capital rule.
Under the rule, an institution whose Sensitivity Measure in the event of a 200
basis point increase or decrease in interest rates exceeds 2% would be
required to deduct an interest rate risk component in calculating its total
capital for purpose of the risk-based capital requirement. See "Regulation--
Federal Savings Institution Regulation." As of December 31, 1996, the most
recent date for which the relevant data is available, the Bank's Sensitivity
Measure, as measured by the OTS, resulting from a 200 basis point decrease in
interest rates was 96 basis points and would result in a $1.0 million
reduction in the NPV of the Bank. As of December 31, 1996, the Bank's
Sensitivity Measure is below the threshold at which the Bank could be required
to hold additional risk-based capital under OTS regulations. The OTS has
postponed the date the component will first be deducted from an institution's
total capital to provide the OTS with an opportunity to review the interest
rate risk approaches taken by the other federal banking agencies. See
"Regulation--Federal Savings Institution Regulation."
40
<PAGE>
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in NPV requires the making
of certain assumptions that may tend to oversimplify the manner in which
actual yields and costs respond to changes in market interest rates. First,
the models assume that the composition of the Bank's interest sensitive assets
and liabilities existing at the beginning of a period remains constant over
the period being measured. Second, the models assume that a particular change
in interest rates is reflected uniformly across the yield curve regardless of
the duration to maturity or repricing of specific assets and liabilities.
Third, the model does not take into account the impact of the Bank's business
or strategic plans on the structure of interest-earning assets and interest-
bearing liabilities. In particular, the Bank's core products and residual
assets which are directly related to the Bank's core products do not behave in
a manner which the OTS model projects. Borrowers of Portfolio Series loans are
less likely to refinance or prepay such loans because of the high cost of
obtaining a high loan to value loan. In addition, management believes that
borrowers of Liberator Series loans are less likely to refinance or prepay
such loans because of their lack of an adequate credit rating or possible
prior credit problems. Accordingly, although the NPV measurement provides an
indication of the Bank's interest rate risk exposure at a particular point in
time, such measurement is not intended to and does not provide a precise
forecast of the effect of changes in market interest rates on the Bank's net
interest income and will differ from actual results. The results of this
modeling are monitored by management and presented to the Board of Directors,
quarterly.
The following table shows the NPV and projected change in the NPV of the
Bank at December 31, 1996 assuming an instantaneous and sustained change in
market interest rates of 100, 200, 300 and 400 basis points ("bp").
INTEREST RATE SENSITIVITY OF NET PORTFOLIO VALUE (NPV)
<TABLE>
<CAPTION>
NPV AS % OF
PORTFOLIO
NET PORTFOLIO VALUE VALUE OF ASSETS
-------------------------- ------------------
CHANGE IN RATES $ AMOUNT $ CHANGE % CHANGE NPV RATIO % CHANGE
--------------- -------- -------- -------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
+400 bp....................... $12,688 (1,393) (10)% 11.99% -97 bp
+300 bp....................... 13,629 (451) (3) 12.73 -23 bp
+200 bp....................... 14,282 201 1 13.22 +26 bp
+100 bp....................... 14,185 104 1 13.10 +14 bp
Static........................ 14,080 12.96
-100 bp....................... 13,613 (468) (3) 12.52 -44 bp
-200 bp....................... 13,038 (1,042) (7) 12.00 -96 bp
-300 bp....................... 12,282 (1,799) (13) 11.33 -163 bp
-400 bp....................... 11,748 (2,332) (17) 10.83 -213 bp
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Bank's primary sources of funds are deposits, FHLB advances, principal
and interest payments on loans, cash proceeds from the sale of loans and
securitizations, and to a lesser extent, interest payments on investment
securities and proceeds from the maturation of investment securities. See
"Risk Factors--Availability of Funding Sources." While maturities and
scheduled amortization of loans are a predictable source of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest
rates, economic conditions and competition. However, the Bank has continued to
maintain the required minimum levels of liquid assets as defined by OTS
regulations. This requirement, which may be varied at the direction of the OTS
depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required ratio is
currently 5%. The Bank's average liquidity ratios were 8.5%, 9.4% and 8.9% for
the years ended December 31, 1996, 1995 and 1994, respectively, and 12.6% and
5.6% for the three months ended March 31, 1997 and 1996, respectively.
Management currently attempts to maintain a minimum liquidity ratio of 5.0%.
The Bank's cash flows are comprised of three primary classifications: cash
flows from operating activities, investing activities and financing
activities. Cash flows used in operating activities were $24.1 million and
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$13.7 million for the three months ended March 31, 1997 and 1996,
respectively, and were $18.7 million, $5.3 million and $6.9 million for the
years ended December 31, 1996, 1995 and 1994, respectively. Such cash flows
primarily consisted of loans originated and purchased for sale (net of loan
fees) of $93.9 million, $51.9 million, $227.2 million, $135.6 million and
$72.6 million, net of proceeds from the sale and securitization of loans held
for sale of $80.0 million, $39.3 million, $212.2 million, $130.1 million and
$66.4 million for the three months ended March 31, 1997 and 1996 and the years
ended December 31, 1996, 1995 and 1994, respectively. Net cash provided by
investing activities consisted primarily of investment purchases offset by
principal collections on loans and proceeds from maturation of investment
purchases. Proceeds from the maturation of investment securities were $1.0
million and $1.0 million for the three months ended March 31, 1997 and 1996,
respectively, and $2.0 million, $9.2 million and $2.0 million for the years
ended December 31, 1996, 1995 and 1994, respectively. Net cash provided by
(used in) financing activities consisted primarily of net activity in deposit
accounts and FHLB advances. The net increase (decrease) in deposits and
advances was $45.1 million and $12.9 million for the three months ended March
31, 1997 and 1996, respectively, and $18.2 million, $596,000 and $(6.3)
million for the years ended December 31, 1996, 1995 and 1994, respectively.
The Bank also received proceeds from the issuance of common stock in the
Private Placement of $3.5 million in August 1996 and $10.0 million from the
sale of the Debentures in March 1997.
At March 31, 1997, the Bank exceeded all of its regulatory capital
requirements with a tangible capital level of $11.5 million, or 7.19% of total
adjusted assets, which is above the required level of $2.4 million, or 1.50%;
core capital of $11.5 million, or 7.19% of total adjusted assets, which is
above the required level of $4.8 million, or 3.0%, and risk-based capital of
$21.5 million, or 10.51% of risk-weighted assets, which is above the required
level of $16.4 million, or 8.0%. See "Capitalization" and "Regulation--Federal
Savings Institution Regulation--Capital Requirements."
The Bank's most liquid assets are cash and short-term investments. The
levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At March 31, 1997,
cash and short-term investments totalled $46.0 million. The Company has other
sources of liquidity if a need for additional funds arises, including the
utilization of FHLB advances. At March 31, 1997, the Bank had no advances
outstanding from the FHLB. Other sources of liquidity include investment
securities maturing within one year. On an on-going basis, the Company
explores opportunities to access credit lines as an additional source of funds
for its mortgage financing operations and recently entered into a mortgage
warehousing line of credit with a national investment banking firm in the
amount of $50.0 million to fund loan originations. See "Risk Factors--
Availability of Funding Sources."
The Bank had no material contractual obligations or commitments for capital
expenditures at March 31, 1997. However, the Bank is in the process of
developing an office to house the Company's and the Bank's executive offices
and the western regional offices of Life Financial Services at a cost of
approximately $1.0 million for leasehold improvements. In addition, the Bank
has entered into an agreement for an upgrade of the Bank's telephone services
in the amount of $930,000 and expects to spend an additional $500,000 for
furniture, fixtures and equipment. At March 31, 1997 the Bank had outstanding
commitments to originate mortgage loans and to purchase mortgage loans of
$13.7 million and $6.2 million, respectively, compared to $5.0 million and
$4.2 million, respectively, at December 31, 1996. The Bank anticipates that it
will have sufficient funds available to meet its current loan origination
commitments. See "Business--Background of the Bank." Certificates of deposit
which are scheduled to mature one year or less from March 31, 1997, totalled
$103.5 million. The Bank expects that a substantial portion of the maturing
certificates of deposit will be retained by the Bank at maturity.
IMPACT OF INFLATION AND CHANGING PRICES
The Financial Statements and Notes thereto presented herein have been
prepared in accordance with Generally Accepted Accounting Principles ("GAAP"),
which require the measurement of financial position and operating results in
terms of historical dollar amounts without considering the changes in the
relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of the Bank's operations. Unlike
industrial companies, nearly all of the assets and liabilities of the Bank are
monetary in nature.
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As a result, interest rates have a greater impact on the Bank's performance
than do the effects of general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the price of
goods and services.
IMPACT OF NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long Lived Assets and for Long Lived Assets to be Disposed
Of" ("SFAS No. 121"). SFAS No. 121 requires that long lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or
circumstances indicate that the carrying amount of an asset may not be
recoverable. However, SFAS No. 121 does not apply to financial instruments,
core deposit intangibles, mortgage and other servicing rights or deferred tax
assets. The adoption of SFAS No. 121 in 1996 did not have a material effect on
the Bank's results of operations or financial condition.
Effective July 1, 1995, the Bank adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights" ("SFAS No. 122"), which amended SFAS No. 65,
"Accounting for Certain Mortgage Banking Activities." SFAS No. 122 requires an
institution that purchases or originates mortgage loans and sells or
securitizes those loans with servicing rights retained to allocate the total
cost of the mortgage loans to the mortgage servicing rights and the loans
(without the mortgage servicing rights) based on their relative fair values.
The impact of adopting SFAS No. 122 was an increase in pretax earnings of
$594,000, net income of $438,000 and earnings per share of $0.23, as adjusted
for the Reorganization, for the year ended December 31, 1995.
In 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), which encourages companies to account for
stock compensation awards based on their fair value at the date the awards are
granted. SFAS No. 123 does not require the application of the fair value
method and allows for the continuance of current accounting methods, which
require accounting for stock compensation awards based on their intrinsic
value as of the grant date. However, SFAS No. 123 requires proforma disclosure
of net income and, if presented, earnings per share, as if the fair value
based method of accounting defined in this Statement had been applied. The
accounting and disclosure requirements of this Statement are effective for
financial statements for fiscal years beginning after December 15, 1995. The
Bank did not adopt the recognition provisions of SFAS No. 123 with respect to
the Stock Option Plan.
In June 1996 the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No.
125"), which was amended by SFAS No. 127. This Statement provides accounting
and reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on consistent application of a financial-
components approach that focuses on control. It distinguishes transfers of
financial assets that are sales from transfers that are secured borrowings.
Under the financial-components approach, after a transfer of financial assets,
an entity recognizes all financial and servicing assets it controls and
liabilities it has incurred and derecognizes financial assets it no longer
controls and liabilities that have been extinguished. The financial-components
approach focuses on the assets and liabilities that exist after the transfer.
Many of these assets and liabilities are components of financial assets that
existed prior to the transfer. If a transfer does not meet the criteria for a
sale, the transfer is accounted for as a secured borrowing with pledge of
collateral. The Statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after December
31, 1996. Retroactive application of this Statement is not permitted. The
adoption of SFAS No. 125 did not have a material impact on the Bank's results
of operations or financial condition.
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share" ("SFAS
No. 128") which is effective for financial statements issued of periods ending
after December 15, 1997. It replaces the presentation of primary earnings per
share with a presentation of basic earnings per share. It also requires the
presentation of diluted earnings per share for entities with complex capital
structures. Diluted earnings per share takes into account the potential
dilution that could occur if securities or other contracts to issue common
stock, such as options, were exercised or converted into common stock. The
Bank does not believe that SFAS No. 128 will have a material impact on its
financial statements.
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<PAGE>
LIFE FINANCIAL CORP.
Life Financial Corp. is a Delaware corporation recently organized by the
Bank as a financial services holding company. The Company will own all of the
capital stock of the Bank upon completion of the Reorganization. Immediately
following the Reorganization, the only significant assets of the Company will
be the capital stock of the Bank. Net proceeds received by the Company will be
used to (i) pay $9.8 million in cash and assume the liability of the Bank's
subordinated debt in order to acquire approximately $12.5 million of residuals
and restricted cash of $6.9 million resulting from the Bank's securitizations
completed during the fourth quarter of 1996 and the first quarter of 1997, see
"Business--Sources of Funds--Borrowings"; (ii) downstream proceeds to the Bank
if necessary to fund additional purchases and sales of loans; (iii) acquire an
interest in or pay the startup costs to establish a subsidiary for the purpose
of providing short term warehouse lines of credit; and (iv) fund general
business activities including expansion of existing mortgage financing
operations, possible acquisitions or development costs of related businesses
as opportunities arise. However, the Company has not entered into any
arrangement, agreement or understanding with respect to future acquisitions
and there can be no assurance that it will do so in the future. No
determination has been made as to the amount of proceeds that will be
allocated to each use, with the exception of the acquisition of the residuals
and restricted cash. On an interim basis, the net proceeds are expected to be
invested in short to intermediate-term investment securities and mortgage-
backed securities. See "Use of Proceeds" and "Business."
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<PAGE>
BUSINESS
BACKGROUND OF THE BANK
The Bank is a federally chartered stock savings bank whose primary business
is the origination and sale of sub-prime one- to four-family residential
mortgage loans and, to a much lesser extent, multi-family residential and
commercial mortgage loans. The Bank was originally chartered in 1983 as a
stock savings and loan association under the laws of the State of California
and became a federally chartered stock savings bank in 1991. The Bank conducts
its business from four locations: the Bank's headquarters in San Bernardino,
California, and three regional lending centers, one in Riverside, California,
one in Jacksonville, Florida and one recently established in the Denver,
Colorado metropolitan area. At March 31, 1997, the Bank had total assets of
$157.7 million, total deposits of $130.8 million and total equity of $11.5
million. During the three months ended March 31, 1997, the Bank originated or
purchased, through its Originators, $92.2 million of sub-prime mortgage
products and sold or securitized $83.2 million of such products. The Bank's
deposits are insured up to the maximum allowable amount by the SAIF of the
FDIC.
During the early 1990's, as a result of reduced employment levels and
corporate relocations in Southern California and the general weakness of the
national economy, the Bank's market area experienced a weakening of real
estate values and a reduction in home sales and construction. When confronted
with increased competition and nominal growth during this same period, the
Bank's results of operations were adversely impacted and the Bank began to
experience increases in total non-performing loans held for investment. In
response, in 1994, the Bank retained new management experienced in sub-prime
lending to redirect its business focus, revise its underwriting policies and
procedures and enhance its related servicing capabilities. A plan was
developed pursuant to which the Bank reorganized its lending operations from
that of a thrift emphasizing traditional mortgage banking and portfolio
lending to that of a diversified financial services operation focusing on the
origination for sale or securitization, with servicing retained, of various
loan products to include Liberator Series loans, Portfolio Series loans, and,
to a much lesser extent, commercial and multi-family real estate loans. The
Bank also adopted revised underwriting policies and instituted more aggressive
procedures for resolving problem loans and for reducing the level of non-
performing assets. As a result of these steps, the Bank improved its
profitability.
As part of the Bank's strategic plan, the Bank developed an internal
structure of operating divisions, each with distinct objectives and management
focus. The five divisions include (i) the Financial Services Division which
emphasizes the wholesale origination of the Bank's core products; (ii) the
Income Capital Services Division which originates and sells commercial and
multi-family mortgage loans; (iii) the Retail Loan Division which concentrates
on offering loan products directly to the public primarily in the Bank's
primary market area; (iv) the Asset Management Division which services loans
and REO for both the Bank and for Loan Purchasers; and (v) the Banking
Division which offers depository services to the public. In 1994, the Bank
began to implement its plan which resulted in:
. An increase in total purchases and originations of loans by 171.5% from
$82.0 million for the year ended December 31, 1993 to $222.6 million for
the year ended December 31, 1996. For the three month period ended March
31, 1997, loans originated and purchased totalled $92.2 million.
. An increase in loan sales and securitizations by 191.0% from $71.0
million for the year ended December 31, 1993 to $206.6 million for the
year ended December 31, 1996. For the three month period ended March 31,
1997, loan sales and securitizations totalled $83.2 million.
. An increase in net income of 1,518.3% from $93,000 for the year ended
December 31, 1993, to $1.5 million for the year ended December 31, 1996.
For the three month period ended March 31, 1997, net income was $2.2
million.
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. An increase in net gains from mortgage financing operations by 663.6%
from $1.1 million for the year ended December 31, 1993, to $8.4 million
for the year ended December 31, 1996. For the three month period ended
March 31, 1997, net gains from mortgage financing operations totalled
$5.9 million.
. A decrease in non-performing assets by 25.0% from $4.0 million at
December 31, 1993, to $3.0 million at December 31, 1996. As a percent of
total assets, non-performing assets decreased by 43.4% from 5.05% at
December 31, 1994 to 2.86% at December 31, 1996. At March 31, 1997, non-
performing assets totalled $2.9 million and, as a percentage of total
assets, were 1.85%.
. An increase in the allowance for estimated loan losses as a percent of
gross loans receivable by 263.1% from 0.65% at December 31, 1993 to
2.36% at December 31, 1996. At March 31, 1997, the allowance for
estimated loan losses as a percent of gross loans receivable was 2.42%.
COMPETITIVE STRENGTHS
Management believes that it enjoys a competitive advantage when compared to
most other finance companies competing in its product areas as a result of the
following factors:
Expertise of Management. The change in direction of the Bank's business
focus commenced with the hiring in 1994 of Daniel L. Perl, the Bank's
President and Chief Executive Officer. Mr. Perl has more than twenty years
of experience in the financial services industry, including the areas of
sub-prime lending, commercial real estate lending, mortgage banking and
investment banking. Additional management expertise includes:
. Mr. Bruce Mills has more than 15 years in banking and regulatory
experience including service at the Federal Home Loan Bank, the
predecessor of the OTS and ten years as chief financial officer of
the Bank.
. Ms. Mary Darter has more than 13 years of lending experience
including sub-prime, bulk acquisition and warehouse lending. She
joined the Bank in March of 1994 having previously worked with Mr.
Perl from 1988 to 1991.
. Mr. Joseph R. L. Passerino has been in the financial services
industry for more than 20 years. His areas of expertise have
included conventional and sub-prime residential loans as well as
commercial lending. Mr. Passerino previously worked with Mr. Perl
from 1985 to 1988.
. Mr. Stephen Sandoval has more than 24 years of extensive experience
in the servicing and collection of mortgage and consumer loans with
a primary focus on loss mitigation including workout alternatives,
bankruptcy and foreclosure processing in addition to traditional day
to day loan servicing functions.
The Board has implemented competitive management incentives to attract and
retain qualified executives. See "The Board of Directors and Management of the
Bank--Benefits--Cash Bonus Plan" and "--Stock Option Plans."
Efficiency of Operations. Management believes that the efficiency of its
operations allows the Bank to offer to its Originators very competitively
priced products. Management believes that this competitive pricing will
increase the volume of loans originated. The efficiency of the Bank's
operations results from:
. Providing Originators with clear, concise and consistent
underwriting standards;
. Well defined core products;
. Low cost, strategically located loan facilities;
. Rapid turnaround time on loan applications;
. Limited number of strong and productive relationships with
Originators; and
. Originations of loans at low premiums or at a discount from par.
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Internal Controls. Management believes that the significant internal
controls that have been established help preserve and assure the overall
quality of loans originated by the Bank. These internal controls include:
. Dual signatures on all loan originations;
. Unanimous approval by a committee of three persons, including a
member of senior management, of any exceptions to the Bank's
underwriting policies;
. Exceptions to the Bank's underwriting policies are kept to a
minimum;
. A limited number of Board-approved appraisers perform or review
appraisals on all loans originated or purchased by the Bank;
. For all loans on first payment default or 60 days overdue, a quality
control review is completed by the Quality Control Underwriter;
. Third party underwriting review of approximately 15.0% of all loans
originated; and
. Weekly underwriting and delinquency meetings are held to review and
update procedures and controls.
Flexible Funding Sources and Structure. As a federally-chartered savings
bank, the Bank has access to funds at a lower cost than its non-regulated
finance company competitors. This advantage is derived from the Bank's
ability to:
. Access a long-term stable funding base through the Bank's deposits
which are insured by the FDIC;
. Increase its deposit base through competitive pricing and possible
branch acquisitions or acquisitions of other depository
institutions; and
. Access funding through the FHLB of San Francisco.
This flexible funding structure will be further enhanced by the
Reorganization of the Bank into the holding company structure because:
. Upon the Reorganization and Public Offering, the Bank will sell its
currently-held residual assets and restricted cash to the Company,
thereby reducing constraints on its risk-based capital; and
. Following the Reorganization, subject to certain limitations, the
Bank may pay dividends to the Company, thereby increasing the
Company's cash flow and potentially reducing the Company's need to
raise additional equity capital.
Diversification Opportunities. Upon the Reorganization, the Company will
become a unitary savings and loan holding company which generally will not
be restricted in the types of business activities which it may conduct
provided that the Bank continues to be a qualified thrift lender ("QTL").
See "Regulation--Federal Savings Institution Regulation--QTL Test." The
Reorganization will provide the Company with:
. The opportunity to expand its current product line and enter into
possible new product areas;
. Broader investment opportunities than the Bank; and
. Alternative access, if necessary, to the capital markets than merely
financing at the Bank.
GROWTH AND OPERATING STRATEGIES
Management believes that, as a result of its competitive strengths, the Bank
and the Company will be able to implement the following growth and operating
strategies:
. Expanding Core Products Through a National Originator Network. The Bank
will continue to emphasize and to expand the origination of its core
products, Liberator Series loans and Portfolio Series loans, for sale
through securitizations and in the secondary market. Continued growth of
core
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products will result primarily from geographic expansion and greater
penetration in existing markets. In particular, since the beginning of
1997, the Bank has widely advertised its NINA loan product, which is a
limited documentation, lower loan-to-value loan program within the
Liberator Series. NINA loans constituted $7.3 million of the $80.1
million of loans in the Bank's 1997-1 securitization during the first
quarter of 1997. In order to improve its ability to service its
expanding network of Originators, the Bank has established strategically
located, low cost regional lending centers in Riverside, California,
Jacksonville, Florida and in the Denver, Colorado metropolitan area.
Over the next twelve months, the Bank intends to open two additional
regional lending centers which are likely to be strategically located in
the Northeast and Midwest sectors of the United States to better serve
its Originators.
. Expanding Retail Lending Production. The Bank's retail lending
operations focus on retail loans located in the Bank's primary market
area of Southern California. To the extent that these loans meet the
criteria for Liberator Series loans or Portfolio Series loans, the
Bank's retail lending operation acts as an origination source for the
Life Financial Services Division of the Bank while loans not meeting
these criteria are sold to Loan Purchasers. The Bank intends to
gradually and selectively expand its retail lending operations beyond
Southern California. As part of this process, the Bank also plans to
establish low cost retail offices selectively throughout the country. In
order to reduce the possibility that its borrowers will refinance their
loans with other lenders, the Bank is seeking to refinance such loans
through its own retail lending operation.
. Expanding Multi-Family and Commercial Lending. In continuing with its
tradition as a niche market lender and in an effort to diversify product
offerings, the Bank, through its Life Income Capital Division, has
recently begun to focus its efforts on the origination and purchase of
multi-family and commercial real estate loans in the range of $50,000 to
$750,000 both in its primary market area and throughout the United
States through a selected group of originators. The Bank is currently
purchasing such loans at a discount and, although there can be no
assurances, expects to be able to continue to purchase such loans at a
discount or low premium. The Bank employs underwriters who specialize in
commercial and multi-family real estate lending and utilizes a select
group of appraisers experienced in these products. In addition, two
members of senior management have considerable expertise in multi-family
and commercial real estate lending. The Bank has been limited in its
ability to originate multi-family and commercial real estate loans by
its level of available capital. The Bank plans to gradually expand such
originations as its available capital increases. The Bank believes that
it has the infrastructure in place to accommodate this expansion. It is
anticipated that all multi-family and commercial real estate loans will
be originated for sale in the secondary market and may also be sold
through securitizations in the future.
. Consistently Refining Operating Procedures. The Bank intends to maintain
loan quality by continuing to refine its underwriting criteria. A
meeting of the Bank's underwriting personnel is held each week in part
to discuss operational issues as well as refinements to the Bank's
underwriting policies. In addition, the Bank conducts a weekly loan
delinquency meeting to discuss problem areas in the Bank's servicing
portfolio in order to reduce the likelihood of the recurrence of such
problems in future loans. As necessary, the Bank adds personnel to its
loan processing staff and continues to utilize advancements in computer
technology to provide prompt turnaround on loans, efficient underwriting
procedures and accurate credit verification. In addition, in the fourth
quarter of 1996, the Bank hired a Quality Control Underwriter who: is
dedicated to maintaining quality control; reviews loan files to assure
that each complies with the Bank's underwriting policies; reviews all
loans upon first payment default and loans sixty days delinquent;
provides feedback and training to the underwriters to minimize future
defaults and delinquencies; and investigates all fraudulent loans.
. Enhancing Servicing Capabilities. As the Bank has transitioned from a
traditional thrift to a diversified financial services operation, it has
expanded its servicing department from a total of four persons at
December 31, 1994 to 16 persons at March 31, 1997. In December 1996, the
Bank hired a department head with 24 years of experience in loan
servicing and collections including responsibility for a
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$10.0 billion portfolio of approximately 255,000 loans and a staff of 70
people. In anticipation of its future servicing needs, the Bank has
dedicated substantial space in its current Riverside facility to house
loan servicing operations and is in the process of implementing new
technology including computer imaging and power dialing.
. Diversifying Funding Sources. In addition to its traditional thrift
funding sources of deposits and loans from the FHLB, the Bank has
diversified its funding sources in recent periods. During the fourth
quarter of 1996 and the first quarter of 1997, net cash received from
the Bank's securitizations provided a significant source of funding to
the Bank, aggregating $128.1 million for those two quarters. The Bank
recently has also entered into a retail mortgage warehouse line of
credit with a national investment banking firm in the amount of $50.0
million and may enter into additional lines of credit in the future.
Following the Reorganization, the Company may further diversify the
current sources of funding through greater access to capital markets.
RESTRUCTURING
General. In order to increase operating flexibility and provide a broader
range of services to its customers, Management has determined (i) to
reorganize into the holding company form of organization, (ii) to form
separate holding company subsidiaries, (iii) to restructure the Bank by
forming separate operating subsidiaries in order to realize possible future
values from such subsidiaries, and (iv) to raise additional capital to fund
operations and expansion.
The Reorganization. The Boards of Directors of the Company and the Bank
unanimously approved and entered into the Plan of Reorganization pursuant to
which the Bank will be reorganized into a holding company structure and become
a wholly-owned subsidiary of the Company. See "The Reorganization." The
Reorganization was approved by the Bank's stockholders at a meeting held on
June 20, 1997 and will be consummated prior to the closing of the Public
Offering. Management believes that the holding company form of organization
will provide the Company with more flexibility and a greater ability to
compete with other financial services companies in the market place.
Formation of Company Subsidiary. The Company has established Life Investment
Holdings for the purpose of holding residual assets created by its asset
securitizations. The Bank currently utilizes an independent third party
trustee for this purpose. Immediately upon the completion of the Public
Offering, the Company will acquire from the Bank $12.5 million of residuals
and restricted cash of $6.9 million resulting from the Bank's securitizations.
Due to regulatory restrictions, the Bank is limited in the amount of
investment in residuals and related assets that it can retain. It is intended
that any future residuals and restricted cash will be purchased by this
subsidiary, as a result of such regulatory limitations. See "--Investment
Activities."
In addition to the foregoing, upon the completion of the Public Offering,
the Company may acquire or establish a subsidiary to provide warehouse lines
of credit to meet the cash flow needs of smaller loan originators on a short-
term basis. It is expected that this financing relationship will in turn
create additional sources of loans for the Company to purchase and securitize.
See "Use of Proceeds."
Formation of Bank Operating Subsidiaries. Applications have been filed by
the Bank with the appropriate regulatory agencies to form several operating
subsidiaries. Although there can be no assurances, the Bank expects to receive
the necessary approvals from the OTS to form these subsidiaries.
. Life Financial Services will assume the functions of the Life Financial
Services Division of the Bank. This subsidiary will continue to focus on
Liberator Series loans and Portfolio Series loans, which are the Bank's
core products. Although the Bank will not complete an asset
securitization during the second quarter of 1997, it is management's
intention to regularly conduct asset securitizations through this
subsidiary. There can be no assurance, however, that any asset
securitizations will be completed in the future. In addition, management
intends to expand the activities of this subsidiary and expects its
operations to create a major source of revenue for the Bank, although
there can be no assurances in this regard.
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<PAGE>
. Life Income Capital is being established for the purpose of originating
and selling multi-family and commercial real estate loans in the $50,000
to $750,000 range. Prior to the third quarter of 1996, the Bank was
substantially limited in its ability to originate such loans by its
level of available capital. At March 31, 1997, multi-family and
commercial real estate and land loans totalled $20.2 million, or 27.2%,
of the Bank's gross loan portfolio. Although there can be no assurances
in this regard, management intends to expand the operations of this
subsidiary and expects the operations of this subsidiary to create an
increased source of revenue for the Bank because of the perceived demand
for and higher yields on such loans. See "Risk Factors--Multi-Family and
Commercial Real Estate Risks" for a discussion of the risks associated
with multi-family and commercial real estate lending.
. Life Asset Management is being established as a direct subsidiary of the
Bank to service loans and REO for both the Bank and for its Loan
Purchasers.
The Retail Lending Division and the Banking Depository Division will remain
within the Bank. In addition, as part of its liquidity and investment
portfolios, the Bank will continue to hold investments in U.S. government and
agency securities. As part of the Bank's Community Reinvestment Act commitment
to the Southern California area and more specifically to the Inland Empire
region, which consists of the counties of San Bernardino and Riverside, the
Bank will lend to and invest in community development programs. As of March
31, 1997, the Bank had committed to lend or invest $2.5 million in such
projects during 1997. See "--Historical and Local Lending Portfolio."
Capital Raising. In order to fund the acquisition of the residuals and
restricted cash currently in the Bank's portfolio, to acquire or form a
subsidiary to provide warehouse lines of credit and for general corporate
purposes, including the origination and purchase of loans to be securitized or
sold in the secondary market and to grow and expand operations through the
establishment of retail lending and mortgage banking offices, the Company is
conducting the Public Offering to raise $28.7 million in net proceeds.
CORE LENDING PRODUCTS
General. The Bank originates, purchases, sells and services primarily non-
conventional mortgage loans principally secured by first and second mortgages
on one- to four-family residences. The Bank has focused on Liberator Series
loans which are for the purchase or refinance of residential real property by
borrowers who may have had prior credit problems or who do not have an
adequate credit history ("sub-prime borrowers"). In addition, the Bank has
originated a substantial number of Portfolio Series loans which are debt
consolidation loans for Agency Qualified Borrowers with loan-to-value ratios
of up to 125%.
The Bank purchases and originates mortgage loans and other real estate
secured loans through a network of Originators on a nationwide basis. Except
for a limited number of loans specifically originated for retention in the
Bank's portfolio as loans held for investment, loans originated or purchased
since 1994 through the Bank's regional lending centers are generally
originated for sale in the secondary mortgage market and, more recently, in
asset securitizations with servicing retained by the Bank.
Marketing. The Bank's primary means of marketing its products is direct
contact between its account executives and Originators. Each of the Bank's 27
account executives is responsible for maintaining and expanding existing
Originator relationships within the account executive's assigned territory
through personal contact and promotional materials. Each account executive is
typically responsible for approximately 20 key Originators and is expected to
have weekly contact with each of these Originators. In addition, each account
executive is responsible for up to 30 additional Originators with whom the
account executive will have frequent contact. Each account executive also
works to develop Originator relationships through "cold calls" and following
up on inquiries made by Originators to the Bank's toll-free number. Each
account executive works as part of a team with one of the Bank's six loan
coordinators and seven assistant coordinators. Each loan coordinator and
assistant loan coordinator works with three or four account executives. The
loan coordinators and their assistants are responsible for inputting the new
loans into the Bank's data systems and for shepherding
50
<PAGE>
the loans from the point of origination through funding. After origination,
the loan coordinators and their assistants are available to talk to
Originators on a daily basis. Loan coordinators and their assistants are
located in each of the Bank's regional lending centers.
The Bank believes that the key element in developing, maintaining and
expanding its relationships with Originators is to provide the highest
possible level of product knowledge and customer service. Each account
executive receives comprehensive training prior to being assigned to a
territory. In most cases, training includes experience in the loan production
department so that the account executive will be familiar with all phases of
loan origination and production and will also become acquainted with the whole
loan coordination team. This training enables the account executive to quickly
review a loan application in order to identify the borrower's probable risk
classification and then assist the Originator in identifying the appropriate
product for the borrower, thereby enhancing the likelihood that the loan will
be approved at the rate and on the terms anticipated by the borrower. After a
loan package is submitted to the Bank, the loan coordination team provides
assistance to the Originator throughout the process to complete the loan
transaction. Account executives and loan coordinators and assistant
coordinators are compensated based on the number and the dollar volume of
loans funded. A significant portion of the regional manager's compensation is
tied to the profitability of his or her regional lending center and includes a
component based on loan performance.
Origination and Purchase of Loans. Loans are originated both through the
Bank's wholesale network of Originators and on a retail basis through the
Bank's Retail Lending Division. The Bank has also made bulk purchases of loans
from time to time and has recently hired a senior management employee
experienced in bulk purchases to gradually expand the Bank's loan purchases.
The Bank's mortgage financing and servicing operations are conducted
primarily through regional lending centers located in Riverside, California,
Jacksonville, Florida and the Denver, Colorado metropolitan area. Over the
next twelve months, the Bank intends to open two additional low cost regional
lending centers which are likely to be strategically located in the Northeast
and Midwest sectors of the United States to better serve its Originators. From
its present locations, the Bank is able to originate or purchase its core
products in the District of Columbia and all 50 states with the exception of
Louisiana, Mississippi and Alaska.
The following table sets forth aggregate dollar amounts and the percentage
of core products originated or purchased by the Bank in each state where 5.0%
or more of the loans were originated or purchased, in either the fourth
quarter of 1996 or the first quarter of 1997, and for all other states as a
group for the periods shown:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
----------------------------
DECEMBER 31, MARCH 31,
1996 1997
------------- -------------
$ % $ %
------- ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
California..................................... $20,434 29.5% $26,421 29.8%
Utah........................................... 6,208 9.0 7,958 9.0
Virginia....................................... 5,810 8.4 5,884 6.6
Florida........................................ 4,897 7.1 3,405 3.8
Maryland....................................... 4,881 7.1 4,492 5.1
North Carolina................................. 3,932 5.7 5,240 5.9
Other.......................................... 22,998 33.2 35,239 39.8
------- ----- ------- -----
Total........................................ $69,160 100.0% $88,639 100.0%
======= ===== ======= =====
</TABLE>
The Bank's geographic markets are currently divided into three regions, with
a completely self-contained mortgage banking team assigned to each region.
Each team is headed up by a regional manager and includes dedicated account
executives, loan cordinators and assistant coordinators, underwriters,
appraisers and other production personnel so that the team can originate and
produce loans in that region. This concept of regional processing teams, which
the Bank believes is efficient but quite rare in the industry, enables the
Bank to more effectively anticipate and respond to Originator and borrower
needs in each region. Management believes that
51
<PAGE>
the concept also appeals to independent brokers who may be reluctant to deal
with a larger, more remote lender. Each regional team is connected to senior
management in Riverside, California by a computer link that enables senior
management to monitor all regional functions on a real time basis.
Personnel staffing a regional lending center are trained in the Bank's
Riverside office. For a period of six to twelve months after the establishment
of a regional lending center all loans originated through that office are
reunderwritten by staff at the Riverside office to assure quality control. In
addition, the Quality Control Underwriter and the Bank's internal auditor
periodically visit the regional lending centers for quality control purposes.
In recent years, the Bank has focused on Liberator Series loans, which are
loans for the purchase or refinance of one- to four-family residential real
property by borrowers who may have had prior credit problems or who do not
have an adequate credit history ("sub-prime borrowers"), and loans which
otherwise do not conform to FHLMC or FNMA guidelines ("conforming loans").
Loans to sub-prime borrowers are perceived by management as being advantageous
to the Bank because they generally have higher interest rates and origination
and servicing fees and generally lower loan-to-value ratios than conforming
loans. In addition, management believes the Bank has the resources to
adequately service loans acquired pursuant to this program as well as the
experience to resolve loans that become non-performing. The Bank has
established specific underwriting policies and procedures, invested in
facilities and systems and developed correspondent relationships with
Originators throughout the country enabling it to develop its niche as an
originator and purchaser of one-to four-family residential loans to sub-prime
borrowers. Since the beginning of 1997, the Bank has widely advertised its
NINA loan product, which is a limited documentation, lower loan-to-value loan
product within the Liberator Series loan portfolio. The Bank intends to
continue to expand the volume of Liberator Series loans which it originates,
to market areas throughout the country, to sub-prime borrowers who meet its
niche lending criteria. See "Risk Factors--Risks Associated with Sub-Prime
Lending."
The following table sets forth selected information relating to originations
of Liberator Series loans during the periods shown:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED
----------------------
DECEMBER 31, MARCH 31,
1996 1997
------------ ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Principal balance................................... $39,465 $39,629
Average principal balance per loan.................. 85 100
Combined weighted average initial loan-to-value
ratio.............................................. 73.4% 72.8%
Percent of first mortgage loans..................... 85.4 91.8
Property securing loans:
Owner occupied..................................... 86.4 77.3
Non-owner occupied................................. 13.6 22.7
Weighted average interest rate:
Fixed-rate......................................... 11.3 10.8
ARMs............................................... 9.6 9.1
</TABLE>
The Bank has originated a substantial number of Portfolio Series loans,
which are debt consolidation loans for Agency Qualified Borrowers, both on a
wholesale basis through its Life Financial Services Division, and through its
Retail Lending Division. These loans are consumer-oriented loans secured by
real estate, primarily home equity lines of credit and second deeds of trust,
for up to 125% of the appraised value of the real estate underlying the
aggregate loans on the property. Although the loan-to-value ratio on Portfolio
Series loans is higher than that offered by other mortgage products,
management believes that the higher yield and the low level of credit risk of
the borrowers offset the risks involved. See "--Underwriting" and "Risk
Factors--High Loan to Value Ratios of Portfolio Series Loans."
52
<PAGE>
The following table sets forth selected information relating to originations
of Portfolio Series loans during the periods shown:
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS ENDED
----------------------
DECEMBER 31, MARCH 31,
1996 1997
------------ ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Principal balance................................... $29,695 $49,010
Average principal balance per loan.................. 31 32
Combined weighted average initial loan-to-value
ratio.............................................. 108.4% 107.7%
Percent of first mortgage loans..................... 0.1 0.5
Property securing loans:
Owner occupied..................................... 99.5 99.8
Non-owner occupied................................. 0.5 0.2
Weighted average interest rate:
Fixed-rate......................................... 14.1 13.8
ARMs............................................... 11.2 10.3
</TABLE>
Use and Qualifications of Originators. The Bank purchases loans from select
Originators throughout the country. Such Originators must be approved by the
Bank prior to submitting loans to the Bank. Pursuant to the Bank's approval
process, each Originator is generally required to have a specified minimum
level of experience in originating non-conforming loans, and provide
representations, warranties, and buy-back provisions to the Bank.
The Bank provides clear and concise criteria regarding its well-defined core
products to Originators with whom it may do business. If, following a period
of training and relationship building, Originators consistently fail to
present a high level of loans meeting the Bank's underwriting criteria, the
Bank will cease to do business with them. As a result, the Bank has developed,
since 1994, a core group of Originators who form its nationwide network of
Originators. The Bank generally classifies the Originators with which it does
business into four classes with descending priority with regard to the terms
and the pricing of the loans the Bank purchases from such Originators.
<TABLE>
<CAPTION>
JUNIOR THIRD PARTY MORTGAGE
CORRESPONDENTS CORRESPONDENTS ORIGINATORS BROKERS(1)
-------------- -------------- ----------- ----------
<S> <C> <C> <C> <C>
Net Worth(2).............. $ 250,000 $100,000 $50,000 N/A
Years in Business......... 2 2 2 N/A
Warehouse Credit
Facility................. Yes Yes No No
Errors and Omissions
Insurance................ $1.0 million $300,000 No No
Number Doing Business With
the Bank at
March 31, 1997........... 81 30 91 613
</TABLE>
- --------
(1) Mortgage brokers are those persons who do not meet the specific foregoing
criteria but have demonstrated to the Bank, or have a reputation for, the
ability to originate real estate secured loans and have acceptable credit
and finance industry references.
(2) The net worth of Correspondents is provided by audited financial
statements prepared in accordance with GAAP. Net worth of Junior
Correspondents and Third Party Originators is provided through unaudited
financial information.
The Bank purchases substantially all loans on an individual basis from
qualified Originators. No single Originator accounted for more than 4.5% of
the loans originated by the Bank for the quarter ended March 31, 1997. It is
the Bank's general policy to limit the percentage of loans closed by any
single Originator to approximately 5.0% of loans closed in any given period.
Underwriting. The underwriting and quality control functions are managed
through the Bank's regional lending center in Riverside, California. The Bank
believes that its underwriting process begins with the
53
<PAGE>
experience of its staff, the education of its network of Originators, the
quality of its correspondent relationships and its loan approval procedures.
As an integral part of its lending operation, the Bank ensures that its
underwriters assess each loan application and subject property against the
Bank's underwriting guidelines.
Personnel in the Bank's regional lending centers review in its entirety each
loan application submitted by the Bank, Originators or through bulk purchases
for approval. The Bank conducts its own underwriting review of each loan,
including those loans originated for or purchased by it from its Originators.
Loan files are reviewed for completeness, accuracy and compliance with the
Bank's underwriting criteria and applicable governmental regulations. This
underwriting process is intended to assess both the prospective borrower's
ability to repay the loan and the adequacy of the real property security as
collateral for the loan granted, tailored to the general nature of the
Portfolio Series and the Liberator Series loans, respectively. Based on the
initial review, the personnel in the regional lending center will inform the
Originators of additional requirements that must be fulfilled to complete the
loan file. The Bank strives to process each loan application received from its
network of Originators as quickly as possible in accordance with the Bank's
loan application approval procedures. Accordingly, most loan applications
receive decisions within 48 hours of receipt and generally are funded within
one day following satisfaction of all conditions for approval of the loan
which is typically seven business days after the initial approval.
Each prospective borrower is required to complete a mortgage loan
application that may include (depending on the program requirement)
information detailing the applicant's liabilities, income, credit history,
employment history and personal information. Since most of the loan
applications are presented through the Bank's network of Originators, the Bank
completes an additional credit report on all applications received. Such
report typically contains information relating to such matters as credit
history with local and national merchants and lenders, installment debt
payments and any record of defaults, bankruptcies, repossessions or judgments.
This credit report is obtained through a sophisticated computer program that
accesses what management believes to be the most appropriate credit bureau in
a particular zip code and combines that information with the Bank's own credit
risk score.
This application and review procedure is used by the Bank to analyze the
applicant's creditworthiness (i.e., a determination of the applicant's ability
to repay the loan). Creditworthiness is assessed by examination of a number of
factors, including calculating a debt-to-income ratio obtained by dividing a
borrower's fixed monthly debt by the borrower's gross monthly income. Fixed
monthly debt generally includes (i) the monthly payment under any related
prior mortgages which will include calculations for insurance and real estate
taxes, (ii) the monthly payment on the loan applied for and (iii) other
installment debt, including, for revolving debt, the required monthly payment
thereon, or, if no such payment is specified, 3% of the balance as of the date
of calculation. Fixed monthly debt does not include any debt (other than
revolving credit debt) described above that matures within less than 10 months
of the date of calculation.
Prior to funding a loan, several procedures are used to verify information
obtained from an applicant. The applicant's outstanding balance and payment
history on any senior mortgage may be verified by calling the senior mortgage
lender. If the senior mortgage lender cannot be reached by telephone to verify
this information, the Originators may rely upon information provided by the
applicant, such as a recent statement from the senior lender and verification
of payment, such as cancelled checks, or upon information provided by national
credit bureaus. In order to verify an applicant's employment status, the
Originators may obtain from the applicant recent tax returns or other tax
forms (e.g., W-2 forms) or current pay stubs or may telephone the applicant's
employer or obtain written verification from the employer. As in the case of
the senior mortgage lender verification procedures, if the employer will not
verify employment history over the telephone, the Bank or other Originators
may rely solely on the other information provided by the applicant. However,
the Bank does offer NINA loans at reduced loan-to-value ratios in lieu of
documenting cash flow and assets of the borrower. See "--Liberator Series
(NINA)" for further information on NINA loans.
Debt to income ratios for Portfolio Series mortgage loans generally do not
exceed 45%, but in certain instances where deemed appropriate by the Bank, the
ratio may go as high as 50%. For Liberator Series mortgage loans, debt to
income ratios may vary depending upon a number of other factors used to
ascertain the creditworthiness of the borrower.
54
<PAGE>
The general criteria currently used by the Bank in classifying prospective
borrowers of its core loan products are summarized in the charts below.
LIBERATOR SERIES (FULL DOCUMENTATION)(1)
<TABLE>
<CAPTION>
"AX" RISK "A-" RISK "B" RISK "C" RISK
----------------------- ----------------------- -------------------- ------------------------
<S> <C> <C> <C> <C>
Maximum Loan-to-
Value Ratio:
Primary
residence...... 95% 95% 80% 75%
Secondary
residence...... 90% 90% 70% 70%
Investor
property....... 90% 85% 65% 65%
Home equity line
of credit(1)... 90% 90% 80% --
Debt Service to
Income Ratio.... 42-50% 42-50% 50% 50%
Mortgage Credit.. Maximum one 30-day Maximum two 30-day Maximum four 30-day Maximum six 30-day
late payment in the late payments in the late payments late payments, two
last 12 months last 12 months or one 60-day late 60-day late payments
payment in the last or one 90-day late
12 months payment in last 12
months
Major Consumer
Credit(2)....... Maximum one 30-day Maximum one 30-day No more than 60 days No more than 90 days
late payment in the late payment in last late on any account late on any account in
last 12 months; 12 months; overall in last 12 months; last 12 months; overall
maximum two 30-day good credit; overall average fair credit
late payments in maximum 25% credit
the last 24 months of credit accounts
delinquent in last
24 months
Minor Consumer
Credit(3)....... Maximum two 30-day Maximum one 30-day No more than 60 days No more than 90 days
late payments in the late payment in last late on any account late on any account in
last 12 months; 12 months; isolated in last 12 months; last 12 months; isolated
maximum three 60-day late payment isolated minor late payment over 90
30-day late allowed with 90-day late payment days allowed with
payments in last compensating factors; allowed with compensating factors
24 months maximum 25% of compensating factors
credit accounts
delinquent in last
24 months
Bankruptcy
Filings......... No bankruptcy in last No bankruptcy in last No bankruptcy in No bankruptcy in last
36 months, except under 24 months, except under last 24 months, 12 months
certain circumstances certain circumstances except under certain
circumstances
Minimum FICO
Score........... 650 620 580 540
<CAPTION>
"CX" RISK
-------------------------
<S> <C>
Maximum Loan-to-
Value
Ratio:
Primary
residence...... 65%
Secondary
residence...... 60%
Investor
property....... 60%
Home equity line
of credit(1)... --
Debt Service to
Income Ratio.... 60%
Mortgage Credit.. Currently delinquent
Major Consumer
Credit(2)....... Sporadic payment
pattern; apparent
disregard toward timely
payments or credit
standing
Minor Consumer
Credit(3)....... Sporadic payment pattern;
apparent disregard toward
timely payments or credit
standing
Bankruptcy
Filings......... Discharged within
12 months
preceding application;
current Chapter 13
or foreclosure
acceptable when paid
in full or cured
from loan proceeds
Minimum FICO
Score........... greater than 540
</TABLE>
- -------
(1) Also includes Portfolio Series home equity lines of credit which are fully
collateralized by the underlying property and which have a loan-to-value
ratio of 90% or less.
(2) Any nationally recognized credit cards and any installment debt.
(3) Department store credit cards, regional credit cards or oil company credit
cards.
55
<PAGE>
LIBERATOR SERIES (NINA)
<TABLE>
<CAPTION>
"Ax" RISK "A-" RISK "B" RISK "C" RISK "Cx" RISK
-------------------- ------------------- -------------------- --------------- --------------------
<S> <C> <C> <C> <C> <C>
Loan-to-Value Ratio:
Primary residence...... 80% 75% 70% 70% 65%
Secondary residence.... 75% 70% 65% 65% 60%
Investor property...... 75% 70% 65% 65% 60%
Mortgage Credit......... Maximum one Maximum two Maximum four Maximum six Currently delinquent
30-day late 30-day late 30-day late 30-day late
payment in the payments in the payments or one payments, two
last 12 months last 12 months 60-day late 60-day late
payment in the payments or
last 12 months one 90-day late
payment in last
12 months
Major Consumer
Credit(1).............. Maximum one Maximum one No more than No more than Sporadic payment
30-day late 30-day late 60 days late on 90 days late patterns; apparent
payment in the payment in last any account on any account disregard toward
last 12 months; 12 months; overall within last in last 12 timely payments
maximum two 30- good credit; 12 months; overall months; overall or credit standing
day late payments maximum 25% average credit fair credit
in the last 24 of credit accounts
months delinquent in
last 24 months
Minor Consumer
Credit(2).............. Maximum two Maximum one No more than No more than Sporadic payment
30-day late 30-day late 60 days late 90 days late on patterns; apparent
payments in the last payment in last on any account any account in disregard toward
12 months; 12 months, isolated in last 12 last 12 months; timely payments or
maximum three 60-day late months; isolated isolated late credit standing
30-day late payment allowed minor 90-day payment over
payments in with compensating late payment 90 days allowed
last 24 months factors; maximum allowed with with
25% of credit compensating factors compensating
accounts delinquent factors
in last 24 months
Bankruptcy Filings...... No bankruptcy No bankruptcy No bankruptcy No bankruptcy Discharged within
in last 36 in last 24 within last 24 in last 12 12 months
months, except months, except months, except months preceding
under certain under certain under certain application; current
circumstances circumstances circumstances Chapter 13 or
foreclosure
acceptable when
paid in full or
cured from loan
proceeds
Minimum FICO Score...... 650 620 580 540 greater than 540
</TABLE>
- --------
(1) Any nationally recognized credit cards and any installment debt.
(2) Department store credit cards, regional credit cards or oil company credit
cards.
56
<PAGE>
PORTFOLIO SERIES(1)
<TABLE>
<CAPTION>
"A+" RISK "Ax" RISK "A-" RISK "B+" RISK
-------------------- -------------------- -------------------- --------------------
<S> <C> <C> <C> <C>
Loan-to-Value Ratio:
100% Second Mortgage... 100% 100% 100% 100%
125% Second Mortgage... 125% 125% 125% 125%
100% Home Equity
Line of Credit........ 100% 100% 100% 100%
Debt Service to Income
Ratio:
100% Second Mortgage... 45-50% 45-50% 45-50% 45%
125% Second Mortgage... 45-50% 45-50% 45-50% 45%
100% Home Equity
Line of Credit........ 45-50% 45-50% 45-50% 45%
Mortgage History:
100% Second Mortgage... No 30-day late No 30-day late No 30-day late One 30-day late
payments in last payments in last payments in last payment in last
36 months 36 months 12 months; one 12 months or two
30-day late 30-day late
payment in payments in
last 24 months last 24 months
125% Second Mortgage... No 30-day late No 30-day late No 30-day late One 30-day late
payments in last payments in last payments in last payment in last
36 months 36 months 24 months 24 months
100% Home Equity
Line of Credit........ No 30-day late No 30-day late No 30-day late One 30-day late
payments in last payments in last payments in last payment in last
36 months 36 months 12 months; one 12 months or two
30-day late 30-day late
payment in payments in last
last 24 months 24 months
Bankruptcy Filings:
100% Second Mortgage... None in last 5 years None in last 5 years None in last 3 years None in last 3 years
125% Second Mortgage... None in last 5 years None in last 5 years None in last 3 years None in last 3 years
100% Home Equity
Line of Credit........ None in last 5 years None in last 5 years None in last 3 years None in last 3 years
Minimum FICO Score:
100% Second Mortgage... 700 670 640 620
125% Second Mortgage... 700 670 640 620
100% Home Equity Line
of Credit............. 700 670 640 620
</TABLE>
- --------
(1) Excludes Portfolio Series home equity lines of credit which are fully
collateralized by the underlying property and which have a loan-to-value
ratio of 90% or less.
57
<PAGE>
Loan Production by Borrower Risk Classification. The following table sets
forth information concerning the Bank's principal balance of fixed rate and
adjustable rate loan production by borrower risk classification for the
periods shown:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE THREE MONTHS ENDED
DECEMBER 31, 1996 MARCH 31, 1997
--------------------------------- ---------------------------------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED
PRODUCT/RISK % OF INTEREST AVERAGE % OF INTEREST AVERAGE
CLASSIFICATIONS(1) VOLUME TOTAL RATE(2) MARGIN(3) VOLUME TOTAL RATE(2) MARGIN(3)
- ------------------ ------- ----- -------- --------- ------- ----- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liberator Series (Full
documentation)
Ax...................... $18,925 48.0% 9.94% 5.24% $17,159 43.3% 9.35% 5.11%
A-...................... 8,790 22.3 10.16 5.52 9,241 23.3 9.85 5.52
B....................... 6,806 17.2 10.26 5.33 7,992 20.2 9.39 4.91
C....................... 2,026 5.1 11.16 5.68 2,555 6.4 10.98 5.77
Cx...................... 2,918 7.4 13.07 7.06 2,682 6.8 11.74 6.62
------- ----- ------- -----
Totals................ $39,465 100.0% 10.34 5.46 $39,629 100.0% 9.74 5.31
======= ===== ======= =====
Portfolio Series
A+...................... $ 2,669 9.0% 13.58 2.50 $ 9,980 20.4 13.22 1.74
Ax...................... 14,452 48.7 13.87 2.18 18,733 38.2 13.53 1.83
A-...................... 9,866 33.2 14.35 3.24 15,193 31.0 14.05 3.27
B+...................... 2,708 9.1 14.10 3.73 5,104 10.4 14.07 2.70
------- ----- ------- -----
Totals................ $29,695 100.0% 14.03 2.74 $49,010 100.0% 13.68 2.32
======= ===== ======= =====
</TABLE>
- --------
(1) For the three months ended March 31, 1997, only 3.0% of the core products
originated by the Bank were Class Cx loans.
(2) Weighted average interest rate includes both ARM loan products and fixed
rate loan products.
(3) Weighted average margin is based solely on ARM products.
Appraisal. All mortgaged properties relating to mortgage loans where
collateral assessment is an integral part of the evaluation process are
appraised by state licensed or certified appraisers. All of the appraisals are
either performed or reviewed by appraisers or appraisal firms approved by the
Bank's Board of Directors. These appraisers are screened and actively reviewed
on a regular basis. Each approved appraiser must have a minimum of $2.0
million of errors and omissions insurance. All appraisers are required to
assess the valuation of the property pursuant to U.S. Government Property
Analysis guidelines and conduct an economic analysis of the geographic region
in which the property is located. Once a loan application file is complete,
the file is reviewed to determine whether the property securing the loan
should undergo a desk or field review. This determination is made based on the
loan-to-value ratio of the underlying property and the type of loan or loan
program. If after the initial desk review, the underwriter requires additional
information with regard to the appraised value of the property, a field review
may also be conducted. The Bank requires the appraiser to address neighborhood
conditions, site and zoning status and the condition and valuation of
improvements. Following each appraisal, the appraiser prepares a report which
(when appropriate) includes a reproduction cost analysis based on the current
cost of constructing a similar building and a market value analysis based on
recent sales of comparable homes in the area. Title insurance policies are
required on all first mortgage liens, with a limited judgment lien report
required on all second lien loans under $100,000.
For Liberator Series loans, because of the sub-prime creditworthiness of the
borrowers, the evaluation of the value of the property securing the loans and
the ratio of loans secured by such property to its value become of greater
importance in the underwriting process. The specific procedures and criteria
utilized in the appraisal process range from a desk review, a field review, to
a second appraisal, depending on the size of the loan and its loan-to-value
ratio.
58
<PAGE>
The value of the mortgaged property has lesser importance with respect to
the Portfolio Series loans in light of their high loan-to-value ratios. As a
result, Portfolio Series loans generally have little or no equity in the
mortgaged property available to repay the loan if it is in default. For
Portfolio Series loans, the Bank accepts the homeowner/mortgagee's "as stated"
value on loans to $35,000. On loans in excess of $35,000 to a maximum of
$50,000, the Bank requires a current tax assessment, a written real estate
broker price opinion, a statistical appraisal or a HUD-1 conformed closing
statement where purchase of the subject property has occurred within the
previous 12 months. For loans in excess of $50,000, a drive-by appraisal
including comparable analysis on a FHLMC Form 704 is required.
Qualified property inspection firms are also utilized for annual property
inspections on all properties 45 days or more delinquent. Property inspections
are intended to provide updated information concerning occupancy, maintenance
and changes in market conditions.
Loan Approval Procedures and Authority. The Board of Directors establishes
the lending policies of the Bank and delegates authority and responsibility
for loan approvals to the Loan Committee and specified officers of the Bank.
All real estate loans must be approved by a quorum of the designated committee
or by the designated individual or individuals.
All loans underwritten by the Bank require the approval and signature of two
underwriters. Where there are exceptions to the Bank's underwriting criteria,
the loan must be unanimously approved by the underwriter, supervisory
underwriter and the Senior Vice President of the Bank or, if not unanimously
approved, by the Bank's President and Chief Executive Officer. Since 1994, it
has been the Bank's policy to adhere strictly to its underwriting standards,
with few exceptions. Additionally, the following committees, groups of
officers and individual officers are granted the authority to approve and
commit the Bank to the funding of the following categories of loans:
<TABLE>
<CAPTION>
LEVEL OF APPROVAL
------------------------------------------------------------------------
ONE STAFF TWO STAFF LOAN LOAN COMMITTEE AND
TYPE OF LOAN UNDERWRITER UNDERWRITERS COMMITTEE BOARD OF DIRECTORS
------------ --------------- ---------------- -------------------- ------------------
<S> <C> <C> <C> <C>
Mortgage loans held for
sale................... -- $550,000 or less -- $550,000 or more
Mortgage loans held for
investment............. -- $250,000 or less More than $250,000 $550,000 or more
but less than
$550,000
Other loans............. Personal loans All other loans All other loans more All other loans in
secured by Bank $25,000 or less than $25,000 but excess of $50,000
deposits less than $50,000
</TABLE>
The Bank will not make loans-to-one borrower that are in excess of
regulatory limits. Pursuant to OTS regulations, loans-to-one borrower cannot
exceed 15% of the Bank's unimpaired capital and surplus. At March 31, 1997,
the Bank's loans-to-one borrower limit equalled $1.9 million. See
"Regulation--Federal Savings Institution Regulation--Loans-to-One Borrower."
LOAN SALES AND ASSET SECURITIZATIONS
Loans are sold by the Bank through securitizations and whole loan sales.
With the exception of customary provisions relating to breaches of
representations and warranties, loans securitized or sold by the Bank are sold
without recourse to the Bank and generally are sold with servicing retained.
See "Risk Factors-- Contingent Risks." For the three months ended March 31,
1996 and the years ended December 31, 1996, 1995 and 1994,
59
<PAGE>
the Bank sold $37.8 million, $154.6 million, $126.9 million and $65.7 million
in loans, respectively. No loans were sold during the three months ended March
31, 1997. For the three months ended March 31, 1997 and the year ended
December 31, 1996, the Bank securitized $83.2 million and $51.9 million,
respectively. No loans were securitized for the three months ended March 31,
1996 or the years ended December 31, 1995 or 1994.
In a securitization, the Bank will generally transfer a pool of loans to a
trust with the Bank retaining the excess cash flows, known as residuals, from
the securitization which consist of the difference between the interest rate
of the mortgages and the coupon rate of the securities after adjustment for
servicing and other costs such as trustee fees and credit enhancement fees.
The cash generally will be used to repay advances on lines of credit used to
finance the pool of loans that were acquired by the Bank. Generally, the
holders of the securities from the securitization are entitled to receive
scheduled principal collected on the pool of securitized loans and interest at
the pass-through interest rate on the certificate balance. The residual asset
represents the subordinated right to receive cash flows from the pool of
securitized loans after payment of the required amounts to the holders of the
securities and the costs associated with the securitization. The Bank
recognizes gain on sale of the loans in the securitization, which represents
the excess of the estimated fair value of the residuals, net of closing and
underwriting costs, less the carrying value of the loans sold in the fiscal
quarter in which such loans are sold. Management believes that it has made
reasonable estimates of the present value of the residual interests on its
balance sheets. Concurrent with recognizing such gain on sale, the Bank
records the residual interests as assets on its balance sheet. The recorded
value of these residual interests are amortized as cash distributions are
received from the trust holding the respective loan pool and are marked to
market on a quarterly basis.
The Bank may arrange for credit enhancement for a transaction to achieve an
improved credit rating on the securities issued if this improves the level of
profitability or cash flow generated by such transaction. This credit
enhancement may take the form of an insurance and indemnity policy, insuring
the holders of the securities of timely payment of the scheduled pass-through
of interest and principal. In addition, the pooling and servicing agreements
that govern the distribution of cash flows from the loan pool included in a
transaction typically require over-collateralization as an additional means of
credit enhancement. Over-collateralization may in some cases also require an
initial deposit, the sale of loans at less than par or retention in the trust
of collections from the pool until a specified over-collateralization amount
has been attained. In the case of the Bank's securitizations in the fourth
quarter of 1996 and the first quarter of 1997, the over-collateralization was
in the form of a cash deposit. The purpose of the over-collateralization is to
provide a source of payment to investors in the event of certain shortfalls in
amounts due to investors. These amounts are subject to increase up to a
reserve level as specified in the related securitization documents. Cash
amounts on deposit are invested in certain instruments as permitted by the
related securitization documents. To the extent amounts on deposit exceed
specified levels, distributions are made to the holder of the residual
interest; and, at the termination of the related trust, any remaining amounts
on deposit are distributed to the holder of the residual interest. Losses
resulting from defaults by borrowers on the payment of principal or interest
on the loans in a securitization will reduce the over-collateralization to the
extent that funds are available and may result in a reduction in the value of
the residual interest. See "Risk Factors--Dependence on Asset Securitizations
and Impact on Quarterly Operating Results."
60
<PAGE>
The Bank has completed two securitizations, one during the fourth quarter of
1996 and one during the first quarter of 1997. The characteristics and results
of these securitizations are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 1996 MARCH 31, 1997
----------------------- --------------------------------------------
1996-1 1997-1A 1997-1B
----------------------- ------------------- ------------------------
<S> <C> <C> <C>
Type of loan securitized....... Fixed Rate Liberator Adjustable Rate Fixed Rate Liberator
Series and Portfolio Liberator Series Series and Portfolio
Series Series
Weighted average coupon........ 13.32% 9.45% 13.02%
Amount of certificates issued.. $55.0 million $38.5 million $61.5 million
Pass-through rate.............. 6.95% 1 month LIBOR 7.49%
plus 21 bp
Amount of loans
securitized(1)................ $51.9 million $33.6 million $46.5 million
Credit enhancement............. MBIA Insurance MBIA Insurance MBIA Insurance
Corporation Corporation Corporation
Initial funding of reserve
accounts...................... $1.6 million $941,000 $3.1 million
Required reserve level to be
funded........................ 9.0% of original 5.5% of original 10.6% of original
outstanding balance outstanding balance outstanding balance
of loans of loans of loans
Gain on sale of loans.......... $4.3 million $5.7 million(2) $5.7 million(2)
Gain on sale of loans as a
percent of loans sold......... 8.29% 7.12%(2) 7.12%(2)
Estimated prepayment speed..... 17.0% H.E.P.(3) 25.0% C.P.R.(3) 17.0% H.E.P.
Discount factor................ 13.5% 13.5% 13.5%
Annual estimated loss
assumption.................... 1.5% 0.5% 0.5% of Liberator Series
loans;
1.5% of Portfolio Series
loans
Servicing fees................. 0.50% for the first six 0.65% for the first 1.00% on fixed rate
months and 1.00% twelve months and loans sold
thereafter 1.00% thereafter
Rating (S&P/Moody's)........... AAA/Aaa AAA/Aaa AAA/Aaa
</TABLE>
- --------
(1) For 1996-1, an additional $3.1 million was funded during quarter ended
March 31, 1997 which created a gain on sale of loans of $267,000. For
1997-1A, $4.9 million was funded in April 1997. For 1997-1B, $15.0 million
was funded in April 1997. All of these prefunded amounts were sold under
the same terms and conditions as set forth in the table above.
(2) The combined gain on sales of loans for 1997-1A and 1997-1B was $5.7
million. The percentages are based on the combined 1997-1A and 1997-1B
securitization.
(3) Home Equity Prepayment ("H.E.P.") and Constant Prepayment Rate ("C.P.R.")
are methods of estimating prepayment speeds.
Although the Bank will continue to sell whole loans, it plans to sell most
loans in the future through securitizations. Securitizations are expected to
increase the Bank's cash flow thereby allowing the Bank to increase its loan
acquisition and origination volume. Securitizations are also expected to
reduce the risks associated with interest rate fluctuations and provide access
to longer term funding sources. The Bank currently intends to conduct regular
securitizations either through private placements or in public offerings.
There can be
61
<PAGE>
no assurance that the Bank will be able to successfully implement this
strategy in the future. See "Risk Factors--Dependence on Asset Securitizations
and Impact on Quarterly Operating Results."
To the extent that loans are not sold through securitizations, whole loans
will be sold pursuant to purchase, sale and servicing agreements negotiated
with Loan Purchasers to purchase loans meeting the Bank's underwriting
criteria. At March 31, 1997 there were no outstanding commitments to deliver
any specific amount of mortgage loans. The Bank retains the servicing rights
on the majority of loans sold. However, the Bank also sells loans on a
servicing released basis and may continue to subservice the loans for a fee
for a period of time. The Bank sells loans to a number of different investors
with which it does business. As such, management believes that no one
relationship with a Loan Purchaser constitutes the predominant source of sales
for the Bank and the Bank does not rely on any specific entities for sales of
its loans.
COMMERCIAL REAL ESTATE AND MULTI-FAMILY REAL ESTATE LENDING
Consistent with its strategy of developing niche lending markets, the Bank
has recently begun to focus its efforts on the origination and purchase of
multi-family and commercial real estate loans both in its primary market area
and throughout the United States. Specifically, the Bank has begun to target
the market for borrowers seeking loans in the range of $50,000 to $750,000,
subject to the Bank's loans-to-one borrower limit, currently $1.9 million,
which are secured by multi-family properties or properties used for commercial
business purposes such as small office buildings, light industrial or retail
facilities. Since the Bank has been able to acquire such loans at a discount
and expects to be able to continue to acquire such loans at a discount or low
premium, management believes that the origination and subsequent sale of
commercial and multi-family real estate loans will increase the Bank's cash
flow. The Bank has streamlined and standardized its processing and commercial
and multi-family real estate loans with a view to sale in the secondary market
or securitization. Since 1994, substantially all commercial and multi-family
real estate loans originated by the Bank have been sold in the secondary
market without recourse. Although there can be no assurances in this regard,
management intends to gradually expand the operations of this subsidiary,
thereby adding a source of revenue for the Bank as well as providing loans for
future securitizations. There can be no assurances, however, that any such
securitization will be completed in the future. Securitization of commercial
and multi-family real estate loans is significantly less standardized and
streamlined than securitization of one- to four-family residential mortgage
loans.
Management believes that it has the infrastructure in place to safely
diversify its product line into this niche market. Two of the Bank's senior
executive officers, Daniel L. Perl and Joseph R. L. Passerino, have combined
experience of approximately 27 years in commercial and multi-family real
estate lending and have developed substantial relationships with commercial
and multi-family real estate originators throughout the United States. In
addition, the Bank works primarily with a select group of approximately 100
mortgage brokers nationwide with specifically delineated credentials. The Bank
also works with two correspondents and expects to expand that number of
approved correspondents to 15 in the near future. Commercial and multi-family
real estate loan correspondents in the Bank's network must have a net worth of
at least $1.0 million, a two to three year history of funding and servicing
multi-family and commercial real estate loans and errors and omissions
insurance of at least $1.0 million. In addition, an on-site inspection of the
facilities of each of these correspondents is conducted by Mr. Passerino.
Where loans are originated by other than this pre-approved group of
correspondents, the Bank will underwrite the loan. The Bank also works with a
contract appraiser with nationwide experience in appraising commercial and
multi-family real estate loans who appraises or reviews the appraisals on all
such properties.
The Bank's policy is not to make commercial or multi-family real estate
loans to borrowers who are in bankruptcy, foreclosure, have loans more than 30
days delinquent or other combinations of credit weaknesses unacceptable to the
Bank. The Bank targets high to medium credit quality borrowers. The Bank's
underwriting procedures provide that commercial real estate loans may be made
in amounts up to 70% of the appraised value of the property depending on the
borrower's creditworthiness. Multi-family real estate loans may be made in
amounts up to 75% of the appraised value of the property. Commercial real
estate loans and multi-family real estate loans may be either fixed rate or
adjustable rate loans. These loans include prepayment penalties if repaid
within the first three to five years. When evaluating a commercial or multi-
family real estate loan, the Bank considers the net operating income of the
property and the borrower's expertise, credit history and personal cash
62
<PAGE>
flows. The Bank has generally required that the properties securing commercial
real estate and multi-family real estate loans have debt service coverage
ratios (the ratio of net operating income to debt service) of at least 120%.
The largest commercial real estate loan in the Bank's held for sale portfolio
at March 31, 1997 was $558,000 and is secured by a nine unit strip shopping
center located in Redlands, California while the largest multi-family real
estate loan in the Bank's held for sale portfolio at March 31, 1997 was
$713,000 secured by a multi-family property located in Miami, Florida. At
March 31, 1997 the Bank's commercial real estate portfolio was $10.3 million,
or 13.8% of total gross loans, $3.2 million of which were held for sale. The
Bank's multi-family real estate portfolio at that same date was $9.9 million,
or 13.4% of total gross loans, $7.8 million of which were held for sale.
Repayment of multi-family and commercial real estate loans generally is
dependent, in large part, on sufficient income from the property to cover
operating expenses and debt service. The Bank attempts to offset the risks
associated with multi-family and commercial real estate lending by primarily
lending to individuals who will be actively involved in the management of the
property and generally to individuals who have proven management experience,
and by making such loans with lower loan-to-value ratios than one- to four-
family loans. See "Risk Factors--Multi-Family and Commercial Real Estate
Risks."
HISTORICAL AND LOCAL LENDING PORTFOLIO
The Bank's portfolio of loans held for investment (the "historical loan
portfolio") was primarily originated prior to 1994. Such loans generally
consist of adjustable rate one- to four-family loans and adjustable rate
multi-family and commercial real estate loans. The Bank's gross historical
loan portfolio has decreased in size from $48.0 million at December 31, 1994
to $38.5 million at December 31, 1996 and was $36.5 million at March 31, 1997.
The largest loan in the Bank's held for investment portfolio at March 31, 1997
was $590,000 secured by a hotel located in San Bernardino, California. At
March 31, 1997, substantially all of the Bank's historical loan portfolio was
secured by properties located in California. For a discussion of loss
experience or the historical and local lending portfolio, see "--Lending
Overview--Allowance for Loan Losses" and "--Non-Accrual and Past Due Loans."
As part of the Bank's ongoing Community Reinvestment Act commitment to the
Southern California area, and more specifically the Inland Empire region, the
Bank has committed to lend and invest $2.5 million through December 31, 1997,
designated as investments in Community Development. This investment in the
local community may be used for (i) lending for home improvement in low to
moderate income areas on one- to four-family residential properties, (ii)
providing redevelopment loans to facilitate the rehabilitation of residential
properties in the low to moderate income areas, (iii) investing in government
bonds which are designated for the purpose of redeveloping low to moderate
income areas, or (iv) participating in programs that provide housing in low to
moderate income areas, including through the Savings Association Mortgage
Company, Inc. ("SAMCO") consortium. Similar commitments are expected to be
made by the Bank in the future.
CONSUMER AND OTHER LENDING
The Bank's consumer and other loans generally consist of overdraft lines of
credit, commercial business loans and unsecured personal loans. At March 31,
1997, the Bank's consumer and other loan portfolio was $3.5 million or 4.8% of
total gross loans. Of this amount, $3.3 million consisted of unsecured home
improvement loans purchased from a single originator in March, 1997. These
loans were purchased as part of management's evaluation of new product lines
for possible future growth.
LOAN SERVICING
Through December 31, 1993, the Bank's loan servicing portfolio consisted
solely of loans originated directly by the Bank and retained for investment or
sold, primarily as participations, to others. Commencing in January of 1994
through June of 1995, the Bank purchased servicing rights to FNMA and FHLMC
loans in order to expand the size of its loan servicing department and to
further develop its loan servicing capabilities. The entire FHLMC servicing
portfolio was resold in December 1995. Effective July 1, 1995, with the
adoption of SFAS No. 122, which required the Bank to capitalize the value of
originated mortgage servicing rights, the Bank began to retain substantially
all servicing rights on loans sold. In addition, the Bank intends to retain
the servicing
63
<PAGE>
rights to the loans it securitizes. The pooling and servicing agreements
related to the securitizations completed in the fourth quarter of 1996 and the
first quarter of 1997 contain provisions with respect to the maximum permitted
loan delinquency rates and loan default rates which, if exceeded, would allow
the termination of the Bank's right to service the related loans. See "Risk
Factors--Risks Related to Mortgage Servicing Rights." Servicing rights with an
allocated fair value of $722,000 and $1.6 million were retained in the
securitizations completed during the fourth quarter of 1996 and the first
quarter of 1997, respectively. At March 31, 1997, the Bank serviced $316.6
million of loans of which $242.3 million were serviced for others.
The loan servicing and collections department has increased in size from
four persons at December 31, 1994 to 16 persons at March 31, 1997. Within this
department, personnel have experience in both sub-prime lending and also in
managing the Bank's non-performing loans in its historical local lending
portfolio. This experience was gained in part during the economic downturn in
Southern California and resulted in a low loss experience for the Bank. See
"--Lending Overview--Allowance for Loan Losses." In addition, in December
1996, the Bank hired a department head with more than 24 years of experience
in loan servicing and collections, including responsibility for a $10.0
billion portfolio of approximately 255,000 loans and a staff of 70 people.
Substantial space in the existing Riverside, California facility will be
allocated to the loan servicing and collections operations upon the opening of
the additional Riverside facility and the transfer of the origination and
administrative functions to these facilities during the third quarter of 1997.
In order to provide the infrastructure to increase productivity, the Bank is
in the process of enhancing its computer and telephonic systems by adding
imaging, which creates an image of each document in a loan file accessible
through the Bank's wide area network, and power dialing, respectively. These
new systems are expected to be implemented by year end.
The Bank's loan servicing activities include (i) the collection and
remittance of mortgage loan payments, (ii) accounting for principal and
interest and other collections and expenses, (iii) holding and disbursing
escrow or impounding funds for real estate taxes and insurance premiums, (iv)
inspecting properties when appropriate, (v) contacting delinquent borrowers,
and (vi) acting as fiduciary in foreclosing and disposing of collateral
properties. The Bank receives a servicing fee for performing these services
for others.
While most of the Bank's servicing portfolio is generated through its
origination and purchase activities, when economically attractive, the Bank
has, from time to time, made bulk purchases of mortgage servicing rights from
financial institutions. The Bank does not intend to make significant bulk
purchases of servicing rights in the near future but may do so depending on
market opportunities. The mortgage loans underlying the servicing rights
retained by the Bank have been historically underwritten by the Bank. These
servicing rights were either originated by mortgage brokers or purchased
through various programs from correspondents or junior correspondents. The
costs to acquire servicing are based on the present value of the estimated
future servicing revenues, net of the expected servicing expenses, for each
acquisition. Major factors impacting the value of servicing rights include
contractual service fee rates, projected mortgage prepayment speed, projected
delinquencies and foreclosures, projected escrow, agency and fiduciary funds
to be held in connection with such servicing and the projected benefit to be
realized from such funds. See "Risk Factors--Risks Related to Mortgage
Servicing Rights."
In addition to weekly loan delinquency meetings which are attended by
members of senior management, the loan committee of the Board of Directors
generally performs a monthly review of all delinquent loans 90 days or more
past due. In addition, management reviews on an ongoing basis all delinquent
loans. The procedures taken by the Bank with respect to delinquencies vary
depending on the nature of the loan and period of delinquency. When a borrower
fails to make a required payment on a loan, the Bank takes a number of steps
to have the borrower cure the delinquency and restore the loan to current
status. The Bank generally sends the borrower a written notice of non-payment
within ten days after the loan is first past due. In the event payment is not
then received, additional letters and phone calls generally are made. If the
loan is still not brought current, the Bank generally sends a notice of the
intent to foreclose 25 days after the loan is first past due. If the borrower
does not cure the delinquency and it becomes necessary for the Bank to take
legal action, which typically occurs after a loan is delinquent at least 30
days or more, the Bank will commence foreclosure proceedings against any
64
<PAGE>
real property that secures the loan. If a loan remains delinquent on the 45th
day, a property inspection will be made to verify occupancy, determine the
condition of the property and as an attempt to contact the borrower in person.
If a foreclosure action is instituted and the loan is not brought current,
paid in full, or refinanced before the foreclosure sale, the real property
securing the loan generally is sold at foreclosure. The Bank's procedures for
repossession and sale of consumer collateral are subject to various
requirements under state consumer protection laws.
Regulation and practices in the United States regarding the liquidation of
properties (e.g., foreclosure) and the rights of the mortgagor in default vary
greatly from state to state. Loans originated or purchased by the Bank are
secured by mortgages, deeds of trust, trust deeds, security deeds or deeds to
secure debt, depending upon the prevailing practice in the state in which the
property securing the loan is located. Depending on local law, foreclosure is
effected by judicial action and/or non-judicial sale, and is subject to
various notice and filing requirements. If foreclosure is effected by judicial
action, the foreclosure proceedings may take several months.
In general, the borrower, or any person having a junior encumbrance on the
real estate, may cure a monetary default by paying the entire amount in
arrears plus other designated costs and expenses incurred in enforcing the
obligation during a statutorily prescribed reinstatement period. Generally,
state law controls the amount of foreclosure expenses and costs, including
attorneys' fees, which may be recovered by a lender.
There are a number of restrictions that may limit the Bank's ability to
foreclose on a property. A lender may not foreclose on the property securing a
junior mortgage loan unless it forecloses subject to each senior mortgage, in
which case the junior lender or purchaser at such a foreclosure sale will take
title to the property subject to the lien securing the amount due on the
senior mortgage. Moreover, if a borrower has filed for bankruptcy protection,
a lender may be stayed from exercising its foreclosure rights. Also, certain
states provide a homestead exemption that may restrict the ability of a lender
to foreclose on residential property.
Credit Quality of Servicing Portfolio. The following table illustrates the
Bank's delinquency and default experience with respect to its loan servicing
portfolio:
<TABLE>
<CAPTION>
AT MARCH 31, 1997 AT DECEMBER 31,
--------------------------------------- ---------------------------------------------------------------------
1996 1995
--------------------------------------- -----------------------------
NUMBER OF % OF % OF NUMBER OF % OF % OF NUMBER OF % OF
LOANS/ LOANS PRINCIPAL SERVICING LOANS/ LOANS PRINCIPAL SERVICING LOANS/ LOANS PRINCIPAL
PROPERTIES SERVICED BALANCE PORTFOLIO PROPERTIES SERVICED BALANCE PORTFOLIO PROPERTIES SERVICED BALANCE
---------- -------- --------- --------- ---------- -------- --------- --------- ---------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Delinquency
percentage(1)(2)
30-59 days...... 22 0.35% $1,490 0.46% 10 0.26% $ 860 0.36% 22 0.74% $2,118
60-89 days...... 1 0.02 92 0.03 -- -- -- -- 9 0.30 482
90 days and
over........... 3 0.05 143 0.05 3 0.08 143 0.06 10 0.33 762
--- ---- ------ ---- --- ---- ------ ---- --- ---- ------
Total
delinquency.... 26 0.42% $1,725 0.54% 13 0.34% $1,003 0.42% 41 1.37% $3,362
=== ==== ====== ==== === ==== ====== ==== === ==== ======
Default
percentage(3)
Foreclosure..... 59 0.95% $6,244 1.96% 56 1.48% $6,279 2.64% 7 0.23% $ 793
Bankruptcy...... 17 0.27 1,220 0.39 9 0.24 778 0.33 2 0.07 288
Real estate
owned(4)....... 13 0.21 1,508 0.48 9 0.24 1,197 0.50 8 0.27 1,221
--- ---- ------ ---- --- ---- ------ ---- --- ---- ------
Total default..... 89 1.43% $8,972 2.83% 74 1.96% $8,254 3.47% 17 0.57% $2,301
=== ==== ====== ==== === ==== ====== ==== === ==== ======
<CAPTION>
At
December
31,
---------
1995
---------
% OF
SERVICING
PORTFOLIO
---------
<S> <C>
Delinquency
percentage(1)(2)
30-59 days...... 0.83%
60-89 days...... 0.19
90 days and
over........... 0.30
----
Total
delinquency.... 1.32%
====
Default
percentage(3)
Foreclosure..... 0.32%
Bankruptcy...... 0.11
Real estate
owned(4)....... 0.48
----
Total default..... 0.91%
====
</TABLE>
- -------
(1) The delinquency percentage represents the number and outstanding principal
balance of loans for which payments are contractually past due, exclusive
of loans in foreclosure, bankruptcy, real estate owned or forbearance.
(2) The past due period is based on the actual number of days that a payment
is contractually past due. A loan as to which a monthly payment was due
60-89 days prior to the reporting period is considered 60-89 days past
due, etc.
(3) The default percentage represents the number and outstanding principal
balance of loans in foreclosure, bankruptcy or real estate owned.
(4) An "REO Property" is a property acquired and held as a result of
foreclosure or deed in lieu of foreclosure.
65
<PAGE>
LENDING OVERVIEW
Loan Portfolio Composition. At March 31, 1997, the Bank's gross loans
outstanding totalled $74.3 million, of which $37.8 million, or 50.9%, were
held for sale and $36.5 million, or 49.1%, were held for investment. The types
of loans that the Bank may originate are subject to federal and state law and
regulations. Interest rates charged by the Bank on loans are affected by the
demand for such loans and the supply of money available for lending purposes
and the rates offered by competitors. These factors are, in turn, affected by,
among other things, economic conditions, monetary policies of the federal
government, including the Federal Reserve Board, and legislative tax policies.
The following table sets forth the composition of the Bank's loan portfolio
in dollar amounts and as a percentage of the portfolio at the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31,
-------------------------------------------------------------------------------------
AT MARCH 31,
1997 1996 1995 1994 1993 1992
---------------- ---------------- ---------------- --------------- --------------- ---------------
PERCENT PERCENT PERCENT PERCENT PERCENT PERCENT
OF OF OF OF OF OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate(1):
Residential:
One- to four-
family............. $50,543 68.02% $54,275 78.67% $54,007 84.04% $53,755 82.62% $55,841 83.01% $53,816 81.68%
Multi-family....... 9,939 13.37 4,752 6.89 2,412 3.75 2,685 4.12 2,296 3.41 2,338 3.55
Commercial and
land............... 10,286 13.84 9,659 14.00 7,522 11.71 8,131 12.50 8,389 12.47 8,930 13.55
Other loans:
Loans secured by
deposit accounts... 156 0.21 177 0.25 186 0.29 213 0.33 396 0.59 381 0.58
Unsecured
commercial loans... 66 0.09 67 0.10 70 0.11 197 0.30 190 0.28 224 0.34
Unsecured consumer
loans.............. 3,321 4.47 65 0.09 63 0.10 84 0.13 162 0.24 200 0.30
------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total gross
loans............ 74,311 100.00% 68,995 100.00% 64,260 100.00% 65,065 100.00% 67,274 100.00% 65,889 100.00%
------- ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Less (plus):
Deferred loan
origination (costs)
fees and
(premiums)
discounts.......... (457) (543) (298) 56 109 209
Allowance for
estimated loan
losses............. 1,801 1,625 1,177 832 436 308
------- ------- ------- ------- ------- -------
Loans receivable,
net.............. $72,967 $67,913 $63,381 $64,177 $66,729 $65,372
======= ======= ======= ======= ======= =======
</TABLE>
- ----
(1) Includes second trust deeds.
66
<PAGE>
Loan Maturity. The following table shows the contractual maturity of the
Bank's gross loans at March 31, 1997. There were $38.3 million of loans held
for sale at March 31, 1997. The table does not reflect prepayment assumptions.
<TABLE>
<CAPTION>
AT MARCH 31, 1997
-----------------------------------------------
TOTAL
ONE- TO MULTI- COMMERCIAL OTHER LOANS
FOUR-FAMILY FAMILY AND LAND LOANS RECEIVABLE
----------- ------ ---------- ------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Amounts due:
One year or less.............. $ 611 $ -- $ 917 $ 247 $ 1,775
After one year:
More than one year to three
years....................... 954 -- 341 293 1,588
More than three years to five
years....................... 546 683 2,881 1,641 5,751
More than five years to 10
years....................... 1,110 275 1,775 1,362 4,522
More than 10 years to 20
years....................... 13,979 961 1,088 -- 16,028
More than 20 years........... 33,343 8,020 3,284 -- 44,647
------- ------ ------- ------ -------
Total amount due........... 50,543 9,939 10,286 3,543 74,311
Less (plus):
Unamortized discounts
(premiums), net............. (571) -- -- -- (571)
Deferred loan origination
fees (costs)................ (35) 106 43 -- 114
Allowance for estimated loan
losses...................... 1,344 66 150 241 1,801
------- ------ ------- ------ -------
Total loans, net........... 49,805 9,767 10,093 3,302 72,967
Loans held for sale, net..... 24,207 7,723 3,137 3,229 38,296
------- ------ ------- ------ -------
Loans held for investment,
net......................... $25,598 $2,044 $ 6,956 $ 73 $34,671
======= ====== ======= ====== =======
</TABLE>
The following table sets forth at March 31, 1997, the dollar amount of gross
loans receivable contractually due after March 31, 1998, and whether such
loans have fixed interest rates or adjustable interest rates. The Bank
adjustable-rate mortgage loans require that any payment adjustment resulting
from a change in the interest rate be made to both the interest and payment in
order to result in full amortization of the loan by the end of the loan term,
and thus, do not permit negative amortization.
<TABLE>
<CAPTION>
DUE AFTER MARCH 31, 1998
--------------------------
FIXED ADJUSTABLE TOTAL
------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Real estate loans:
Residential:
One- to four-family............................ $19,399 $30,533 $49,932
Multi-family................................... 1,236 8,703 9,939
Commercial and land............................. 593 8,776 9,369
Other loans..................................... 3,296 -- 3,296
------- ------- -------
Total gross loans receivable................. $24,524 $48,012 $72,536
======= ======= =======
</TABLE>
67
<PAGE>
The following tables set forth the Bank's loan originations, purchases,
sales and principal repayments for the periods indicated:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR
ENDED MARCH 31, THE YEAR ENDED DECEMBER 31,
--------------------- -----------------------------
1997 1996 1996 1995 1994
---------- ---------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Gross loans(1):
Beginning balance......... $ 68,995 $ 64,260 $ 64,260 $ 65,065 $ 67,274
Loans originated:
One- to four-family(2).. 52,961 16,722 100,745 38,259 34,740
Multi-family............ 5,220 550 2,976 -- 85
Commercial and land..... 779 3,050 7,172 -- 266
Other loans............. 50 40 126 358 452
---------- ---------- --------- --------- ---------
Total loans
originated........... 59,010 20,362 111,019 38,617 35,543
Loans purchased(3)....... 33,180 30,566 111,534 96,155 37,272
---------- ---------- --------- --------- ---------
Total................. 161,185 115,188 286,813 199,837 140,089
Less:
Principal repayments..... 2,854 1,976 9,184 6,719 7,440
Sales of loans........... -- 37,838 154,620 126,875 65,713
Securitizations of
loans................... 83,174 -- 51,944 -- --
Transfer to REO.......... 846 700 2,070 1,983 1,871
---------- ---------- --------- --------- ---------
Total loans........... 74,311 74,674 68,995 64,260 65,065
Loans held for sale...... 37,819 32,761 30,454 21,397 17,097
---------- ---------- --------- --------- ---------
Ending balance loans held
for investment........... $ 36,492 $ 41,913 $ 38,541 $ 42,863 $ 47,968
========== ========== ========= ========= =========
</TABLE>
- --------
(1) Gross loans includes loans held for investment and loans held for sale.
(2) Includes second trust deeds.
(3) Loans purchased consist predominantly of one- to four-family residential
Liberator Series and Portfolio Series loans.
Delinquencies and Classified Assets. Federal regulations and the Bank's
Classification of Assets Policy require that the Bank utilize an internal
asset classification system as a means of reporting problem and potential
problem assets. The Bank has incorporated the OTS internal asset
classifications as a part of its credit monitoring system. The Bank currently
classifies problem and potential problem assets as "Substandard," "Doubtful"
or "Loss" assets. An asset is considered "Substandard" if it is inadequately
protected by the current net worth and paying capacity of the obligor or of
the collateral pledged, if any. "Substandard" assets include those
characterized by the "distinct possibility" that the insured institution will
sustain "some loss" if the deficiencies are not corrected. Assets classified
as "Doubtful" have all of the weaknesses inherent in those classified
"Substandard" with the added characteristic that the weaknesses present make
"collection or liquidation in full," on the basis of currently existing facts,
conditions, and values, "highly questionable and improbable." Assets
classified as "Loss" are those considered "uncollectible" and of such little
value that their continuance as assets without the establishment of a specific
loss allowance is not warranted. Assets which do not currently expose the
insured institution to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are required to be designated
"Special Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, under current OTS policy the Bank is
required to consider establishing a general valuation allowance in an amount
deemed prudent by management. The general valuation allowance, which is a
regulatory term, represents a loss allowance which has been established to
recognize the inherent credit risk associated with lending and investing
activities, but which, unlike specific allowances, has not been allocated to
particular problem assets.
68
<PAGE>
When an insured institution classifies one or more assets, or portions
thereof, as "Loss," it is required either to establish a specific allowance
for losses equal to 100% of the amount of the asset so classified or to charge
off such amount.
A savings institution's determination as to the classification of its assets
and the amount of its valuation allowances is subject to review by the OTS
which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment
of adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation allowances. Generally, the
policy statement recommends that institutions have effective systems and
controls to identify, monitor and address asset quality problems; that
management has analyzed all significant factors that affect the collectibility
of the portfolio in a reasonable manner; and that management has established
acceptable allowance evaluation processes that meet the objectives set forth
in the policy statement. As a result of the declines in local and regional
real estate market values and the significant losses experienced by many
financial institutions, there has been a greater level of scrutiny by
regulatory authorities of the loan portfolios of financial institutions
undertaken as part of the examination of institutions by the OTS and the FDIC.
While the Bank believes that it has established an adequate allowance for
estimated loan losses, there can be no assurance that regulators, in reviewing
the Bank's loan portfolio, will not request the Bank to materially increase at
that time its allowance for estimated loan losses, thereby negatively
affecting the Bank's financial condition and earnings at that time. Although
management believes that an adequate allowance for estimated loan losses has
been established, actual losses are dependent upon future events and, as such,
further additions to the level of allowances for estimated loan losses may
become necessary.
The Bank's Internal Asset Review Committee reviews and classifies the Bank's
assets quarterly and reports the results of its review to the Board of
Directors. The Bank classifies assets in accordance with the management
guidelines described above. REO is classified as Substandard. The following
table sets forth information concerning loans, REO and total assets classified
as substandard at March 31, 1997. At March 31, 1997 the Bank had $2.2 million
of assets classified as Special Mention, $4.0 million of assets classified as
Substandard, no assets classified as Doubtful and $456,000 of assets
classified as Loss. As of March 31, 1997, assets classified as Special Mention
include 19 loans totalling $1.7 million secured by one- to four-family
residential properties. At March 31, 1997, the largest loan classified as
Special Mention had a loan balance of $301,000 and is secured by commercial
real estate. As set forth below, as of March 31, 1997, assets classified as
Substandard, Doubtful and Loss include 43 loans totalling $3.2 million.
<TABLE>
<CAPTION>
AT MARCH 31, 1997
---------------------------------------------------------------------------------
TOTAL SUBSTANDARD,
LOANS REO DOUBTFUL AND LOSS ASSETS
------------------------- ----------------------------- -------------------------
NUMBER NUMBER
GROSS NET OF GROSS NET NUMBER OF GROSS NET OF
BALANCE BALANCE(1) LOANS BALANCE BALANCE(1) PROPERTIES BALANCE BALANCE(1) ASSETS
------- ---------- ------ ------- ---------- ---------- ------- ---------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential:
One- to four-family.... $3,026 $2,607 40 $1,266 $1,183 11 $4,292 $3,790 51
Multi-family........... 45 45 1 -- -- -- 45 45 1
Commercial and land..... 131 131 1 -- -- -- 131 131 1
Other loans............. 10 -- 1 -- -- -- 10 -- 1
------ ------ --- ------ ------ --- ------ ------ ---
Total loans............ $3,212 $2,783 43 $1,266 $1,183 11 $4,478 $3,966 54
====== ====== === ====== ====== === ====== ====== ===
</TABLE>
- --------
(1) Net balances are reduced for specific loss allowances established against
substandard loans and real estate.
Non-Accrual and Past-Due Loans. The following table sets forth information
regarding non-accrual loans, troubled-debt restructurings and REO in the
Bank's loans held for investment. There was one troubled-debt restructured
loan within the meaning of SFAS 15, and eleven REO properties at March 31,
1997. Until March 31, 1996 it was the policy of the Bank to cease accruing
interest on loans at the time foreclosure proceedings
69
<PAGE>
commenced, which typically occurred when a loan is 45 days past due or
possibly longer depending on the circumstances, which period will not exceed
90 days past due. Subsequent to March 31, 1996, the Bank adopted a policy to
cease accruing interest on loans 90 days or more past due. For the three
months ended March 31, 1997 and 1996 and the years ended December 31, 1996,
1995, 1994, 1993 and 1992, respectively, the amount of interest income that
would have been recognized on nonaccrual loans if such loans had continued to
perform in accordance with their contractual terms was $53,000, $41,000,
$150,000, $66,000, $106,000, $117,000 and $84,000, none of which was
recognized. For the same periods, the amount of interest income recognized on
troubled debt restructurings was $0, $3,000, $12,000, $11,000, $10,000,
$1,000, and $0.
<TABLE>
<CAPTION>
AT MARCH 31, AT DECEMBER 31,
-------------- --------------------------------------
1997 1996 1996 1995 1994 1993 1992
------ ------ ------ ------ ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Non-accrual loans:
Residential real
estate:
One- to four-
family............. $1,683 $2,226 $2,361 $1,305 $1,766 $1,919 $1,606
Multi-family........ 45 -- 45 -- -- -- --
Commercial and land... -- -- -- 82 78 197 283
Other loans........... 10 -- 10 10 45 62 2
------ ------ ------ ------ ------ ------ ------
Total............... 1,738 2,226 2,416 1,397 1,889 2,178 1,891
REO, net(1)............. 1,183 975 561 827 555 1,772 1,377
------ ------ ------ ------ ------ ------ ------
Total non-performing
assets............. $2,921 $3,201 $2,977 $2,224 $2,444 $3,950 $3,268
====== ====== ====== ====== ====== ====== ======
Restructured loans...... $ 131 $ 131 $ 131 $ 131 $ -- $ 15 $ --
Classified assets,
gross.................. 4,478 3,923 4,829 3,929 3,951 4,165 4,827
Allowance for estimated
loan losses as a
percent of gross loans
receivable(2).......... 2.42% 1.57% 2.36% 1.83% 1.28% 0.65% 0.47%
Allowance for estimated
loan losses as a
percent of total non-
performing loans(3).... 103.62 52.65 67.26 84.25 44.04 20.02 16.29
Non-performing loans as
a percent of gross
loans
receivable(2)(3)....... 2.34 2.98 3.50 2.17 2.90 3.24 2.87
Non-performing assets as
a percent of total
assets(3).............. 1.85 3.69 2.86 3.00 3.42 5.05 4.15
</TABLE>
- --------
(1) REO balances are shown net of related loss allowances.
(2) Gross loans includes loans receivable held for investment and loans
receivable held for sale.
(3) Non-performing assets consist of non-performing loans and REO. Prior to
April 1, 1996, non-performing loans consisted of all loans 45 days or more
past due and all other non-accrual loans. Following March 31, 1996, non-
performing loans consisted of all loans 90 days or more past due and all
other non-accrual loans.
70
<PAGE>
The following table sets forth delinquencies in the Bank's loan portfolio as
of the dates indicated:
<TABLE>
<CAPTION>
AT MARCH 31, 1997 AT DECEMBER 31, 1996
--------------------------------- ---------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
---------------- ---------------- ---------------- ----------------
NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS
------ --------- ------ --------- ------ --------- ------ ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family..... 2 $198 21 $1,683 3 $354 21 $2,361
Multi-family............ -- -- 1 45 -- -- 1 45
Commercial and land..... 1 131 -- -- -- -- -- --
Other loans............. -- -- 1 10 -- -- 1 10
--- ---- --- ------ --- ---- --- ------
Total................. 3 $329 23 $1,738 3 $354 23 $2,416
=== ==== === ====== === ==== === ======
Delinquent loans to
total gross loans...... 0.44% 2.34% 0.51% 3.50%
==== ====== ==== ======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1995 AT DECEMBER 31, 1994
--------------------------------- ---------------------------------
60-89 DAYS 90 DAYS OR MORE 60-89 DAYS 90 DAYS OR MORE
---------------- ---------------- ---------------- ----------------
NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL NUMBER PRINCIPAL
OF BALANCE OF BALANCE OF BALANCE OF BALANCE
LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS LOANS OF LOANS
------ --------- ------ --------- ------ --------- ------ ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family..... 8 $446 13 $1,286 5 $375 8 $1,728
Multi-family............ -- -- -- -- -- -- -- --
Commercial and land..... -- -- -- -- -- -- 1 77
Other loans............. -- -- 1 10 -- -- -- --
--- ---- --- ------ --- ---- --- ------
Total................. 8 $446 14 $1,296 5 $375 9 $1,805
=== ==== === ====== === ==== === ======
Delinquent loans to
total gross loans...... 0.69% 2.01% 0.58% 2.78%
==== ====== ==== ======
</TABLE>
71
<PAGE>
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in its loan portfolio and the general economy. The allowance
for loan losses is maintained at an amount management considers adequate to
cover estimated losses in loans receivable which are deemed probable and
estimable. The allowance is based upon a number of factors, including current
economic conditions, actual loss experience and industry trends. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to make additional provisions for loan losses based upon
information available at the time of the review. As of March 31, 1997, the
Bank's allowance for loan losses was 2.42% of gross loans compared to 2.36% as
of December 31, 1996. The Bank had non-accrual loans of $1.7 million and $2.4
million at March 31, 1997 and December 31, 1996, respectively. The Bank will
continue to monitor and modify its allowances for loan losses as conditions
dictate.
The following table sets forth activity in the Bank's allowance for loan
losses for the periods set forth in the table.
<TABLE>
<CAPTION>
AT OR FOR THE
THREE MONTHS
ENDED
MARCH 31, AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------- -------------------------------------------
1997 1996 1996 1995 1994 1993 1992
------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at beginning of
period................. $ 1,625 $ 1,177 $ 1,177 $ 832 $ 436 $ 308 $ 299
Provision for loan
losses................. 500 68 963 1,194 1,306 404 129
Charge-offs:
Real Estate:
One- to four-
family............. 332 63 668 736 771 301 60
Multi-family........ -- -- 45 -- -- -- --
Commercial and
land............... -- -- 11 111 47 -- --
Other loans........... -- 10 10 67 95 -- 60
------- ------- ------- ------- ------- ------- -------
Total............. 332 73 734 914 913 301 120
Recoveries.............. 8 -- 219 65 3 25 --
------- ------- ------- ------- ------- ------- -------
Balance at end of
period................. $ 1,801 $ 1,172 $ 1,625 $ 1,177 $ 832 $ 436 $ 308
======= ======= ======= ======= ======= ======= =======
Average net loans
outstanding............ $98,890 $72,916 $72,556 $65,521 $65,566 $68,511 $62,522
Net charge-offs to
average net loans
outstanding............ 0.33% 0.10% 0.71% 1.30% 1.39% 0.40% 0.19%
</TABLE>
72
<PAGE>
The following table sets forth the amount of the Bank's allowance for loan
losses, the percent of allowance for loan losses to total allowance and the
percent of gross loans to total gross loans in each of the categories listed
at the dates indicated.
<TABLE>
<CAPTION>
AT MARCH 31,
-------------------------------------------------------
1997 1996
--------------------------- ---------------------------
PERCENT OF PERCENT OF
GROSS GROSS
LOANS IN LOANS IN
PERCENT EACH PERCENT EACH
OF CATEGORY OF CATEGORY
ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL
TO TOTAL GROSS TO TOTAL GROSS
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ --------- ---------- ------ --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
One- to four-family..... $1,353 75.12% 68.02% $ 967 82.51% 81.54%
Multi-family............ 66 3.66 13.37 18 1.54 4.01
Commercial
and land................ 150 8.33 13.84 178 15.18 14.04
Other................... 232 12.89 4.77 9 0.77 0.41
------ ------ ------ ------ ------ ------
Total allowance for
loan losses........... $1,801 100.00% 100.00% $1,172 100.00% 100.00%
====== ====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------------------------------------------------
1996 1995 1994
------------------------- ------------------------- -------------------------
PERCENT PERCENT PERCENT
OF GROSS OF GROSS OF GROSS
LOANS IN LOANS IN LOANS IN
PERCENT EACH PERCENT EACH PERCENT EACH
OF CATEGORY OF CATEGORY OF CATEGORY
ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL
TO TOTAL GROSS TO TOTAL GROSS TO TOTAL GROSS
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ --------- -------- ------ --------- -------- ------ --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-
family........... $1,462 89.97% 78.67% $1,001 85.05% 84.04% $604 72.60% 82.62%
Multi-family..... 20 1.23 6.89 14 1.19 3.75 10 1.20 4.12
Commercial
and land......... 124 7.63 14.00 143 12.15 11.71 164 19.71 12.50
Other............ 19 1.17 0.44 19 1.61 0.50 54 6.49 0.76
------ ------ ------ ------ ------ ------ ---- ------ ------
Total allowance
for loan
losses.......... $1,625 100.00% 100.00% $1,177 100.00% 100.00% $832 100.00% 100.00%
====== ====== ====== ====== ====== ====== ==== ====== ======
<CAPTION>
----------------------------------------------------
1993 1992
------------------------- -------------------------
PERCENT PERCENT
OF GROSS OF GROSS
LOANS IN LOANS IN
PERCENT EACH PERCENT EACH
OF CATEGORY OF CATEGORY
ALLOWANCE TO TOTAL ALLOWANCE TO TOTAL
TO TOTAL GROSS TO TOTAL GROSS
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ --------- -------- ------ --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
One- to four-
family........... $287 65.83% 83.01% $225 73.05% 81.68%
Multi-family..... 10 2.29 3.41 6 1.95 3.55
Commercial
and land......... 98 22.48 12.47 57 18.51 13.55
Other............ 41 9.40 1.11 20 6.49 1.22
---- ------ ------ ---- ------ ------
Total allowance
for loan
losses.......... $436 100.00% 100.00% $308 100.00% 100.00%
==== ====== ====== ==== ====== ======
</TABLE>
73
<PAGE>
REO
At March 31, 1997, the Bank had $1.2 million of REO, net of allowances. Real
estate properties acquired through or in lieu of loan foreclosure are
initially recorded at the lower of fair value or the balance of the loan at
the date of foreclosure through a charge to the allowance for estimated loan
losses. After foreclosure, valuations are periodically performed by management
and an allowance for losses is established by a charge to operations if the
carrying value of a property exceeds its fair value less estimated cost to
sell. It is the policy of the Bank to obtain an appraisal on all REO at the
time of possession and every six months thereafter.
INVESTMENT ACTIVITIES
Federally chartered savings institutions, such as the Bank, have the
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various federal agencies, certificates of
deposit of insured banks and savings institutions, bankers' acceptances, and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-
grade corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Bank must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations. See
"Regulation--Federal Savings Institution Regulation--Liquidity." Historically,
the Bank has maintained liquid assets above the minimum OTS requirements and
at a level considered to be adequate to meet its normal daily activities.
The investment policy of the Bank as established by the Board of Directors
attempts to provide and maintain liquidity, generate a favorable return on
investments without incurring undue interest rate and credit risk, and
complement the Bank's lending activities. Specifically, the Bank's policies
generally limit investments to government and federal agency-backed securities
and non-government guaranteed securities, including corporate debt
obligations, that are investment grade. The Bank's policies provide the
authority to invest in marketable equity securities meeting the Bank's
guidelines and in mortgage-backed securities guaranteed by the U.S. government
and agencies thereof and other financial institutions.
At March 31, 1997 the Bank had $9,000 in its mortgage-backed securities
portfolio, all of which were insured or guaranteed by the FHLMC and are being
held-to-maturity. The Bank may increase its investment in mortgage-backed
securities in the future depending on its liquidity needs and market
opportunities. Investments in mortgage-backed securities involve a risk that
actual prepayments will be greater than estimated prepayments over the life of
the security which may require adjustments to the amortization of any premium
or accretion of any discount relating to such instruments thereby reducing the
net yield on such securities. There is also reinvestment risk associated with
the cash flows from such securities. In addition, the market value of such
securities may be adversely affected by changes in interest rates.
At March 31, 1997, the residual assets, which resulted from the Bank's asset
securitizations conducted during the fourth quarter of 1996 and the first
quarter of 1997, of $12.5 million were classified as trading securities. For
regulatory reasons, the residual assets and restricted cash will be sold to
Life Investment Holdings immediately following the Public Offering. Future
residuals and related assets generated by asset securitizations will be held
by the Bank only until they can be sold to Life Investment Holdings or
disposed of in some other transaction. The residual assets and any future
residuals generated by future asset securitizations and held by the Company
will be marked to market on a quarterly basis with unrealized gains and losses
recorded in operations. See "Risk Factors--Dependence on Asset Securitizations
and Impact on Quarterly Operating Results" and "--Loan Sales and Asset
Securitizations."
74
<PAGE>
The following table sets forth certain information regarding the carrying
and fair values of the Bank's securities at the dates indicated. There were no
securities available-for-sale at the dates indicated:
<TABLE>
<CAPTION>
AT DECEMBER 31,
AT MARCH 31, -----------------------------------------------
1997 1996 1995 1994
--------------- --------------- --------------- ---------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE VALUE VALUE
-------- ------ -------- ------ -------- ------ -------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities:
Held-to-maturity:
U.S. Treasury and
other agency
securities........ $9,012 $8,980 $8,827 $8,785 $2,689 $2,689 $2,846 $2,838
FHLMC.............. 9 10 10 10 11 11 13 13
------ ------ ------ ------ ------ ------ ------ ------
Total securities
held-to-
maturity........ $9,021 $8,990 $8,837 $8,795 $2,700 $2,700 $2,859 $2,851
====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Bank's securities as
of March 31, 1997. There were no securities available for sale at March 31,
1997.
<TABLE>
<CAPTION>
AT MARCH 31, 1997
-----------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE
YEAR TO FIVE YEARS TO TEN MORE THAN TEN
ONE YEAR OR LESS YEARS YEARS YEARS TOTAL
----------------- ----------------- ----------------- ----------------- -----------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities:
Held-to-maturity:
U.S. Treasury and
other agency
securities............ $4,006 5.78% $4,008 6.06% $-- -- % $-- -- % $8,014 5.92%
FHLMC.................. -- -- -- 9 6.88 9 6.88
------ ------ ---- ---- ------
Total held-to-
maturity............ 4,006 5.78 4,008 6.06% -- 9 6.88% 8,023 5.92%
FHLB stock............. 998 -- -- -- 998
------ ------ ---- ---- ------
Total securities
held-to-maturity.... $5,004 $4,008 $-- $ 9 $9,021
====== ====== ==== ==== ======
</TABLE>
75
<PAGE>
SOURCES OF FUNDS
General. Deposits, loan repayments and prepayments, proceeds from sales and
securitization of loans, cash flows generated from operations and borrowings
are the primary sources of the Bank's funds for use in lending, investing and
for other general purposes.
Deposits. The Bank offers a variety of deposit accounts with a range of
interest rates and terms. The Bank's deposits consist of passbook savings,
checking accounts, money market savings accounts and certificates of deposit.
For the three months ended March 31, 1997, certificates of deposit constituted
83.6% of total average deposits. The term of the fixed-rate certificates of
deposit offered by the Bank vary from 30 days to eighteen years and the
offering rates are established by the Bank on a weekly basis. Specific terms
of an individual account vary according to the type of account, the minimum
balance required, the time period funds must remain on deposit and the
interest rate, among other factors. The flow of deposits is influenced
significantly by general economic conditions, changes in money market rates,
prevailing interest rates and competition. At March 31, 1997, the Bank had
$103.5 million of certificate accounts maturing in one year or less. While the
Bank does accept out of area deposits, the Bank's deposits are obtained
predominantly from the areas surrounding its home office. The Bank relies
primarily on customer service and long-standing relationships with customers
to attract and retain these deposits; however, market interest rates and rates
offered by competing financial institutions significantly affect the Bank's
ability to attract and retain deposits. In order to meet its liquidity needs
for the purchase of loans, from time to time the Bank offers above market
interest rates on short term certificate accounts and may utilize brokered
deposits during periods the Bank maintains a well-capitalized status. The Bank
is currently "adequately capitalized" and, without the prior approval of the
regulators, may not accept brokered deposits. This is not expected to
materially impact the Bank as the Bank has other available sources of funds.
At March 31, 1997, the Bank had $792,000 in brokered deposits. Although the
Bank has a significant portion of its deposits in shorter term certificates of
deposit, management monitors activity on the Bank's certificate of deposit
accounts and, based on historical experience, and the Bank's current pricing
strategy, believes that it will retain a large portion of such accounts upon
maturity. Further increases in short-term certificate of deposit accounts,
which tend to be more sensitive to movements in market interest rates than
core deposits, may result in the Bank's deposit base being less stable than if
it had a large amount of core deposits which, in turn, may result in further
increases in the Bank's cost of deposits. Notwithstanding the foregoing, the
Bank believes that it will continue to have access to sufficient amounts of
certificate of deposit accounts which, together with other funding sources,
will provide it with the necessary level of liquidity to continue to implement
its business strategies.
The following table presents the deposit activity of the Bank for the
periods indicated:
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS
ENDED MARCH 31, FOR THE YEAR ENDED DECEMBER 31,
-------------- -------------------------------
1997 1996 1996 1995 1994
------- ------ ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net deposits (withdrawals).... $43,797 $2,233 $ 15,700 $ (1,329) $ (8,880)
Interest credited on deposit
accounts..................... 1,300 830 2,476 3,175 2,561
------- ------ ---------- ---------- ----------
Total increase (decrease)
in deposit accounts...... $45,097 $3,063 $ 18,176 $ 1,846 $ (6,319)
======= ====== ========== ========== ==========
</TABLE>
At March 31, 1997, the Bank had $33.1 million in certificate accounts in
amounts of $100,000 or more maturing as follows:
<TABLE>
<CAPTION>
WEIGHTED
MATURITY PERIOD AMOUNT AVERAGE RATE
--------------- ------- ------------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Three months or less.................................. $14,573 5.81%
Over three through 12 months.......................... 17,230 5.86
Over 12 months........................................ 1,263 5.70
-------
Total............................................. $33,066 5.83
=======
</TABLE>
76
<PAGE>
The following table sets forth the distribution of the Bank's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented. For balances and weighted
average interest rates at March 31, 1997 and December 31, 1996 and 1995, see
"Notes to Financial Statements" provided elsewhere herein.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED MARCH 31, FOR THE YEAR ENDED DECEMBER 31,
-------------------------- -----------------------------------------------------------------------------
1997 1996 1995 1994
-------------------------- ------------------------- ------------------------- -------------------------
PERCENT PERCENT PERCENT PERCENT
OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE BALANCE DEPOSITS RATE
-------- -------- -------- ------- -------- -------- ------- -------- -------- ------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Passbook
accounts.......... $ 3,959 3.83% 2.02% $ 4,401 6.03% 2.09% $ 5,090 7.53% 2.50% $ 7,048 10.13% 2.23%
Money market
accounts.......... 3,025 2.93 3.04 4,233 5.80 2.79 5,493 8.12 2.62 6,512 9.36 2.50
Checking
accounts.......... 10,006 9.68 2.44 7,048 9.65 1.59 6,434 9.51 1.43 6,180 8.88 1.54
-------- ------ ------- ------ ------- ------ ------- ------
Total........... 16,990 16.44 2.45 15,682 21.48 2.05 17,017 25.16 2.13 19,740 28.37 2.10
Certificate
accounts:
Three months or
less............. 35,385 34.24 5.18 3,994 5.47 5.66 11,570 17.11 5.09 16,952 24.36 3.60
Four through 12
months........... 31,021 30.02 6.40 36,519 50.01 5.23 20,762 30.71 5.44 21,768 31.28 4.19
13 through 36
months........... 13,794 13.35 4.97 10,204 13.98 6.25 11,188 16.54 5.93 7,218 10.37 5.11
37 months or
greater.......... 6,148 5.95 5.69 6,616 9.06 6.36 7,088 10.48 6.32 3,913 5.62 5.86
-------- ------ ------- ------ ------- ------ ------- ------
Total
certificate
accounts........ 86,348 83.56 5.62 57,333 78.52 5.57 50,608 74.84 5.59 49,851 71.63 4.25
-------- ------ ------- ------ ------- ------ ------- ------
Total average
deposits........ $103,338 100.00% 5.10 $73,015 100.00% 4.81 $67,625 100.00% 4.72 $69,591 100.00% 3.64
======== ====== ======= ====== ======= ====== ======= ======
</TABLE>
77
<PAGE>
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at the dates indicated and the periods to
maturity of the certificate accounts outstanding at March 31, 1997.
<TABLE>
<CAPTION>
PERIOD TO MATURITY FROM MARCH 31, 1997 AT DECEMBER 31,
-------------------------------------------------------------------- -----------------------
TWO TO
LESS THAN ONE TO THREE THREE TO FOUR TO MORE THAN
ONE YEAR TWO YEARS YEARS FOUR YEARS FIVE YEARS FIVE YEARS TOTAL 1996 1995 1994
--------- --------- ------ ---------- ---------- ---------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts:
0 to 4.00%............ $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 477 $ 9,674
4.01 to 5.00%......... 2,251 280 89 1 4 61 2,686 3,504 5,710 16,098
5.01 to 6.00%......... 77,825 5,490 547 180 465 61 84,568 60,145 32,298 15,282
6.01 to 7.00%......... 23,096 567 543 220 19 82 24,527 3,891 10,676 5,481
7.01 to 8.00%......... 178 200 767 79 94 253 1,571 1,890 2,641 1,487
8.01 to 9.00%......... 100 -- -- -- -- -- 100 -- -- 22
Over 9.01%............ -- -- -- -- -- -- -- -- -- --
-------- ------ ------ ----- ----- ----- -------- ------- ------- -------
Total................. $103,450 $6,537 $1,946 $ 480 $ 582 $ 457 $113,452 $69,430 $51,802 $48,044
======== ====== ====== ===== ===== ===== ======== ======= ======= =======
</TABLE>
Borrowings. From time to time the Bank has obtained advances from the FHLB
as an alternative to retail deposit funds and internally generated funds and
may do so in the future as part of its operating strategy. FHLB advances may
also be used to acquire certain other assets as may be deemed appropriate for
investment purposes. These advances are collateralized primarily by certain of
the Bank's mortgage loans and mortgage-backed securities and secondarily by
the Bank's investment in capital stock of the FHLB. See "Regulation--Federal
Home Loan Bank System." Such advances are made pursuant to several different
credit programs, each of which has its own interest rate and range of
maturities. The maximum amount that the FHLB will advance to member
institutions, including the Bank, fluctuates from time-to-time in accordance
with the policies of the OTS and the FHLB. At March 31, 1997, the Bank had no
outstanding advances from the FHLB.
The Bank recently entered into a mortgage warehousing line of credit with a
national investment banking firm in the amount of $50.0 million. The line of
credit will be used for the origination or purchase of residential mortgage
loans. Upon the completion of the Reorganization, and upon the formation of
the warehouse financing subsidiary of the Company, it is expected that the
line of credit will become a line of credit of the Company. See "Business--
Growth and Operating Strategies."
On March 14, 1997, the Bank issued Debentures in the aggregate principal
amount of $10.0 million through the Debenture Offering. The Debentures will
mature on March 15, 2004 and bear interest at the rate of 13 1/2% per annum,
payable semi-annually. The Debentures qualify as supplementary capital under
regulations of the OTS which capital may be used to satisfy the risk-based
capital requirements in an amount up to 100% of the Bank's core capital. See
"Regulation--Federal Savings Institution Regulation--Capital Requirements." By
enhancing the Bank's capital position the Debentures provide support for the
Bank's current operations. The Debentures are direct, unconditional
obligations of the Bank ranking with all other existing and future unsecured
and subordinated indebtedness of the Bank. They are subordinated on
liquidation, as to principal and interest, and premium, if any, to all claims
against the Bank having the same priority as savings account holders or any
higher priority.
The Debentures are redeemable at the option of the Bank, in whole or in
part, at any time after September 15, 1998, at the aggregate principal amount
thereof, plus accrued and unpaid interest, if any. Following the
Reorganization, the Bank may substitute the Company in its place as obligor on
the Debentures. If such Substitution occurs, holders of the Debentures will
have the option, at September 15, 1998 or at such later time as the
Substitution occurs, to require the Company to purchase all or part of the
holder's outstanding Debentures at a price equal to 100% of the principal
amount repurchased plus accrued interest through the repurchase date. If the
Substitution occurs, upon a change in control of the Company holders of the
Debentures will have the option to require the Company to purchase all or part
of the holder's outstanding Debenture at a price equal to 101% of the
principal amount repurchased plus accrued interest through the repurchase
date. Any such repurchase would have a material adverse impact on the
Company's liquidity after September 15, 1998. See "Risk Factors--Risks Related
to Debentures."
78
<PAGE>
The following table sets forth certain information regarding the Bank's
borrowed funds at or for the periods ended on the dates indicated:
<TABLE>
<CAPTION>
AT OR FOR THE
THREE MONTHS ENDED AT OR FOR THE YEAR
MARCH 31, ENDED DECEMBER 31,
-------------------- ----------------------
1997 1996 1996 1995 1994
--------- --------- ------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
FHLB advances:
Average balance outstanding...... $ 11,824 $ 6,889 $4,259 $3,112 $1,863
Maximum amount outstanding at any
month-end during the period..... 19,950 13,900 13,900 7,600 7,000
Balance outstanding at end of
period.......................... -- 9,800 -- -- 1,250
Weighted average interest rate
during
the period...................... 5.63% 5.98% 5.93% 6.55% 4.87%
Debentures:
Average balance outstanding...... $ 3,526 -- -- -- --
Maximum amount outstanding at any
month-end during the period..... 10,000 -- -- -- --
Balance outstanding at end of
period.......................... 10,000 -- -- -- --
Weighted average interest rate
during
the period...................... 13.50% -- -- -- --
Total:
Average balance outstanding...... $ 15,350 $ 6,889 $4,259 $3,112 $1,863
Maximum amount outstanding at any
month-end during period......... 19,950 13,900 13,900 7,600 7,000
Balance outstanding at end of
period.......................... 10,000 9,800 -- -- 1,250
Weighted average interest rate
during the period............... 6.36% 5.98% 5.93% 6.55% 4.87%
</TABLE>
Asset Securitizations. The Bank completed two asset securitizations, one
during the fourth quarter of 1996 and one during the first quarter of 1997.
Net cash proceeds to the Bank from these asset securitizations for each of
these periods were $50.0 million and $78.1 million, respectively. As the Bank
anticipates that it will conduct regular asset securitizations in the future,
it is expected that gain on sale of loans securitized will constitute a
substantial source of cash flow for the Bank's future loan originations,
although there can be no assurance in this regard. See "Risk Factors--
Dependence on Asset Securitizations and Impact on Quarterly Operating
Results."
COMPETITION
As a purchaser and originator of mortgage loans, the Bank faces intense
competition, primarily from mortgage banking companies, commercial banks,
credit unions, thrift institutions, credit card issuers and finance companies.
Many of these competitors in the financial services business are substantially
larger and have more capital and other resources than the Bank. Furthermore,
certain large national finance companies and conforming mortgage originators
have announced their intention to adapt their conforming origination programs
and allocate resources to the origination of non-conforming loans. In
addition, certain of these larger mortgage companies and commercial banks have
begun to offer products similar to those offered by the Bank targeting
customers similar to those of the Bank. The entrance of these competitors into
the Bank's market could have a material adverse effect on the Bank's results
of operations and financial condition.
Competition can take many forms, including convenience in obtaining a loan,
service, marketing and distribution channels and interest rates. Furthermore,
the current level of gains realized by the Bank and its competitors on the
sale of the type of loans purchased and originated is attracting additional
competitors, including at least one quasi-governmental agency, into this
market with the effect of lowering the gains that may
79
<PAGE>
be realized by the Bank on future loan sales. Competition may be affected by
fluctuations in interest rates and general economic conditions. During periods
of rising rates, competitors which have "locked in" low borrowing costs may
have a competitive advantage. During periods of declining rates, competitors
may solicit the Bank's borrowers to refinance their loans. During economic
slowdowns or recessions, the Bank's borrowers may have new financial
difficulties and may be receptive to offers by the Bank's competitors.
The Bank depends largely on Originators for its purchases and originations
of new loans. The Bank's competitors also seek to establish relationships with
the Bank's Originators. The Bank's future results may become more exposed to
fluctuations in the volume and cost of its wholesale loans resulting from
competition from other purchasers of such loans, market conditions and other
factors.
In addition, the Bank faces increasing competition for deposits and other
financial products from non-bank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds and annuities. In order to
compete with these other institutions with respect to deposits and fee
services, the Bank relies principally upon local promotional activities,
personal relationships established by officers, directors and employees of the
Bank and specialized services tailored to meet the individual needs of the
Bank's customers.
PROPERTIES
As of March 31, 1997, the Bank conducted its business through five offices.
The Bank has entered into a lease on a property in Riverside, California,
which will house, as of the third quarter of 1997, the Company's and the
Bank's executive offices and the western regional office of Life Financial
Services. Projected leasehold improvements on this property are expected to be
approximately $1.0 million. The Bank has also entered into a lease on an
additional property located in Riverside in which it intends to open a second
branch office of the Bank in the third quarter of 1997.
<TABLE>
<CAPTION>
ORIGINAL NET BOOK VALUE
YEAR OF PROPERTY OR
LEASED LEASED DATE OF LEASEHOLD
OR OR LEASE IMPROVEMENTS AT
LOCATION OWNED ACQUIRED EXPIRATION MARCH 31, 1997
-------- ------ -------- ---------- ---------------
<S> <C> <C> <C> <C>
1598 E. Highland Avenue
San Bernardino, CA................ Leased 1986 2001 $249,000
4110 Tigris Way
Riverside, CA..................... Owned 1996 -- 543,000
7751 Belfort Parkway
Suite 150
Jacksonville, FL.................. Leased 1996 1997 --
161 McKinley Street
Corona, CA........................ Leased 1996 -- (1) --
Parker Place
Aurora, CO........................ Leased 1997 2000 93,000
</TABLE>
- --------
(1) The property in Corona is rented on a month-to-month basis.
80
<PAGE>
SUBSIDIARIES
As of March 31, 1997 the Bank had no subsidiaries. For a discussion of the
Company's restructuring plan and establishment of subsidiaries, see "Summary"
and "--Growth and Operating Strategies."
LEGAL PROCEEDINGS
The Company and the Bank are not involved in any pending legal proceedings
other than legal proceedings occurring in the ordinary course of business.
Management believes that none of these legal proceedings, individually or in
the aggregate, will have a material adverse impact on the results of
operations or financial condition of the Company and the Bank.
PERSONNEL
As of March 31, 1997, the Bank had 164 full-time employees and 6 part-time
employees. The employees are not represented by a collective bargaining unit
and the Bank considers its relationship with its employees to be good. See
"The Board of Directors and Management of the Bank--Benefits" for a
description of certain compensation and benefit programs offered to the
Company's and Bank's employees.
81
<PAGE>
FEDERAL AND STATE TAXATION
General. The Company and the Bank will report their income on a calendar
year basis using the accrual method of accounting and will be subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts discussed
below. The following discussion of tax matters is intended only as a summary
and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Company. The statute of limitations has closed
for federal tax purposes through the 1992 tax year and for California
Franchise Tax Board purposes through the 1991 tax year.
Bad Debt Reserve. Historically, savings institutions such as the Bank which
met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrifts") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income. The Bank's deduction with
respect to "qualifying real property loans," which are generally loans secured
by certain interests in real property, were computed using an amount based on
the Bank's actual loss experience, or a percentage equal to 8% of the Bank's
taxable income, computed with certain modifications and reduced by the amount
of any permitted addition to the non-qualifying reserve.
In August, 1996, the provisions repealing the current thrift bad debt rules
were passed by Congress as part of "The Small Business Job Protection Act of
1996." The new rules eliminate the 8% of taxable income method for deducting
additions to the tax bad debt reserves for all thrifts for tax years beginning
after December 31, 1995. These rules also require that all thrift institutions
recapture all or a portion of their bad debt reserves added since the base
year (last taxable year beginning before January 1, 1988). The Bank has
previously recorded a deferred tax liability equal to the bad debt recapture
and as such, the new rules will have no effect on net income or federal income
tax expense.
For tax years beginning after December 31, 1995, the Bank is permitted to
maintain a tax reserve equal to the greater of the base year reserve of the
reserve calculated using the experience method available to small (average
assets less than $500 million) commercial banks as of the year of the change.
Any excess of the reserve as of the year of the change over the allowable
reserves must be recaptured into taxable income evenly over a period of six
years beginning in the 1996 taxable year subject to the suspension rule
described below. As of March 31, 1997, the Bank has an excess amount subject
to recapture equal to $330,000.
The experience method allows an institution to maintain a bad debt reserve
equal to the ratio of the net charge-offs for the last six years divided by
total loans for those years multiplied by the total loans outstanding at the
end of the current year. However, this method permits the institution to
maintain a minimum reserve balance equal to its reserve balance at the end of
its base year, adjusted for declines in the loan portfolio for the base year.
Although deductions are allowed for the calculated addition to the bad debt
reserve, net recoveries are not taken into taxable income. The Bank is
currently using the "6-year moving average" method to calculate its bad debt
reserve. The Bank anticipates that it will continue this practice.
Distributions. To the extent that the Bank makes "non-dividend
distributions" to the Company that are considered as made (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for
such losses exceeds the amount that would have been allowed under the
experience method, or (ii) from the supplemental reserve for losses on loans
("Excess Distributions"), then an amount based on the amount distributed will
be included in the Bank's taxable income. Non-dividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock, and distributions in partial or
complete liquidation. However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax
purposes, will not be considered to result in a distribution from the Bank's
bad debt reserve. Thus, any dividends to the Company that would reduce amounts
appropriated to the Bank's bad debt reserve and deducted for federal income
tax purposes would create a tax liability for the Bank. The amount of
additional taxable income created from an Excess Distribution is an amount
that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if the Bank makes a "non-dividend
distribution," then approximately one and one-half times the amount so used
82
<PAGE>
would be includable in gross income for federal income tax purposes, assuming
a 34% corporate income tax rate (exclusive of state and local taxes). See
"Regulation" and "Dividend Policy" for limits on the payment of dividends of
the Bank. The Bank does not intend to pay dividends that would result in a
recapture of any portion of its bad debt reserve.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as
amended (the "Code"), imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses). In addition, for taxable years
beginning after December 31, 1986 and before January 1, 1996, an environmental
tax of .12% of the excess of AMTI (with certain modifications) over $2.0
million is imposed on corporations, including the Bank, whether or not an
Alternative Minimum Tax ("AMT") is paid. The Bank does not expect to be
subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may exclude from
its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction
is generally 70% in the case of dividends received from unaffiliated
corporations with which the Company and the Bank will not file a consolidated
tax return, except that if the Company or the Bank own more than 20% of the
stock of a corporation distributing a dividend then 80% of any dividends
received may be deducted.
STATE AND LOCAL TAXATION
State of California. The California franchise tax rate applicable to the
Bank equals the franchise tax rate applicable to corporations generally, plus
an "in lieu" rate approximately equal to personal property taxes and business
license taxes paid by such corporations (but not generally paid by banks or
financial corporations such as the Bank); however, the total tax rate cannot
exceed 11.3%. Under California regulations, bad debt deductions are available
in computing California franchise taxes using a three or six year weighted
average loss experience method. The Company, as a savings and loan holding
company commercially domiciled in California, will generally be treated as a
financial corporation and subject to the general corporate tax rate plus the
"in lieu" rate as discussed previously for the Bank.
State of Delaware Taxation. As a Delaware holding company not earning income
in Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its chartering agency, and the FDIC, as the insurer of the Bank's
deposit accounts. The Bank is a member of the FHLB System. The Bank's deposit
accounts are insured up to applicable limits by the SAIF managed by the FDIC.
The Bank must file reports with the OTS and the FDIC concerning its activities
and financial condition in addition to obtaining regulatory approvals prior to
entering into certain transactions such as mergers with, or acquisitions of,
other financial institutions. There are periodic examinations by the OTS and
the FDIC to test the Bank's compliance with various regulatory requirements.
This regulation and supervision establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for
the protection of the insurance fund and depositors. The regulatory structure
also gives the regulatory authorities extensive discretion in connection with
their supervisory and enforcement activities and examination policies,
including policies with respect to the classification of assets and the
establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the OTS, the FDIC or the Congress, could
have a material adverse impact on the Company, the Bank or their operations.
The Company, as a savings and loan holding company,
83
<PAGE>
will also be required to file certain reports with, and otherwise comply with
the rules and regulations of, the OTS and the SEC under the federal securities
laws.
Any change in the regulatory structure or the applicable statutes or
regulations, whether by the OTS, the FDIC or the Congress, could have a
material impact on the Company, the Bank, their operations, or the
Reorganization. Congress is expected to consider in 1997 the elimination of
the federal thrift charter and the abolition of the OTS. The results of such
consideration, including possible enactment of legislation, is uncertain.
Therefore, the Bank is unable to determine the extent to which the results of
such consideration or possible legislation, if enacted, would affect its
business. See "Risk Factors--Financial Institution Regulation and Possible
Legislation."
Certain of the regulatory requirements applicable to the Bank and to the
Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings associations set
forth in this Prospectus does not purport to be complete descriptions of such
statutes and regulations and their effects on the Bank and the Company and is
qualified in its entirety by reference to such statutes and regulations.
FEDERAL SAVINGS INSTITUTION REGULATION
Business Activities. The activities of federal savings institutions are
governed by the Home Owners' Loan Act, as amended (the "HOLA") and, in certain
respects, the Federal Deposit Insurance Act ("FDI Act") and the regulations
issued by the OTS and FDIC to implement these statutes. These laws and
regulations delineate the nature and extent of the activities in which federal
associations may engage. In particular, many types of lending authority for
federal associations, e.g., commercial, non-residential real property loans
and consumer loans, are limited to a specified percentage of the
institutions's capital or assets. Specifically, commercial loans are limited
to 20% of total assets and amounts in excess of 10% of assets may only be used
for small business loans. Consumer loans are limited to 35% of assets.
Loans-to-One Borrower. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans-to-one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by readily-
marketable collateral, which is defined to include certain financial
instruments and bullion but excludes real estate. At March 31, 1997, the
Bank's general limit on loans-to-one borrower was $1.9 million. At March 31,
1997, the Bank's largest aggregate amount of loans-to-one borrower consisted
of $713,000.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings association is required to maintain at least 65% of
its "portfolio assets" (total assets less: (i) specified liquid assets up to
20% of total assets; (ii) intangibles, including goodwill; and (iii) the value
of property used to conduct business) in certain "qualified thrift
investments" (primarily residential mortgages and related investments,
including certain mortgage-backed and related securities and 50% of the dollar
amount of residential mortgages originated by the institution and sold within
90 days) in at least 9 months out of each 12 month period. A savings
association that fails the QTL test must either convert to a bank charter or
operate under certain restrictions. As of March 31, 1997, the Bank maintained
91.68% of its portfolio assets in qualified thrift investments and, therefore,
met the QTL test. Recent legislation has expanded the extent to which
education loans, credit card loans and small business loans may be considered
as "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon
all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to
stockholders of another institution in a cash-out merger and other
distributions charged against capital. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level. An
institution that exceeds all fully phased-in regulatory capital requirements
before and after a proposed capital distribution ("Tier 1 Bank") and has not
been advised by the OTS that it is in need of more than normal supervision,
could, after prior notice to, but without the approval of the OTS, make
capital distributions during a calendar year equal to the greater of: (i) 100%
of its net earnings to date during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" (the excess capital over
its fully phased in capital requirements) at the
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beginning of the calendar year; or (ii) 75% of its net earnings for the
previous four quarters. Any additional capital distributions would require
prior OTS approval. In the event the Bank's capital fell below its capital
requirements or the OTS notified it that it was in need of more than normal
supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital
distribution by any institution, which would otherwise be permitted by the
regulation, if the OTS determines that such distribution would constitute an
unsafe or unsound practice.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a
specified percentage (currently 5%) of its net withdrawable deposit accounts
plus short-term borrowings. OTS regulations also require each savings
institution to maintain an average daily balance of short-term liquid assets
at a specified percentage (currently 1%) of the total of its net withdrawable
deposit accounts and borrowings payable in one year or less. Monetary
penalties may be imposed for failure to meet these liquidity requirements. The
Bank's average liquidity ratio for the three months ended March 31, 1997 was
12.6%, which exceeded the applicable requirements. The Bank has never been
subject to monetary penalties for failure to meet its liquidity requirements.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources."
Assessments. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations and supervision of the
Bank. The general assessment, paid on a semi-annual basis, is based upon the
savings institution's total assets, including consolidated subsidiaries, as
reported in the Bank's latest quarterly Thrift Financial Report. The
assessments paid by the Bank for the three months ended March 31, 1997 and the
year ended December 31, 1996 totalled $14,000 and $27,000, respectively.
Branching. OTS regulations permit federally chartered savings associations
to branch nationwide under certain conditions. Generally, federal savings
associations may establish interstate networks and geographically diversify
their loan portfolios and lines of business. The OTS authority preempts any
state law purporting to regulate branching by federal savings associations.
For a discussion of the impact of proposed legislation, see "Risk Factors--
Financial Institution Regulation and Possible Legislation."
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (i.e., any company that
controls or is under common control with the Bank, including the Company and
any non-savings institution subsidiaries that the Company may establish) is
limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section
23A restricts the aggregate amount of covered transactions with any individual
affiliate to 10% of the capital and surplus of the savings institution and
also limits the aggregate amount of covered transactions with all affiliates
to 20% of the savings institution's capital and surplus. Certain transactions
with affiliates are required to be secured by collateral in an amount and of a
type described in Section 23A, and the purchase of low quality assets from
affiliates is generally prohibited. Section 23B generally requires that
certain transactions with affiliates, including loans and asset purchases,
must be on terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders who
participate in the conduct of the affairs of the institution, and independent
contractors (including attorneys, appraisers and accountants) who knowingly or
recklessly participate in a wrongful action likely to have a significant
adverse effect on an insured institution. Formal enforcement action may range
from the issuance of a capital directive or cease and desist order to removal
of officers or directors, receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS that enforcement action be taken with respect to a
particular savings institution. If action is not taken by the Director, the
FDIC has authority to take such action itself under certain circumstances.
Federal and state law also establishes criminal penalties for certain
violations.
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Standards for Safety and Soundness. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. The Guidelines set forth the
safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before
capital becomes impaired. The Guidelines address internal controls and
information systems; internal audit system; credit underwriting; loan
documentation; interest rate risk exposure; asset growth; asset quality;
earnings; and compensation, fees and benefits. If the appropriate federal
banking agency determines that an institution fails to meet any standard
prescribed by the Guidelines, the agency may require the institution to submit
to the agency an acceptable plan to achieve compliance with the standard, as
required by the FDI Act. The final regulations establish deadlines for the
submission and review of such safety and soundness compliance plans.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital
standard, a 3% leverage (core capital) ratio and an 8% risk based capital
standard. Core capital is defined as common stockholder's equity (including
retained earnings), certain non-cumulative perpetual preferred stock and
related surplus and minority interests in equity accounts of consolidated
subsidiaries less intangibles other than certain mortgage servicing rights and
credit card relationships. The OTS regulations require that, in meeting the
leverage ratio, tangible and risk-based capital standards institutions
generally must deduct investments in and loans to subsidiaries engaged in
activities not permissible for a national bank. In addition, the OTS prompt
corrective action regulation provides that a savings institution that has a
leverage capital ratio of less than 4% (3% for institutions receiving the
highest CAMEL examination rating) will be deemed to be "undercapitalized" and
will be subject to certain restrictions. See "--Prompt Corrective Regulatory
Action."
The risk-based capital standard for savings institutions requires the
maintenance of a ratio of total capital (which is defined as core capital plus
supplementary capital) to risk-weighted assets of 8%. In determining the
amount of risk-weighted assets, all assets, including certain off-balance
sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by
the OTS capital regulation based on the risks the OTS believes are inherent in
the type of asset. The components of core capital are equivalent to those
discussed earlier under the 3% leverage standard. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate term preferred stock and, within specified limits, the
general allowance for loan and lease losses. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100% of
core capital.
The OTS has incorporated an interest rate risk component into its regulatory
capital rule. The final interest rate risk rule also adjusts the risk-
weighting for certain mortgage derivative securities. Under the rule, savings
associations with "above normal" interest rate risk exposure would be subject
to a deduction from total capital for purposes of calculating their risk-based
capital requirements. A savings association's interest rate risk is measured
by the decline in the net portfolio value of its assets (i.e., the difference
between incoming and outgoing discounted cash flows from assets, liabilities
and off-balance sheet contracts) that would result from a hypothetical 200-
basis point increase or decrease in market interest rates, divided by the
estimated economic value of the association's assets, as calculated in
accordance with guidelines set forth by the OTS. A savings association whose
measured interest rate risk exposure exceeds 2% must deduct an interest rate
component in calculating its total capital under the risk-based capital rule.
The interest rate risk component is an amount equal to one-half of the
difference between the institution's measured interest rate risk and 2%,
multiplied by the estimated economic value of the association's assets. That
dollar amount is deducted from an association's total capital in calculating
compliance with its risk-based capital requirement. Under the rule, there is a
two quarter lag between the reporting date of an institution's financial data
and the effective date for the new capital requirement based on that data. A
savings association with assets of less than $300 million and risk-based
capital
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ratios in excess of 12% is not subject to the interest rate risk component,
unless the OTS determines otherwise. The rule also provides that the Director
of the OTS may waive or defer an association's interest rate risk component on
a case-by-case basis. The OTS has postponed the date that the component will
first be deducted from an institution's total capital to provide it with an
opportunity to review the interest rate risk approaches taken by the other
federal banking agencies.
At March 31, 1997, the Bank met each of its capital requirements. Due to the
fluctuations in the Bank's total assets as a result of its mortgage banking
operations, the Bank has been required by the OTS since the Bank's examination
completed August 9, 1996 to compute its regulatory capital ratios based upon
the higher of (1) the average of total assets based on month-end results; or
(2) total assets as of the quarter end. Total assets at the end of the quarter
ended March 31, 1997 were higher than the month end averages, and therefore
the OTS capital averaging requirement did not have an effect on the Bank's
regulatory capital ratios. See "Capitalization" for a table which sets forth
in terms of dollars and percentages the OTS tangible, leverage and risk-based
capital requirements, the Bank's historical amounts and percentages at March
31, 1997 and pro forma capitalization of the Company based upon the issuance
of the shares within the Estimated Price Range.
PROMPT CORRECTIVE REGULATORY ACTION
Under the OTS prompt corrective action regulations, the OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of under-
capitalization. Generally, a savings institution that has a total risk-based
capital of less than 8.0% or a leverage ratio or a Tier 1 risk-based capital
ratio that is less than 4.0% is considered to be undercapitalized (Tier 1
Capital is equivalent to core capital). A savings institution that has a total
risk-based capital less than 6.0%, a Tier 1 risk-based capital ratio of less
than 3.0% or a leverage ratio that is less than 3.0% is considered to be
"significantly undercapitalized" and a savings institution that has a tangible
capital to assets ratio equal to or less than 2.0% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
critically undercapitalized. The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date an
association receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by each parent holding company, subject to an aggregate
limit on liability. In addition, numerous mandatory supervisory actions may
become immediately applicable to the institution depending upon its category,
including, but not limited to, increased monitoring by regulators,
restrictions on growth, and capital distributions and limitations on
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
INSURANCE OF DEPOSIT ACCOUNTS
Deposits of the Bank are presently insured by the SAIF. Both the SAIF and
the BIF (the deposit insurance fund that covers most commercial bank deposits)
are statutorily required to be recapitalized to a 1.25% of insured reserve
deposits ratio. Until recently, members of the SAIF and BIF were paying
average deposit insurance premiums of between 24 and 25 basis points. The BIF
met the required reserve in 1995, whereas the SAIF was not expected to meet or
exceed the required level until 2002 at the earliest. This situation was
primarily due to the statutory requirement that SAIF members make payments on
bonds issued in the late 1980s by the Financing Corporation ("FICO") to
recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted
a new assessment rate schedule of from 0 to 27 basis points under which 92% of
BIF members paid an annual premium of only $2,000. With respect to SAIF member
institutions, the FDIC adopted a final rule retaining the previously existing
assessment rate schedule applicable to SAIF member institutions of 23 to 31
basis points. As long as the premium differential continued, it could have had
adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members such as the Bank could have
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been placed at a substantial competitive disadvantage to BIF members with
respect to pricing of loans and deposits and the ability to achieve lower
operating costs.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the "Funds Act") which, among other things, imposed a
special one-time assessment on SAIF member institutions, including the Bank,
to recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a
special assessment of 65.7 basis points on SAIF assessable deposits held as of
March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The
SAIF Special Assessment was recognized by the Bank as an expense in the
quarter ended September 30, 1996 and is generally tax deductible. The SAIF
Special Assessment recorded by the Bank amounted to $448,000 on a pre-tax
basis and $256,000 on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds
across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits
will be assessed for FICO payment at a rate of 1.3 basis points, while SAIF
deposits will pay 6.48 basis points. Full pro rata sharing of the FICO
payments between BIF and SAIF members will occur on the earlier of January 1,
2000 or the date the BIF and SAIF are merged. The Funds Act specifies that the
BIF and SAIF will be merged on January 1, 1999, provided no savings
associations remain as of that time.
As a result of the Funds Act, the FDIC voted to lower SAIF assessments to 0
to 27 basis points as of January 1, 1997, a range comparable to that of BIF
members and recently voted to maintain the same rate range for the second half
of 1997. However, SAIF members will continue to make the FICO payments
described above. The FDIC also lowered the SAIF assessment schedule for the
fourth quarter of 1996 to 18 to 27 basis points. Management cannot predict the
level of FDIC insurance assessments on an on-going basis, whether the savings
association charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
The Bank's assessment rate for the three months ended March 31, 1997 and the
year ended December 31, 1996 was 9 and 26 basis points, respectively, and the
premium paid for these periods was $18,000 and $622,000 (including the SAIF
Special Assessment), respectively. A significant increase in SAIF insurance
premiums would likely have an adverse effect on the operating expenses and
results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is
in an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or
the OTS. The management of the Bank does not know of any practice, condition
or violation that might lead to termination of deposit insurance.
THRIFT RECHARTERING LEGISLATION
The Funds Act provides that the BIF and SAIF will merge on January 1, 1999
if there are no more savings associations as of that date. That legislation
also requires that the Department of Treasury submit a report to Congress by
March 31, 1999 that makes recommendations regarding a common financial
institutions charter, including whether the separate charters for thrifts and
banks should be abolished. Various proposals to eliminate the federal thrift
charter, create a uniform financial institutions charter and abolish the OTS
have been introduced in the Congress. However, the Bank is unable to predict
whether such legislation would be enacted and, if so, the extent to which the
legislation would restrict the Bank's ability to engage in certain activities
or otherwise disrupt its operations.
TRUTH IN LENDING
The Truth in Lending Act ("TILA") and Regulation Z promulgated thereunder
requires lenders, such as the Bank, to provide a disclosure statement to
borrowers which explains the terms and cost of credit, including, but not
limited to, the amount financed, finance charges, other charges and prepayment
terms. Regulation Z
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applies to a wide variety of lending transactions, including mortgage loans
and credit cards. The TILA provides borrowers with a three day right to cancel
certain credit transactions, including certain residential mortgage loans and
other loans where a customer pledges his or her principal dwelling as security
for the loan. Failure to comply with the provisions of the TILA could subject
a lender to criminal and civil sanctions.
The TILA was amended effective October 1, 1995 to impose new disclosure
requirements and substantive limitations on closed-end home equity mortgage
loans bearing rates or fees above a certain percentage or amount ("TILA
Amendments"). Specifically, the TILA Amendments apply to loans secured by a
customer's principal dwelling (other than a residential mortgage loan to
acquire or construct a borrower's principal dwelling, a reverse mortgage
transaction or home equity lines of credit) with (i) an annual percentage rate
which exceeds by more than ten percentage points the yield on U.S. Treasury
securities having comparable periods of maturity; or (ii) total loan
origination fees and other fees payable by the customer which exceed the
greater of 8% of the loan amount or $400 ("Covered Loans"). Additional
disclosures are required to be provided to the customer under the TILA
Amendments for all Covered Loans not less than three business days prior to
the consummation of the transaction.
OTHER LENDING LAWS
The Bank is also required to comply with the Equal Credit Opportunity Act of
1974, as amended ("ECOA"), which prohibits creditors from discriminating
against applicants on certain prohibited bases, including race, color,
religion, national origin, sex, age or marital status. Regulation B
promulgated under ECOA restricts creditors from obtaining certain types of
information from loan applicants. Among other things, it also requires certain
disclosures by the lender regarding consumer rights and requires lenders to
advise applicants of the reasons for any credit denial. In instances where the
applicant is denied credit or the rate or charge for loans increases as a
result of information obtained from a consumer credit agency, another statute,
the Fair Credit Reporting Act of 1970, as amended, requires lenders to supply
the applicant with the name and address of the reporting agency. In addition,
the Bank is subject to the Fair Housing Act and regulations thereunder, which
broadly prohibit certain discriminatory practices in connection with the
Bank's business. The Bank is also subject to the RESPA and the Home Mortgage
Disclosure Act.
In addition, the Bank is subject to various other Federal and state laws,
rules and regulations governing, among other things, procedures which must be
followed by mortgage lenders and servicers, and disclosures which must be made
to consumer borrowers. Failure to comply with such laws, as well as with the
laws described above, may result in civil and criminal liability.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB, is required to acquire and
hold shares of capital stock in the FHLB in an amount at least equal to 1% of
the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Bank was in compliance
with this requirement with an investment in FHLB stock at March 31, 1997 of
$1.0 million. FHLB advances must be secured by specified types of collateral
and all long-term advances may only be obtained for the purpose of providing
funds for residential housing finance. At March 31, 1997, the Bank had no
outstanding FHLB advances.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest
on advances to their members. For the years ended December 31, 1996, 1995 and
1994, dividends from the FHLB to the Bank amounted to $34,000, $30,000 and
$20,000, respectively. If dividends were reduced, the Bank's net interest
income would likely also be reduced. Further, there can be no assurance that
the impact of recent or future legislation on the FHLBs will not also cause a
decrease in the value of the FHLB stock held by the Bank.
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FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts. The
Federal Reserve Board regulations generally require that reserves be
maintained against aggregate transaction accounts as follows: for accounts
aggregating $52.0 million or less (subject to adjustment by the Federal
Reserve Board) the reserve requirement is 3%; and for accounts greater than
$52.0 million, the reserve requirement is $1.6 million plus 10% (subject to
adjustment by the Federal Reserve Board between 8% and 14%) against that
portion of total transaction accounts in excess of $52.0 million. The first
$4.3 million of otherwise reservable balances (subject to adjustment by the
Federal Reserve Board) are exempted from the reserve requirements. The Bank is
in compliance with the foregoing requirements. Because required reserves must
be maintained in the form of either vault cash, a non-interest-bearing account
at a Federal Reserve Bank or a pass-through account as defined by the Federal
Reserve Board, the effect of this reserve requirement is to reduce the Bank's
interest-earning assets. FHLB System members are also authorized to borrow
from the Federal Reserve "discount window," but Federal Reserve Board
regulations require institutions to exhaust all FHLB sources before borrowing
from a Federal Reserve Bank.
HOLDING COMPANY REGULATION
The Company will be a non-diversified unitary savings and loan holding
company within the meaning of the HOLA. As such, the Company will be required
to register with the OTS and will be subject to OTS regulations, examinations,
supervision and reporting requirements. In addition, the OTS has enforcement
authority over the Company and its non-savings institution subsidiaries. Among
other things, this authority permits the OTS to restrict or prohibit
activities that are determined to be a serious risk to the subsidiary savings
institution. The Bank must notify the OTS 30 days before declaring any
dividend to the Company.
As a unitary savings and loan holding company, the Company generally will
not be restricted under existing laws as to the types of business activities
in which it may engage, provided that the Bank continues to be a QTL. See "--
Federal Savings Institution Regulation--QTL Test" for a discussion of the QTL
requirements. Upon any non-supervisory acquisition by the Company of another
savings association, the Company would become a multiple savings and loan
holding company (if the acquired institution is held as a separate subsidiary)
and would be subject to extensive limitations on the types of business
activities in which it could engage. The HOLA limits the activities of a
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the Bank Holding Company ("BHC") Act, subject to the
prior approval of the OTS, and to other activities authorized by OTS
regulation. Proposed legislation would treat all savings and loan holding
companies as bank holding companies and limit, with narrow "grandfather"
rights for existing savings and loan holding companies, the activities of such
companies to those permissible for bank holding companies. See "Risk Factors--
Financial Institution Regulation and Possible Legislation."
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5%
of the voting stock of another savings institution, or holding company
thereof, without prior written approval of the OTS; from acquiring or
retaining, with certain exceptions, more than 5% of a non-subsidiary holding
company or savings association; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS
must consider the financial and managerial resources and future prospects of
the company and institution involved, the effect of the acquisition on the
risk to the insurance funds, the convenience and needs of the community and
competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, except: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies, and (ii) the acquisition
of a savings institution in another state if the laws of the state of the
target savings institution specifically permit such acquisitions. The states
vary in the extent to which they permit interstate savings and loan holding
company acquisitions.
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FEDERAL SECURITIES LAWS
The Company has filed with the SEC a registration statement on Form S-1
under the Securities Act for the registration of the Common Stock to be issued
in the Public Offering and a registration statement on a Form S-4 under the
Securities Act for the registration of the Common Stock to be issued in the
Reorganization. Upon the effectiveness of the registration statement the
Company's Common Stock will be registered with the SEC under the Exchange Act.
The Company will then be subject to the information, proxy solicitation,
insider trading restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of shares of the Common Stock to
be issued in the Reorganization and Public Offering does not cover the resale
of such shares. Shares of the Common Stock purchased in the Public Offering by
persons who are not affiliates of the Company may be resold without
registration. Shares purchased by an affiliate of the Company will be subject
to the resale restrictions of Rule 144 under the Securities Act. If the
Company meets the current public information requirements of Rule 144 under
the Securities Act, each affiliate of the Company who complies with the other
conditions of Rule 144 (including those that require the affiliate's sale to
be aggregated with those of certain other persons) would be able to sell in
the public market, without registration, a number of shares not to exceed, in
any three-month period, the greater of (i) 1% of the outstanding shares of the
Company or (ii) the average weekly volume of trading in such shares during the
preceding four calendar weeks. Provision may be made in the future by the
Company to permit affiliates to have their shares registered for sale under
the Securities Act under certain circumstances.
THE BOARD OF DIRECTORS AND MANAGEMENT OF THE COMPANY
The following table sets forth certain information regarding executive
officers and directors of the Company.
<TABLE>
<CAPTION>
NAME AGE(1) POSITION(S) HELD WITH COMPANY
---- ------ -----------------------------
<C> <C> <S>
Daniel L. Perl 48 Director, President and Chief Executive Officer
L. Bruce Mills, Jr. 40 Executive Vice President, Chief Financial
Officer and Corporate Secretary
Ronald G. Skipper 56 Chairman of the Board
Richard C. Caldwell 56 Director
John D. Goddard 58 Director
Milton E. Johnson 59 Director
</TABLE>
- --------
(1) As of March 31, 1997.
BIOGRAPHICAL INFORMATION
Daniel L. Perl joined the Bank in 1994 as the Senior Vice President and
Chief Loan Officer. Mr. Perl was recently promoted to the position of
President and Chief Executive Officer of the Bank. Mr. Perl has over twenty
years of continuous experience in real estate finance. Prior to joining the
Bank, Mr. Perl served in management positions with various mortgage finance
companies and banking institutions. From 1991 to 1993, Mr. Perl was a Senior
Vice President with WCP Trading Corporation.
L. Bruce Mills, Jr. joined the Bank in 1987 as the Chief Financial Officer.
Mr. Mills currently serves as the Executive Vice President and Chief Financial
Officer of the Bank. Prior to joining the Bank, Mr. Mills served as an
examiner with the Federal Home Loan Bank of San Francisco.
Ronald G. Skipper is the Chairman of the Board of the Company and has served
as a Director of the Bank since 1983. Mr. Skipper is a self-employed attorney
and has been practicing law for 31 years.
Richard C. Caldwell is the Chairman of the Board of the Bank. Mr. Caldwell
was elected to the Board of Directors of the Bank in 1983 and has served as
Chairman of the Board since 1983. Mr. Caldwell has been a partner of Caldwell
& Moreland Insurance Brokers since 1995. From 1982 to 1995, Mr. Caldwell has
been President and sole owner of Caldwell & Hunt Insurance Brokers.
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John D. Goddard has served as a Director of the Bank since 1988. Mr. Goddard
is a Certified Public Accountant. Mr. Goddard has been President of Goddard
Accountancy Corporation since 1962.
Milton E. Johnson has served as a Director of the Bank since 1983. Mr.
Johnson has been the President of Home Lumber Company, a building materials
supplier, since 1960. In addition, Mr. Johnson has been a partner in Central
Nevada Hay Company since 1987.
In addition to the foregoing, Robert K. Riley has been nominated to become a
member of the Board following the Reorganization. Mr. Riley is the co-founder
and Chief Executive Officer of Millenium Asset Management, L.L.C., an SEC-
registered investment advisory firm, and also serves on the Board of Directors
of MBIC, an American subsidiary of a large Belgian bank. From 1992 to 1996,
Mr. Riley worked for the Millenium Group, a consulting firm focused on
designing asset securitization systems and developing risk management programs
for European banks.
The Board of Directors of the Company is divided into three classes, each of
which contains approximately one-third of the Board. The directors shall be
elected by the stockholders of the Company for staggered three year terms, or
until their successors are elected and qualified. One class of directors,
consisting of Messrs. Richard C. Caldwell and Milton E. Johnson, has a term of
office expiring at the first annual meeting of stockholders; a second class,
consisting of Messrs. Ronald G. Skipper and Daniel L. Perl, has a term of
office expiring at the second annual meeting of stockholders; and a third
class, consisting of Mr. John D. Goddard, has a term of office expiring at the
third annual meeting of stockholders.
The officers of the Company are elected annually and hold office until their
respective successors have been elected and qualified or until death,
resignation or removal by the Board of Directors. Since the formation of the
Company, none of the executive officers or other personnel has received
remuneration from the Company.
COMMITTEES OF THE BOARD OF DIRECTORS OF THE COMPANY
The Company has established an Audit Committee consisting of Messrs.
Skipper, Caldwell and Goddard and a Personnel/Compensation Committee
consisting of Messrs. Skipper, Goddard and Johnson.
DIRECTORS' COMPENSATION
The directors of the Company who are not also employees of the Company will
receive a monthly retainer for acting in such capacity following the
Reorganization. The monthly retainer for the Chairman of the Board shall be
$2,000 while the fee for other non-employee directors will be $1,500. In
addition, upon the Reorganization each non-employee director will receive fees
for each month preceding the Reorganization starting with February 1997 for
services performed on behalf of the Company.
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<PAGE>
THE BOARD OF DIRECTORS AND MANAGEMENT OF THE BANK
DIRECTORS
The following table sets forth certain information regarding the Board of
Directors of the Bank.
<TABLE>
<CAPTION>
POSITION(S) HELD WITH THE DIRECTOR TERM
NAME AGE(1) BANK SINCE EXPIRES
---- ------ ------------------------- -------- -------
<C> <C> <S> <C> <C>
Richard C. Caldwell 56 Chairman of the Board 1983 1997
Daniel L. Perl(2) 48 Director, President and Chief 1996 1997
Executive Officer
John D. Goddard 58 Director 1988 1999
Milton E. Johnson 59 Director 1983 1997
Edgar C. Keller 76 Director 1983 1999
Ronald G. Skipper 56 Director 1983 1998
</TABLE>
- --------
(1) As of March 31, 1997.
(2) Mr. Perl was elected by the Board of Directors to fill the vacancy created
by the resignation of a director in June 1996.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth certain information regarding the executive
officers of the Bank who are not also directors.
<TABLE>
<CAPTION>
NAME AGE(1) POSITION(S) HELD WITH THE BANK
---- ------ ------------------------------
<S> <C> <C>
L. Bruce Mills, Jr. 40 Executive Vice President, Secretary and Treasurer
Joseph R.L. Passerino 42 Senior Vice President
Mary E. Darter 36 Senior Vice President
</TABLE>
- --------
(1) As of March 31, 1997.
BIOGRAPHICAL INFORMATION
DIRECTORS AND EXECUTIVE OFFICERS OF THE BANK WHO ARE NOT DIRECTORS AND
EXECUTIVE OFFICERS OF THE COMPANY
Edgar C. Keller has been a Director of the Bank since 1983. Mr. Keller was a
partner with the law firm of Keller & Holt from 1963 until 1994. After such
time, Mr. Keller was a partner with the law firm of Keller & Keller until his
retirement in 1996.
Joseph R. L. Passerino joined the Bank in February 1994. He was named senior
vice president in September 1996 and is responsible for all loans originated
by the Bank nationally. Prior to that, from 1988 to 1994, Mr. Passerino was in
charge of loan production for St. Thomas Capital Corp.
Mary E. Darter joined the Bank in March 1994. She was named senior vice
president in September 1996. Ms. Darter is primarily responsible for mortgage
financing operations. Prior to joining the Bank, Ms. Darter was employed by
Imperial Credit Industries/Southern Pacific Thrift and Loan from 1991 to 1994
in charge of the warehouse line of credit division and bulk acquisitions.
COMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS OF THE BANK
The Board of Directors meets on a monthly basis and may have additional
special meetings upon the request of the Chairman of the Board. During the
year ended December 31, 1996, the Board of Directors had 12 regular meetings
and 6 special meetings. No director attended fewer than 75% of the total
number of Board meetings held during this period.
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The Board of Directors of the Bank has established the following Board and
management committees:
The Audit Committee consists of Messrs. Keller and Goddard. The Bank's
Internal Auditors report to this committee. The purpose of this committee is
to review the audit function and management actions regarding the
implementation of audit findings. The committee also maintains a liaison with
the outside auditors and reviews the adequacy of internal controls. The
committee meets quarterly or as necessary.
The Loan Committee consists of Messrs. Skipper, Caldwell, Johnson and Perl.
This Committee exercises the authority of the Board pertaining to loan matters
and approves or rejects all loans presented by management. This Committee also
reviews the workout solutions of problem loans, and approves the
classification of assets and the establishment of adequate valuation
allowances. The Committee meets monthly.
The Executive Committee consists of Messrs. Caldwell, Goddard and Skipper.
This committee exercises the authority of the Board of Directors with respect
to matters requiring action between meetings of the Board of Directors. Any
actions by this committee require subsequent ratification by the Board of
Directors at the next regular meeting. The Executive Committee meets as
needed.
The Investment Committee consists of Messrs. Goddard, Caldwell, Johnson and
Mills. The purpose of this committee is to adopt and maintain policies
regarding the investment portfolio and to monitor the interest rate and the
credit risks of liquidity portfolio investments. This committee meets semi-
annually or as needed.
The Personnel/Compensation Committee consists of Messrs. Keller, Johnson,
Caldwell and Goddard. This Committee is responsible for all matters regarding
compensation and benefits, hiring, termination and affirmative action issues.
The committee meets semi-annually or as needed.
The Asset Classification Committee consists of Messrs. Mills and Perl. The
purpose of this committee is to review the Bank's loan portfolio and monitor
the classification of assets. This committee meets quarterly.
The Bank also maintains a Budget Committee consisting of Messrs. Caldwell,
Goddard and Mills.
DIRECTORS' COMPENSATION
Directors' Fees. Directors of the Bank who are not also employees of the
Bank receive a retainer of $950 per month for serving on the Bank's Board of
Directors except the Chairman of the Board who receives $1200 per month.
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<PAGE>
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth, for the year
ended December 31, 1996, the cash compensation paid by the Bank, as well as
certain other compensation paid or accrued for those years, to the chief
executive officer, the former chief executive officer and the other most
highly compensated executive officer of the Bank whose compensation exceeded
$100,000 in fiscal year 1996 (the "Named Executive Officers").
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
--------------------------------
COMPENSATION AWARDS PAYOUTS
--------------------------------------- --------------------- ----------
RESTRICTED SECURITIES
NAME AND PRINCIPAL OTHER STOCK UNDERLYING LTIP ALL OTHER
POSITIONS(1) YEAR SALARY($) BONUS($) COMPENSATION($) AWARDS($) OPTIONS(#) PAYOUTS($) COMPENSATION($)
------------------ ---- --------- ---------- --------------- ---------- ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Daniel L. Perl.......... 1996 $75,000 $1,464,374(2) $-- $-- 192,960 $-- $ 2,370(3)
President and Chief
Executive Officer
Nora Vineyard........... 1996 76,083 -- -- -- -- -- 88,300(4)
Former President and
Chief Executive Officer
Joseph R.L. Passerino... 1996 29,000 217,199 -- -- 12,540 -- 2,300(3)
Senior Vice President
</TABLE>
- --------
(1) Ms. Vineyard retired from the position of President and Chief Executive
Officer in July 1996 at which time Mr. Perl was elected to fill these
positions.
(2) Includes $1,079,185 earned by Mr. Perl during 1996 which was paid in 1997.
See "--Previous Employment Agreement."
(3) Represents amount contributed by the Bank pursuant to the Bank's 401(k)
Plan.
(4) Includes $500 contributed by the Bank pursuant to the Bank's 401(k) Plan.
Also includes a cash payment of $60,000 plus title to a 1996 automobile
with a market value of $27,800 pursuant to an agreement reached between
Mrs. Vineyard and the Bank upon her retirement from her position with the
Bank. See "--Consultation Agreement."
PREVIOUS EMPLOYMENT AGREEMENT
The Bank entered into an employment agreement with Mr. Perl on December 31,
1993. This employment agreement was intended to ensure that the Bank would be
able to maintain a stable and competent loan operation. The continued success
of the Bank depends to a significant degree on the skills and competence of
Mr. Perl. The employment agreement provided for a one year term which could be
extended for an additional three year period. The employment agreement
provided that Mr. Perl's base salary was $75,000. In addition to the base
salary, the employment agreement provided for Mr. Perl to receive certain
incentive compensation. The incentive compensation was determined by a
specific formula tied to the performance of the Bank's mortgage financing
operations. Mr. Perl earned approximately $1.5 million in incentive
compensation and $75,000 in base salary during the year ended December 31,
1996.
LETTER AGREEMENT
In order to ensure continuity of management during the period prior to the
Reorganization, the Company and the Bank and Mr. Perl have entered into the
Letter Agreement to replace the previous employment agreement, effective
January 1, 1997, through the later of the date of the completion of the Public
Offering and the Reorganization. The Letter Agreement also sets forth the
basic terms of the employment agreements between Mr. Perl and each of the Bank
and the Company upon the completion of the Reorganization. The terms of the
proposed agreements are set forth in "--Employment Agreements."
The Letter Agreement provides that during the period of its effectiveness,
Mr. Perl will serve as President and Chief Executive Officer of the Company
and the Bank, and will receive a base salary of $400,000 per year ("Base
Salary"), plus a bonus equal to 8.0% of the average after tax net income in
excess of 10.0% return on
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average equity, as defined in the letter agreement ("Bonus"). The Bonus should
be excluded from the Code Section 162(m) calculation of the $1 million maximum
limit on tax-deductible compensation payable to Mr. Perl pursuant to the rules
for newly public companies under Section 162(m) of the Code. Such Bonus shall
be payable no later than March 15, 1998. Payment of the Base Salary and Bonus
are dependent upon the Bank maintaining minimum regulatory capital
requirements and there being no OTS supervisory directive in place regarding
the Bank and its operations or the services performed by Mr. Perl.
The Letter Agreement provides for termination of Mr. Perl's employment by
the Bank or the Company for cause as defined in the Letter Agreement at any
time. In the event the Bank or the Company chooses to terminate Mr. Perl's
employment for reasons other than for cause during the effective period of the
Letter Agreement, Mr. Perl, or in the event of death, his beneficiary, would
be entitled to receive two times Base Salary plus a Bonus equal to $2.2
million. In the event the Bank is not in compliance with its minimum capital
requirements or if such payment would cause the Bank's capital to be reduced
below minimum regulatory capital requirements, such payments shall be deferred
until such time as the Bank or successor thereto is in capital compliance.
Under the Letter Agreement, in the event Mr. Perl voluntarily terminates his
employment with the Company or the Bank without the written approval of the
Boards of Directors of the Company and the Bank, as the case may be, Mr. Perl
has agreed not to compete with the Company or the Bank within the continental
United States for a period of one year following termination. Mr. Perl has
further agreed, in the event of a breach of the non-compete provision, to pay
as liquidated damages an aggregate sum of $500,000 in which event the non-
compete provision will expire.
EMPLOYMENT AGREEMENTS
Upon the consummation of the Reorganization, the Bank and the Company will
enter into employment agreements (collectively, the "Employment Agreements")
with Mr. Perl. The Employment Agreements are intended to ensure that the Bank
and the Company will be able to maintain a stable and competent management
base after the Offerings. The continued success of the Bank and the Company
depends to a significant degree on the skills and competence of Mr. Perl.
The Employment Agreements provide for three-year terms for Mr. Perl. The
Bank Employment Agreement provides that, commencing on the first anniversary
date and continuing each anniversary date thereafter, the Board of Directors
may extend the agreement for an additional year so that the remaining term
shall be three years, unless written notice of non-renewal is given by the
Board of Directors after conducting a performance evaluation of Mr. Perl. The
term of the Company Employment Agreement shall be extended on a daily basis
unless written notice of non-renewal is given by the Board of the Company. The
Bank and Company Employment Agreements provide that Mr. Perl's salary will be
reviewed annually. The Bank Employment Agreement provides that Mr. Perl will
receive a Base Salary of $150,000 per year while the Company Employment
Agreement provides that he will receive a Base Salary of $250,000 per year
(together, the "Base Salary"), plus a bonus equal to 8.0% of the average of
the after tax net income of the Company in excess of 10% return on average
equity, as defined in the Employment Agreements ("Bonus"). Such Base Salary is
pro rated between the Bank and the Company depending upon the duties performed
for and the obligations to each of the Bank and the Company, respectively,
while the Bonus shall be paid by the Company. The Bonus for each year shall be
payable by the Company no later than March 15 of the following year. In
addition to the Base Salary and Bonus, the Employment Agreements provide for,
among other things, participation in stock benefits plans and other fringe
benefits substantially equivalent to those in which Mr. Perl was participating
or otherwise deriving benefit from immediately prior to the beginning of the
terms of the Employment Agreements. The Employment Agreements provide for
termination by the Bank or the Company for cause as defined in the Employment
Agreements at any time. In the event the Bank or the Company chooses to
terminate Mr. Perl's employment for reasons other than for cause, or in the
event of Mr. Perl's resignation from the Bank or the Company upon: (i) failure
to re-elect Mr. Perl to his current offices; (ii) a material change in Mr.
Perl's functions, duties or responsibilities; (iii) a relocation of Mr. Perl's
principal place of employment by more than 30 miles; (iv) a material reduction
in the benefits or perquisites to Mr. Perl from those being provided at the
effective date of the Employment Agreement, unless consented to by Mr. Perl or
such reduction is part of a nondiscriminatory
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<PAGE>
reduction applicable to all employees; (v) liquidation or dissolution of the
Bank or the Company; or (vi) a breach of the Employment Agreement by the Bank
or the Company, Mr. Perl or, in the event of death, his beneficiary would be
entitled to receive, pursuant to the Bank Employment Agreement, those payments
due to Mr. Perl for the remaining term of the Employment Agreement or,
pursuant to the Company Employment Agreement, an amount equal to three times
his Base Salary under that Employment Agreement for the preceding year plus
two times his Bonus for the preceding year; provided, however, that in the
event that the Boards of Directors determine that such payment would have a
material adverse affect on the Company's financial condition or results of
operations, then the Company and the Bank shall pay Mr. Perl two times the
previous year's Base Salary under that Employment Agreement, Common Stock of
the Company having a fair market value equal to one times the previous year's
Base Salary under that Employment Agreement and two times the previous year's
Bonus. In the event that Mr. Perl is terminated without cause during 1997, he
will be entitled to two times Base Salary and a Bonus equal to $2.2 million.
The Bank and the Company would also continue to pay for Mr. Perl's life,
health, dental and disability coverage for the remaining term of the
Employment Agreement. Under certain circumstances, upon any termination of Mr.
Perl, he is subject to a non-compete and liquidated damages provision and a
confidentiality provision relating to information in his possession regarding
the Company or the Bank. In the event that Mr. Perl thereafter breaches the
non-compete provision, the Employment Agreements provide that he shall pay the
Bank and the Company, in the aggregate, $500,000, as liquidated damages, in
which event the non-compete provision will expire.
Under the Employment Agreements, if voluntary or involuntary termination
follows a change in control of the Bank or the Company, Mr. Perl or, in the
event of his death, his beneficiary, would be entitled to a severance payment
equal to the greater of: (i) the payments due for the remaining terms of the
agreement; or (ii) three times the average of the five preceding taxable
years' annual compensation. The Bank and the Company would also continue Mr.
Perl's life, health, and disability coverage for thirty-six months.
Payments to Mr. Perl under the Bank's Employment Agreement will be
guaranteed by the Company in the event that payments or benefits are not paid
by the Bank. In the event the Bank is not in compliance with its minimum
capital requirements or if any payment under the Bank Employment Agreement
would cause the Bank's capital to be reduced below minimum regulatory capital
requirements, such payments shall be deferred until such time as the Bank or
Successor thereto is in capital compliance. Payment under the Company's
Employment Agreement would be made by the Company. All reasonable costs and
legal fees paid or incurred by Mr. Perl pursuant to any dispute or question of
interpretation relating to the Employment Agreements shall be paid by the Bank
or Company, respectively, if Mr. Perl is successful on the merits pursuant to
a legal judgment, arbitration or settlement. The Employment Agreements also
provide that the Bank and Company shall indemnify Mr. Perl to the fullest
extent allowable under federal and Delaware law, respectively. In the event of
a change in control of the Bank or the Company during 1997, the total amount
of payments due under the Agreements, based on Base Salary to be paid to Mr.
Perl and Bonus would be $3.0 million.
CONSULTATION AGREEMENT
The Bank has entered into a five year consulting agreement with Mrs. Nora L.
Vineyard commencing on July 15, 1996 (the "Agreement"). Mrs. Vineyard will
receive compensation in the amount of $120,000 for a period of three years and
$90,000 for the remaining two years of the Agreement. The Agreement provides
Mrs. Vineyard with medical insurance during the term of the Agreement.
Pursuant to the terms of the Agreement, Mrs. Vineyard will be available to
provide advisory and consulting services and will give the Company and the
Bank the benefit of her special knowledge, skills, contacts and business
experience. A portion of the future payments due pursuant to this Agreement
were accrued and expensed during the year ended December 31, 1996. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Comparison of Operating Results for the Year Ended December 31,
1996 and December 31, 1995."
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<PAGE>
BENEFITS
Insurance Plans. All full-time employees are covered as a group for
comprehensive hospitalization, including major medical, long-term disability,
accidental death and dismemberment insurance and group term life insurance.
Cash Bonus Plan. The Bank adopted a cash bonus plan (the "Bonus Plan")
effective February 1996. All employees except for commissioned employees and
employees with employment contracts are eligible to participate. The Bonus
Plan paid an aggregate of approximately $100,000 in 1996. For 1997, the Bonus
Plan will pay bonuses in the aggregate of 15% of the after tax profits of the
Bank in excess of a 15% return on average equity, as defined in the Bonus
Plan.
401(k) Plan. The Bank maintains the Life Savings Bank Employee's Savings
Plan ("401(k) Plan"), a tax-qualified cash or deferred arrangement (i.e.,
401(k) feature), under Section 401(a) of the Code. The 401(k) Plan provides
participants with benefits upon retirement, death, disability or termination
of employment with the Bank. Employees are eligible to participate in the plan
following the completion of 6 months of service with the Bank and the
attainment of age 21.
Participants may authorize the Bank to contribute to the 401(k) Plan, on
their behalf, from 1% to 15% of their compensation, not to exceed certain
legally permissible limits, including an overall dollar limit of $9,500 for
1997. The 401(k) Plan provides for discretionary matching and profit sharing
contributions by the Bank. The Bank currently matches 25% of the first 8% of
the deferral by a Participant under the 401(k) Plan each year. Each plan year,
the Bank may also make an additional contribution to the 401(k) Plan (a
"profit sharing contribution"). The profit sharing contribution, if made by
the Bank, is allocated to each Participant's account based on the
Participant's compensation for the year relative to the compensation of all
participants for the year.
Participants are always 100% vested in their deferral contributions.
Participants become 20% vested in the Bank's matching contributions and profit
sharing contributions after the completion of two years of service with the
Bank. Their vested interest in the matching contributions and profit sharing
contributions increases by 20% for each year of service completed, so that
after the completion of 6 years of service, the Participant is 100% vested in
the Bank's matching contributions and profit sharing contributions.
A Participant's vested portion of his or her 401(k) Plan account is
distributable from the 401(k) Plan upon termination of the participant's
employment, death, disability or retirement. Participants may also receive
hardship distributions and loans from the 401(k) Plan. Any distribution made
to a Participant prior to the Participant's attainment of age 59 1/2 is
subject to a 10% tax penalty. The Board of Directors may at any time
discontinue the Bank's contributions to employee accounts. For the years ended
December 31, 1996, 1995 and 1994, the Bank's matching contributions to the
401(k) Plan were $21,000, zero and $7,000, respectively.
The 401(k) Plan permits Participants to direct the investment of their
401(k) plan account into various investment alternatives. The investment
accounts are valued daily and participants are provided with information
regarding the market value of the participant's investments and all
contributions made on his or her behalf on at least an annual basis. In
connection with the Reorganization of the Bank and the Offering, the Bank will
amend the 401(k) Plan to permit Participants to invest in an Employer Stock
Fund as one of the investment alternatives. The Employer Stock Fund will be
invested primarily in shares of Common Stock.
Employee Stock Purchase Plan. The Company has adopted, as of January 1997,
the Life Financial Employee Stock Purchase Plan ("ESPP"), pursuant to which
the Company may make available for sale to employees shares of its Common
Stock at a price equal to no less than 85% of the fair market value of the
Common Stock on the date of purchase. The ESPP is designed to give eligible
employees the opportunity to purchase shares of Company Common Stock through
payroll deductions of up to a specified amount of their total compensation.
The ESPP will become effective upon the completion of the Offerings.
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ESOP. Following the Reorganization and Offering, the Company intends to
implement an employee stock ownership plan ("ESOP"). The ESOP is intended to
be a tax-qualified retirement plan under Section 401(a) of the Code designed
to invest primarily in the Common Stock. The ESOP will provide eligible
employees with the opportunity to receive a Company-funded retirement benefit
based on the value of the Common Stock and any other investment held by the
plan. Employees of the Company who have completed certain eligibility and
minimum service requirements will be eligible to participate in the ESOP. The
Company's contributions to the ESOP will be allocated to participants accounts
based on the ratio each participant's compensation bears to all participants'
compensation. It is expected that a Participant's account under the ESOP will
vest at the same rate as employer contributions to the 401(k) Plan vest (i.e.
20% after two years of service with full vesting after six years). It is
anticipated that the shares purchased by the ESOP will be funded through
contributions from the general funds of the Company on an annual basis and
will equal up to two percent (2.0%) of the issued and outstanding shares of
the Company at the time of purchase. Any such contributions shall be at the
discretion of the Board of Directors of the Company. Although the ESOP does
permit the use of borrowed funds, it is not intended that borrowed funds will
be used to acquire such shares.
STOCK OPTION PLANS
The Board of Directors of the Bank adopted the Life Savings Bank, Federal
Savings Bank 1996 Stock Option Plan (the "Bank Option Plan"), a stock-based
benefit plan which provides for the granting of stock options to eligible
officers, employees and directors of the Bank, on November 21, 1996. The Board
of Directors of the Bank has reserved 321,600 shares for issuance under the
Bank Option Plan. The Bank Option Plan was approved by stockholders of the
Bank at an annual meeting held on May 21, 1997. Upon completion of the
Reorganization, the Bank Option Plan will, by operation of law and pursuant to
the Bank Option Plan, become an option plan of the Company.
The Board of Directors of the Company has adopted the Life Financial Corp.
1997 Stock Option Plan (the "Company Option Plan") which will become effective
upon the completion of the Public Offering (The Bank Option Plan and the
Company Option Plan will sometimes hereinafter be referred to as the "Option
Plans"). The Board of Directors of the Company has reserved shares equal to
10% of the issued and outstanding shares of the Company giving effect to the
Reorganization and the Public Offering, including Company options to be
exchanged for Bank options pursuant to the Bank Option Plan for issuance under
the Option Plans. Stock options with respect to shares of the Bank's Common
Stock granted under the Bank Option Plan and outstanding prior to completion
of the Reorganization will automatically become options to purchase three
shares of the Company's Common Stock upon identical terms and conditions. The
Company will assume all of the Bank's obligations with respect to the Bank
Option Plan. Following the completion of the Reorganization, the Option Plans
will be available to directors, officers and employees of the Company and to
directors, officers and employees of its direct or indirect subsidiaries,
including the Bank, as selected pursuant to the Option Plans and all
references to the Bank's Common Stock under the Bank Option Plan will be
deemed references to the Company's Common Stock. The following description of
the Option Plans reflects the Option Plans as they will exist upon
consummation of the Reorganization.
The stock option benefits provided under the Option Plans are designed to
attract and retain qualified directors and personnel in key positions, provide
directors, officers and key employees with a proprietary interest in the
Company, and as an incentive to contribute to the success of the Bank and the
Company and reward key employees for outstanding performance. The Option Plans
provides for the grant of: (i) options to purchase the Company's Common Stock
intended to qualify as incentive stock options under Section 422 of the Code
("Incentive Stock Options"); (ii) options that do not so qualify ("Non-
Statutory Stock Options"); and (iii) Limited Rights. Limited Rights are
exercisable only upon a change in control of the Bank or the Company. Upon
exercise of "Limited Rights" in the event of a change in control, the employee
will be entitled to receive a lump sum cash payment equal to the difference
between the exercise price of the related option and the fair market value of
the shares of common stock subject to the option on the date of exercise of
the right in lieu of purchasing the stock underlying the option. Except for
options granted to directors, all options granted contemporaneously with
adoption of the Option Plans are intended to be Incentive Stock Options to the
extent
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permitted under Section 422 of the Code. The Option Plans will be in effect
for a period of ten years from the dates of adoption by the Boards of
Directors of the Bank and the Company, respectively. It is intended that the
Option Plans will be revised to include a per person, per year grant limit in
order to prevent compensation attributable to options from being included in
the $1 million tax-deductible compensation cap of Section 162(m) of the Code.
Under the Option Plans, the Personnel/Compensation Committee determines
which officers and employees will be granted options and Limited Rights,
whether such options are to be incentive or non-statutory stock options, the
number of shares subject to each option, the exercise price of each stock
option, whether such options may be exercised by delivering other shares of
Common Stock and when such options become exercisable. The per share exercise
price of a stock option is required to be at least equal to the fair market
value of a share of Common Stock on the date the option is granted under the
Option Plan. The Bank Committee has granted options to purchase 192,960, and
12,540 shares respectively to Messrs. Perl and Passerino and has granted
options to purchase an aggregate of 25,080 shares to two other executive
officers as a group at an exercise price of $3.33, on a pro forma basis as of
December 31, 1996. An additional 25,000, 15,000 and 30,000 options have been
granted to Messrs. Perl and Passerino and two other executive officers as a
group, respectively, under the Company Option Plan at the Offering Price
effective as of the Reorganization.
An optionee will not be deemed to have received taxable income upon grant or
exercise of any Incentive Stock Option, provided that such shares received
through the exercise of such option are not disposed of by the employee for at
least one year after the date the stock is received in connection with the
option exercise and two years after the date of grant of the option. No
compensation deduction would be able to be taken by the Company as a result of
the grant or exercise of Incentive Stock Options, provided such shares are not
disposed of before the expiration of the period described above (a
"disqualifying disposition"). In the case of a Non-Statutory Stock Option and
in the case of a disqualifying disposition of an Incentive Stock Option, an
optionee will be deemed to receive ordinary income upon exercise of the stock
option in an amount equal to the amount by which the exercise price is
exceeded by the fair market value of the Common Stock purchased by exercising
the option on the date of exercise. The amount of any ordinary income deemed
to be received by an optionee upon the exercise of a Non-Statutory Stock
Option or due to a disqualifying disposition of an Incentive Stock Option
would be a deductible expense for tax purposes for the Company. In the case of
Limited Rights, upon exercise, the option holder would have to include the
amount paid to him or her upon exercise in his gross income for federal income
tax purposes in the year in which the payment is made and the Company would be
entitled to a deduction for federal income tax purposes of the amount paid.
Stock options will become vested and exercisable in the manner specified by
the Company. The options granted by the Bank in connection with the adoption
of the Bank Option Plan will vest at a rate of 33.3% per year, beginning on
November 21, 1999. It is anticipated that options granted by the Company in
connection with the Reorganization and the Public Offering under the Company
Option Plan will vest at a rate of 33.3% per year beginning on the third
anniversary of the date of the Reorganization and Public Offering. Incentive
Stock Options granted in connection with the Option Plans could be exercisable
for three months following the date on which the employee ceases to perform
services for the Bank or the Company, except that in the event of death,
disability, retirement or termination of an employee's service following
change in control of the Bank or the Company, options accelerate and become
fully vested and could be exercisable for up to one year thereafter or such
longer period as determined by the Company. However, any Incentive Stock
Options exercised more than three months following the date the employee
ceases to perform services as an employee would be treated as a Non-Statutory
Stock Option as described above. In the event of retirement, if the optionee
continues to perform services as a director on behalf of the Bank, the Company
or an affiliate, unvested options would continue to vest in accordance with
their original vesting schedule until the optionee ceases to serve as a
director. Non-Statutory Stock Options granted in connection with the Option
Plans could be exercisable for one year following the date on which the
employee ceases to perform services for the Bank or the Company, except that
in the case of death, disability, retirement or termination of the optionee's
service following a change in control, options accelerate and become fully
vested and could be exercisable for up to one year thereafter or such longer
period as determined by the Committee.
100
<PAGE>
All Options granted by the Bank to outside directors under the Bank Option
Plan would be Non-Statutory Stock Options and will vest and become exercisable
commencing three years after the date of adoption of the Bank Option Plan at
the rate of 33.3% per year, and would expire upon the earlier of ten years
following the date of grant or one year following the date the optionee ceases
to be a director or consulting director. The Committee has granted options to
purchase 9,180 shares to each of the outside directors of the Bank at an
exercise price of $3.33, on a pro forma basis as of December 31, 1996. It is
anticipated that options granted by the Company in connection with the
Reorganization and the Public Offering will vest at a rate of 33.3% per year
beginning on the third anniversary date of the Reorganization and the Public
Offering. The Compensation Committee of the Company has granted options to
purchase 17,500 shares to each of the outside directors under the Company
Option Plan at an exercise price equal to the Offering Price effective upon
the Reorganization. In the event of the death or disability of a participant
or termination of a participant's service following a change in control of the
Company or the Bank, all previously granted options would immediately vest and
become fully exercisable.
A change in control is be defined in the Option Plans generally to occur
when a person or group of persons acting in concert acquires beneficial
ownership of 20% or more of any class of equity security of the Company or the
Bank or in the event of a tender or exchange offer, merger or other form of
business combination, sale of all or substantially all of the assets of the
Company or the Bank or contested election of directors which resulted in the
replacement of a majority of the Board of Directors by persons not nominated
by the directors in office prior to the contested election.
The following table lists all grants of options and stock appreciation
rights ("SARs") under the Option Plan to the Named Executive Officers for
fiscal 1996 and contains certain information about the potential value of
those options based upon certain assumptions as to the appreciation of the
Company's stock over the life of the option.
OPTIONS GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
----------------------------------------------- VALUE AT ASSUMED
NUMBER OF % OF TOTAL EXERCISE ANNUAL RATES OF
SECURITIES OPTION/SARS OR STOCK PRICE
UNDERLYING GRANTED TO BASE APPRECIATION FOR
OPTIONS/ EMPLOYEES PRICE OPTIONS(1)
SARS GRANTED IN PER EXPIRATION ------------------
NAME (#)(2)(3)(4)(5) FISCAL YEAR SHARE DATE(6) 5% 10%
---- --------------- ----------- -------- ---------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Daniel L. Perl.......... 192,960 60.00% $3.33 11/21/06 $404,811 $1,021,665
Joseph R.L. Passerino... 12,540 3.90 3.33 11/21/06 26,308 66,396
</TABLE>
- --------
(1) The amounts represent certain assumed rates of appreciation. Actual gains,
if any, on stock option exercises and Common Stock holdings are dependent
on the future performance of the Common Stock and overall stock market
conditions. There can be no assurance that the amounts reflected in this
table will be realized.
(2) Options granted pursuant to the Bank Option Plan become exercisable in
equal installments at an annual rate of 33.3% beginning November 21, 1999,
unless otherwise accelerated.
(3) The purchase price may be paid in cash or in Common Stock.
(4) Under limited circumstances, such as death or disability of an employee,
the employee (or his beneficiary) may request that the Company, in
exchange for the employee's surrender of an option, pay to the employee
(or beneficiary), the amount by which the fair market value of the Common
Stock exceeds the exercise price of the option on the date of the
employee's termination of employment. It is within the Company's
discretion to accept or reject such a request.
(5) To the extent possible, options will be treated as incentive options.
(6) The option term is ten years.
101
<PAGE>
The following table provides certain information with respect to the number
of shares of Common Stock represented by outstanding options held by the Named
Executive Officers as of December 31, 1996. Also reported are the values for
"in-the-money" options which represent the positive spread between the
exercise price of any such existing stock options and the year end price of
the Common Stock. No stock appreciation rights were granted to the Named
Executive Officers during the year ended December 31, 1996.
FISCAL YEAR-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF SECURITIES UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTION/SARS AT
FISCAL YEAR END(#) FISCAL YEAR END($)
---------------------------- ----------------------------
NAME EXERCISABLE/UNEXERCISABLE(1) EXERCISABLE/UNEXERCISABLE(2)
- ---- ---------------------------- ----------------------------
<S> <C> <C>
Daniel L. Perl.......... 0/192,960 0/0
Joseph R.L. Passerino... 0/12,540 0/0
</TABLE>
- --------
(1) The options in this table have an exercise price of $3.33, and become
exercisable at an annual rate of 33.3% beginning November 21, 1999. The
options will expire ten years from the date of grant.
(2) Based on market value of the underlying stock at January 21, 1997, minus
the exercise price. The bid and ask prices for the Bank's common stock on
January 21, 1997 was $3.00 and $3.67 per share, respectively. Therefore,
using the average of the bid and ask prices, there is no positive spread
between the exercise price of the options and the price of the common
stock of the Bank.
TRANSACTIONS WITH CERTAIN RELATED PERSONS
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA") requires that all loans or extensions of credit to executive
officers and directors must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with the general public and must not involve more than the normal
risk of repayment or present other unfavorable features. In addition, loans
made to a director or executive officer in excess of the greater of $25,000 or
5% of the Bank's capital and surplus (up to a maximum of $500,000) must be
approved in advance by a majority of the disinterested members of the Board of
Directors.
The Bank's current policy provides that all loans made by the Bank to its
directors and officers are made in the ordinary course of business, are made
on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with other persons
and do not involve more than the normal risk of collectibility or present
other unfavorable features. During 1996, the law firm of Keller and Keller
provided legal representation to the Bank for which it was paid approximately
$2,300 for legal fees and related services. Until his retirement in 1996, Mr.
Edgar C. Keller, a director of the Bank was a partner with Keller and Keller.
In addition, the Bank purchased four policies of insurance from Caldwell &
Moreland Insurance Brokers, Inc. for approximately $45,000 which yielded
commissions of approximately $5,600. Richard C. Caldwell is a director of the
Bank and the Company and a partner of Caldwell & Moreland Insurance Brokers,
Inc.
SECURITY OWNERSHIP OF MANAGEMENT AND OTHER BENEFICIAL OWNERS
At March 31, 1997, the Bank had 1,070,572 shares of common stock
outstanding. In connection with the Reorganization each share of common stock
will be exchanged for three shares of the Common Stock of the Company.
102
<PAGE>
The following table sets forth, as of March 31, 1997, on a pro forma basis,
giving effect to the Reorganization and the sale of 2,900,000 shares in the
Public Offering, certain information as to those persons who were known by
management to be beneficial owners of more than 5% of the Company's
outstanding shares of Common Stock, each director, each Named Executive
Officer and the shares of Common Stock beneficially owned by all directors and
executive officers of the Company as a group.
<TABLE>
<CAPTION>
PERCENTAGE
BENEFICIALLY
OWNED(1)
-----------------
BEFORE AFTER
NAME OF NUMBER OF PUBLIC PUBLIC
BENEFICIAL OWNER POSITION(S) WITH THE BANK SHARES(1) OFFERING OFFERING
---------------- -------------------------- --------- -------- --------
<S> <C> <C> <C> <C>
Richard C. Caldwell Chairman of the Board 180,678(2) 5.63% 2.96%
John D. Goddard Director 169,926(3) 5.29 2.78
Ronald G. Skipper Director 156,000(4) 4.86 2.55
Milton E. Johnson Director 113,526(5) 3.53 1.86
Daniel L. Perl Director, President and Chief 74,922(6) 2.33 1.23
Executive Officer
Edgar C. Keller Director 51,522(7) 1.60 0.84
Joseph R.L. Passerino Senior Vice President 4,428 0.14 0.07
L. Bruce Mills Jr. Executive Vice President, 1,098 0.03 0.02
Secretary and Treasurer
Bay Pond Investors Bermuda 316,500 9.85 5.18
LP(8)
Bay Pond Partners LP(8)
One Pierpoint Plaza
Brooklyn, New York 11201
Rath Foundation 300,000 9.34 4.91
3140 Box Canyon Road
Santa Ynez, California 93460
Kramer Spellman, L.P.(9) 280,500 8.73 4.59
Pine Boston Partners LP(9)
Boston Provident Partners LP(9)
BP Institutional Partners
LP(9)
Maritime Global Subsidiary I,
Ltd.(9)
2050 Center Avenue
Suite 300
Fort Lee, New Jersey 07024
All Executive Officers and 752,100(10)(11) 23.42 12.31
Directors as a Group
(9 persons)
</TABLE>
- --------
(1) The number of shares of Common Stock outstanding and the number owned by
the individuals or entities listed does not include any shares issuable
pursuant to outstanding options, none of which may be exercised until
November 21, 1999.
(2) All shares are held through a qualified employee benefit plan in which
Mr. Caldwell is a participant.
(3) Of these shares, 76,128 are held by Mr. Goddard and his wife as joint
tenants and 93,798 are held in the John D. Goddard Corporation Profit
Sharing Plan and Trust.
(4)These shares are held in the Ronald Skipper Pension Sharing Plan.
(5) Of these shares, 14,004 are held by Mr. Johnson and his wife as joint
tenants, 83,646 are held in an IRA account for Mr. Johnson and his wife,
9,414 are held in custodial accounts for minors, 4,614 are held in joint
tenancy with other family members and 1,848 are owned of record by two
other family members.
103
<PAGE>
(6) Of these shares, 22,506 are held in joint tenancy with Mr. Perl's wife
and 52,416 are held in the Navieve Financial Corp. Profit Sharing Trust.
(7) Of these shares, 46,122 are held as tenants in common with another party.
(8) Bay Pond Investors Bermuda LP holds 79,500 shares and Bay Pond Partners
LP holds 237,000 shares.
(9) Kramer Spellman, L.P. is the general partner of Pine Boston Partners LP,
Boston Provident Partners LP and BP Institutional Partners LP, and is the
discretionary investment manager of Maritime Global Subsidiary I, Ltd. Of
the 280,500 shares, 36,300 are held by Maritime Global Subsidiary--LTD,
36,600 are held by Pine Boston Partner LP, 182,400 are held by Boston
Provident Partners LP and 25,200 are held by BP Institutional Partners
LP.
(10) Does not include 46,122 shares of Common Stock held by Mrs. Nora L.
Vineyard who is currently serving as a consultant to the Bank.
(11) Does not include 24,480 shares held by Louis E. Yeager who retired from
the Bank's Board of Directors on May 21, 1997.
104
<PAGE>
THE REORGANIZATION
GENERAL
The Boards of Directors of the Bank and the Company unanimously approved and
entered into the Plan of Reorganization pursuant to which the Bank will be
reorganized into a holding company structure and become the wholly owned
subsidiary of the Company and each share of common stock of the Bank
outstanding immediately prior to the Reorganization will be converted into
three shares of Company Common Stock. The Plan of Reorganization contemplates
that the Reorganization will be a tax-free transaction under the Code.
The Plan of Reorganization has been approved by the OTS. The Plan of
Reorganization was approved by the affirmative vote of the holders of a
majority of the outstanding shares of the Bank's common stock eligible to be
cast at the adjourned annual meeting of stockholders held on June 20, 1997.
The Reorganization will be consummated immediately prior to the closing of the
Public Offering.
TAX CONSEQUENCES OF REORGANIZATION
The following discussion of the material federal income tax consequences of
the Reorganization is based on the Code, Treasury regulations, Internal
Revenue Service rulings, and judicial and administrative decisions in effect
as of the date hereof, all of which are subject to change at any time,
possibly with retroactive effect. The following discussion does not address
all of the federal income tax consequences that may be relevant to Bank
stockholders in light of such holders' particular circumstances or to holders
subject to special rules, such as foreign persons, financial institutions,
tax-exempt organizations or insurance companies.
The Bank has received an opinion of Muldoon, Murphy & Faucette, with regard
to federal income tax matters, and from Deloitte & Touche LLP, with regard to
California state income tax matters to the effect that, assuming the
Reorganization is consummated under the Plan of Reorganization and provided
that in the transaction the stockholders of the Bank will exchange stock
possessing control (defined to be at least 80% of the total vote and value) of
all classes of the Bank stock for Common Stock of the Company, then, the
Reorganization will constitute a reorganization within the meaning of Section
368(a)(1)(A) of the Code and that: (1) no gain or loss will be recognized by
the Bank upon the receipt of assets of Interim in exchange for Bank common
stock; (2) no gain or loss will be recognized by the stockholders of the Bank
upon the transfer of their common stock in the Bank to the Company solely for
the Company's Common Stock; (3) the total basis of the Company's Common Stock
to be received by the stockholders of the Bank in the Reorganization will, in
each instance, be the same as the total basis of such common stock of the
Bank, exchanged therefor; (4) the holding period of Company Common Stock
received by the stockholders of the Bank in the Reorganization will, in each
instance, include the period during which the stockholders held the Bank
common stock exchanged therefor, provided, that the Bank's common stock is
held as a capital asset on the date of the Reorganization; (5) no gain or loss
will be recognized by the Bank as a result of the transaction; and (6) no gain
or loss will be recognized by the Company upon its receipt of the Bank's
common stock solely in exchange for the issuance of Company Common Stock to
Bank stockholders. Accordingly, if the Reorganization transaction satisfies
the conditions noted above, the Reorganization will have no adverse federal or
state income tax effects on the Company, the Bank, or the stockholders of the
Bank.
RESTRICTIONS ON ACQUISITION OF THE COMPANY
GENERAL
Certain provisions in the Company's Certificate of Incorporation and Bylaws
and in its management remuneration, together with provisions of Delaware
corporate law, may have anti-takeover effects. Regulatory restrictions may
also make it difficult for persons or companies to acquire control of the
Company. In addition, under certain circumstances, the Company may be subject
to section 2115 of the California General Corporation
105
<PAGE>
Law. This may have the effect of superseding certain provisions of the
Company's Certificate of Incorporation and Bylaws as interpreted by Delaware
law, particularly those provisions providing for a staggered board of
directors, eliminating cumulative voting, electing and removing directors,
calling of special meetings and approval of certain corporate transactions. In
addition, California law is more restrictive than Delaware law as to the
payment of dividends. However, if its securities remain listed on the National
Market System of the Nasdaq Stock Market and there are at least 800
stockholders, or if fewer than 50% of the Company's stockholders have
addresses outside California, the Company will be exempt from the provisions
of Section 2115.
RESTRICTIONS IN THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
A number of provisions of the Company's Certificate of Incorporation and
Bylaws deal with matters of corporate governance and certain rights of
stockholders. The following discussion is a general summary of the provisions
of the Company's Certificate of Incorporation and Bylaws which might be deemed
to have a potential "anti-takeover" effect. These provisions may have the
effect of discouraging a future takeover attempt which is not approved by the
Board of Directors but which individual Company stockholders may deem to be in
their best interests or in which stockholders may receive a substantial
premium for their shares over then current market prices. As a result,
stockholders who might desire to participate in such a transaction may not
have an opportunity to do so. Such provisions will also render the removal of
the current Board of Directors or management of the Company more difficult.
The following description of certain of the provisions of the Certificate of
Incorporation and Bylaws of the Company is necessarily general and reference
should be made in each case to such Certificate of Incorporation and Bylaws,
which are incorporated herein by reference. See "Additional Information" as to
how to obtain a copy of these documents.
Limitation on Voting Rights. The Certificate of Incorporation of the Company
provides that in no event shall any record owner of any outstanding Common
Stock which is beneficially owned, directly or indirectly, by a person who
beneficially owns in excess of 10% of the then outstanding shares of Common
Stock (the "Limit") be entitled or permitted to any vote in respect of the
shares held in excess of the Limit. Beneficial ownership is determined
pursuant to Rule 13d-3 of the General Rules and Regulations promulgated
pursuant to the Exchange Act, and includes shares beneficially owned by such
person or any of his affiliates (as defined in the Certificate of
Incorporation), shares which such person or his affiliates have the right to
acquire upon the exercise of conversion rights or options and shares as to
which such person and his affiliates have or share investment or voting power,
but shall not include shares beneficially owned by employee benefit plans or
directors, officers and employees of the Bank or Company or shares that are
subject to a revocable proxy and that are not otherwise beneficially owned, or
deemed by the Company to be beneficially owned, by such person and his
affiliates. The Certificate of Incorporation also contains provisions
authorizing the Board of Directors to construe and apply the Limit and to
demand that any person reasonably believed to beneficially own Common Stock in
excess of the Limit (or hold of record Common Stock beneficially owned in
excess of the Limit) to provide the Company with certain information. No
assurance can be given that a court applying Delaware law would enforce such
provisions of the Certificate of Incorporation. The Certificate of
Incorporation of the Company further provides that this provision limiting
voting rights may only be amended upon the vote of 80% of the outstanding
shares of voting stock (after giving effect to the limitation on voting
rights).
Board of Directors. The Board of Directors of the Company is divided into
three classes, each of which shall contain approximately one-third of the
whole number of members of the Board. Each class shall serve a staggered term,
with approximately one-third of the total number of directors being elected
each year. The Company's Certificate of Incorporation and Bylaws provide that
the size of the Board shall be determined by a majority of the directors. The
Certificate of Incorporation and the Bylaws provide that any vacancy occurring
in the Board, including a vacancy created by an increase in the number of
directors or resulting from death, resignation, retirement, disqualification,
removal from office or other cause, may be filled for the remainder of the
unexpired term exclusively by a majority vote of the directors then in office.
The classified Board is intended to provide for continuity of the Board of
Directors and to make it more difficult and time consuming for a stockholder
group to fully use its voting power to gain control of the Board of Directors
without the consent of
106
<PAGE>
the incumbent Board of Directors of the Company. The Certificate of
Incorporation of the Company provides that a director may be removed from the
Board of Directors prior to the expiration of his term only for cause, upon
the vote of 80% of the outstanding shares of voting stock.
In the absence of these provisions, the vote of the holders of a majority of
the shares could remove the entire Board, with or without cause, and replace
it with persons of such holders' choice.
Cumulative Voting, Special Meetings and Action by Written Consent. The
Certificate of Incorporation does not provide for cumulative voting for any
purpose. Moreover, special meetings of stockholders of the Company may be
called only by the Board of Directors of the Company. The Certificate of
Incorporation also provides that any action required or permitted to be taken
by the stockholders of the Company may be taken only at an annual or special
meeting and prohibits stockholder action by written consent in lieu of a
meeting.
Authorized Shares. The Certificate of Incorporation authorizes the issuance
of 25,000,000 shares of Common Stock and 5,000,000 shares of Preferred Stock.
The shares of Common Stock and Preferred Stock were authorized in an amount
greater than that to be issued in the Reorganization and the Public Offering
to provide the Company's Board of Directors with as much flexibility as
possible to effect, among other transactions, financings, acquisitions, stock
dividends, stock splits and employee stock options. However, these additional
authorized shares may also be used by the Board of Directors consistent with
its fiduciary duty to deter future attempts to gain control of the Company.
The Board of Directors also has sole authority to determine the terms of any
one or more series of Preferred Stock, including voting rights, conversion
rates, and liquidation preferences. As a result of the ability to fix voting
rights for a series of Preferred Stock, the Board has the power, to the extent
consistent with its fiduciary duty, to issue a series of Preferred Stock to
persons friendly to management in order to attempt to block a post-tender
offer merger or other transaction by which a third party seeks control, and
thereby assist management to retain its position. The Company's Board of
Directors currently has no plans for the issuance of additional shares, other
than the issuance of additional shares and upon exercise of stock options to
be issued pursuant to the terms of the Incentive Plan.
Stockholder Vote Required to Approve Business Combinations with Principal
Stockholders. The Certificate of Incorporation requires the approval of the
holders of 80% of the Company's outstanding shares of voting stock to approve
certain "Business Combinations," as defined therein, and related transactions.
Under Delaware law, absent this provision, Business Combinations, including
mergers, consolidations and sales of all or substantially all of the assets of
a corporation must, subject to certain exceptions, be approved by the vote of
the holders of only a majority of the outstanding shares of Common Stock of
the Company and any other affected class of stock. Under the Certificate of
Incorporation, 80% approval of stockholders is required in connection with any
transaction involving an Interested Stockholder (as defined below) except (i)
in cases where the proposed transaction has been approved in advance by a
majority of those members of the Company's Board of Directors who are
unaffiliated with the Interested Stockholder and were directors prior to the
time when the Interested Stockholder became an Interested Stockholder or (ii)
if the proposed transaction meets certain conditions set forth therein which
are designed to afford the stockholders a fair price in consideration for
their shares in which case, if a stockholder vote is required, approval of
only a majority of the outstanding shares of voting stock would be sufficient.
The term "Interested Stockholder" is defined to include any individual,
corporation, partnership or other entity (other than the Company or its
subsidiary) which owns beneficially or controls, directly or indirectly, 10%
or more of the outstanding shares of voting stock of the Company. This
provision of the Certificate of Incorporation applies to any "Business
Combination," which is defined to include: (i) any merger or consolidation of
the Company or any of its subsidiaries with or into any Interested Stockholder
or Affiliate (as defined in the Certificate of Incorporation) of an Interested
Stockholder; (ii) any sale, lease, exchange, mortgage, transfer, or other
disposition to or with any Interested Stockholder or Affiliate of 25% or more
of the assets of the Company or combined assets of the Company and its
subsidiary; (iii) the issuance or transfer to any Interested Stockholder or
its Affiliate by the Company (or any subsidiary) of any securities of the
Company in exchange for any assets, cash or securities the value of which
equals or exceeds 25% of the fair market value of the Common Stock of the
Company; (iv) the adoption of any plan for the liquidation or dissolution of
the Company proposed by or on behalf of any Interested Stockholder or
Affiliate thereof; and (v) any reclassification
107
<PAGE>
of securities, recapitalization, merger or consolidation of the Company which
has the effect of increasing the proportionate share of Common Stock or any
class of equity or convertible securities of the Company owned directly or
indirectly by an Interested Stockholder or Affiliate thereof.
Evaluation of Offers. The Certificate of Incorporation of the Company
further provides that the Board of Directors of the Company, when evaluating
any offer of another "Person" (as defined therein) to: (i) make a tender or
exchange offer for any equity security of the Company; (ii) merge or
consolidate the Company with another corporation or entity; or (iii) purchase
or otherwise acquire all or substantially all of the properties and assets of
the Company, may, in connection with the exercise of its judgment in
determining what is in the best interest of the Company, the Bank and the
stockholders of the Company, give due consideration to all relevant factors,
including, without limitation, the social and economic effects of acceptance
of such offer on the Company's customers and the Bank's present and future
account holders, borrowers and employees; on the communities in which the
Company and the Bank operate or are located; and on the ability of the Company
to fulfill its corporate objectives as a savings and loan holding company and
on the ability of the Bank to fulfill the objectives of a federally chartered
stock savings association under applicable statutes and regulations. No
assurance can be given that a court applying Delaware law would enforce the
foregoing provision of the Certificate of Incorporation. By having these
standards in the Certificate of Incorporation of the Company, the Board of
Directors may be in a stronger position to oppose such a transaction if the
Board concludes that the transaction would not be in the best interest of the
Company, even if the price offered is significantly greater than the then
market price of any equity security of the Company.
Amendment of Certificate of Incorporation and Bylaws. Amendments to the
Company's Certificate of Incorporation must be approved by a majority vote of
its Board of Directors and also by a majority of the outstanding shares of its
voting stock; provided, however, that an affirmative vote of at least 80% of
the outstanding voting stock entitled to vote (after giving effect to the
provision limiting voting rights) is required to amend or repeal certain
provisions of the Certificate of Incorporation, including the provision
limiting voting rights, the provisions relating to approval of certain
business combinations, calling special meetings, the number and classification
of directors, director and officer indemnification by the Company and
amendment of the Company's Bylaws and Certificate of Incorporation. The
Company's Bylaws may be amended by its Board of Directors, or by a vote of 80%
of the total votes eligible to be voted at a duly constituted meeting of
stockholders.
Certain Bylaw Provisions. The Bylaws of the Company also require a
stockholder who intends to nominate a candidate for election to the Board of
Directors, or to raise new business at a stockholder meeting to give at least
90 days advance notice to the Secretary of the Company. The notice provision
requires a stockholder who desires to raise new business to provide certain
information to the Company concerning the nature of the new business, the
stockholder and the stockholder's interest in the business matter. Similarly,
a stockholder wishing to nominate any person for election as a director must
provide the Company with certain information concerning the nominee and the
proposing stockholder.
ANTI-TAKEOVER EFFECTS OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
AND MANAGEMENT REMUNERATION
The provisions described above are intended to reduce the Company's
vulnerability to takeover attempts and certain other transactions which have
not been negotiated with and approved by members of its Board of Directors.
The provisions of the employment agreement with Mr. Perl and the Stock Option
Plans may also discourage takeover attempts by increasing the costs to be
incurred by the Bank and the Company in the event of a takeover. See "The
Board of Directors and Management of the Bank--Employment Agreements" and "--
Stock Option Plans."
The Company's Board of Directors believes that the provisions of the
Certificate of Incorporation, Bylaws and management remuneration plans to be
established are in the best interest of the Company and its stockholders. An
unsolicited non-negotiated proposal can seriously disrupt the business and
management of a corporation and cause it great expense. Accordingly, the Board
of Directors believes it is in the best interests of
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the Company and its stockholders to encourage potential acquirors to negotiate
directly with management and that these provisions will encourage such
negotiations and discourage non-negotiated takeover attempts. It is also the
Board of Directors' view that these provisions should not discourage persons
from proposing a merger or other transaction at a price that reflects the true
value of the Company and that otherwise is in the best interest of all
stockholders.
DELAWARE CORPORATE LAW
The State of Delaware has a statute designed to provide Delaware
corporations with additional protection against hostile takeovers. The
takeover statute, which is codified in Section 203 of the Delaware General
Corporate Law ("Section 203"), is intended to discourage certain takeover
practices by impeding the ability of a hostile acquiror to engage in certain
transactions with the target company.
In general, Section 203 provides that a "Person" (as defined therein) who
owns 15% or more of the outstanding voting stock of a Delaware corporation (an
"Interested Stockholder") may not consummate a merger or other business
combination transaction with such corporation at any time during the three-
year period following the date such "Person" became an Interested Stockholder.
The term "business combination" is defined broadly to cover a wide range of
corporate transactions including mergers, sales of assets, issuances of stock,
transactions with subsidiaries and the receipt of disproportionate financial
benefits.
The statute exempts the following transactions from the requirements of
Section 203: (i) any business combination if, prior to the date a person
became an Interested Stockholder, the Board of Directors approved either the
business combination or the transaction which resulted in the stockholder
becoming an Interested Stockholder; (ii) any business combination involving a
person who acquired at least 85% of the outstanding voting stock in the
transaction in which he became an Interested Stockholder, with the number of
shares outstanding calculated without regard to those shares owned by the
corporation's directors who are also officers and by certain employee stock
plans; (iii) any business combination with an Interested Stockholder that is
approved by the Board of Directors and by a two-thirds vote of the outstanding
voting stock not owned by the Interested Stockholder; and (iv) certain
business combinations that are proposed after the corporation had received
other acquisition proposals and which are approved or not opposed by a
majority of certain continuing members of the Board of Directors. A
corporation may exempt itself from the requirements of the statute by adopting
an amendment to its Certificate of Incorporation or Bylaws electing not to be
governed by Section 203. At the present time, the Board of Directors does not
intend to propose any such amendment.
REGULATORY RESTRICTIONS ON ACQUISITIONS OF THE COMPANY
Any proposal to acquire 10% of any class of equity security of the Company
generally would be subject to approval by the OTS under the Change in Bank
Control Act. The OTS requires all persons seeking control of a savings
institution, and, therefore, indirectly its holding company, to obtain
regulatory approval prior to offering to obtain control. Federal law generally
provides that no "person," acting directly or indirectly or through or in
concert with one or more other persons, may acquire directly or indirectly
"control," as that term is defined in OTS regulations, of a federally-insured
savings institution without giving at least 60 days' written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition.
Such acquisitions of control may be disapproved if it is determined, among
other things, that: (i) the acquisition would substantially lessen
competition; (ii) the financial condition of the acquiring person might
jeopardize the financial stability of the savings institution or prejudice the
interests of its depositors; or (iii) the competency, experience or integrity
of the acquiring person or the proposed management personnel indicates that it
would not be in the interest of the depositors or the public to permit the
acquisition of control by such person. Such change in control restrictions on
the acquisition of holding company stock are not limited to three years after
conversion but will apply for as long as the regulations are in effect.
Persons holding revocable or irrevocable proxies may be deemed to be
beneficial owners of such securities under OTS regulations and therefore
prohibited from voting all or the portion of such proxies in excess of the 10%
aggregate beneficial ownership limit. Such regulatory restrictions may prevent
or inhibit proxy contests for control of the Company or the Bank which have
not received prior regulatory approval.
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DESCRIPTION OF CAPITAL STOCK OF THE COMPANY
GENERAL
The Company is authorized to issue 25,000,000 shares of Common Stock having
a par value of $.01 per share and 5,000,000 shares of preferred stock having a
par value of $.01 per share (the "Preferred Stock"). The Company currently
expects to issue 3,211,716 shares of Common Stock and no shares of Preferred
Stock in the Reorganization and 2,900,000 shares in the Public Offering
(3,335,000 shares, if the Underwriter's overallotment option is exercised in
full). Except as discussed above in "Restrictions on Acquisition of the
Company," each share of the Company's Common Stock will have the same relative
rights as, and will be identical in all respects with, each other share of
Common Stock. Upon payment of the Purchase Price for the Common Stock, all
such stock will be duly authorized, fully paid and non-assessable.
The Common Stock of the Company will represent non-withdrawable capital,
will not be an account of an insurable type, and will not be insured by the
FDIC or any governmental agency.
COMMON STOCK
Dividends. The Company can pay dividends out of statutory surplus or from
certain net profits if, as and when declared by its Board of Directors. The
payment of dividends by the Company is subject to limitations which are
imposed by law and applicable regulation. See "Dividend Policy" and
"Regulation." The holders of Common Stock of the Company will be entitled to
receive and share equally in such dividends as may be declared by the Board of
Directors of the Company out of funds legally available therefor. If the
Company issues Preferred Stock, the holders thereof may have a priority over
the holders of the Common Stock with respect to dividends.
Voting Rights. The holders of Common Stock of the Company will possess
exclusive voting rights in the Company. They will elect the Company's Board of
Directors and act on such other matters as are required to be presented to
them under Delaware law or the Company's Certificate of Incorporation or as
are otherwise presented to them by the Board of Directors. Except as discussed
in "Restrictions on Acquisition of the Company," each holder of Common Stock
will be entitled to one vote per share and will not have any right to cumulate
votes in the election of directors. If the Company issues Preferred Stock,
holders of the Preferred Stock may also possess voting rights. Certain matters
require an 80% shareholder vote. See "Restrictions on Acquisition of the
Company."
As a federal savings bank, corporate powers and control of the Bank are
vested in its Board of Directors, who elect the officers of the Bank and who
fill any vacancies on the Board of Directors. Subsequent to the
Reorganization, voting rights will be vested exclusively in the owners of the
shares of capital stock of the Bank, which will be the Company, and voted at
the direction of the Company's Board of Directors. Consequently, the holders
of the Common Stock will not have direct control of the Bank.
Liquidation. In the event of any liquidation, dissolution or winding up of
the Bank, the Company, as holder of the Bank's capital stock, would be
entitled to receive, after payment or provision for payment of all debts and
liabilities of the Bank (including all deposit accounts and accrued interest
thereon) all assets of the Bank available for distribution. In the event of
liquidation, dissolution or winding up of the Company, the holders of its
Common Stock would be entitled to receive, after payment or provision for
payment of all its debts and liabilities, all of the assets of the Company
available for distribution. If Preferred Stock is issued, the holders thereof
may have a priority over the holders of the Common Stock in the event of
liquidation or dissolution.
Preemptive Rights. Holders of the Common Stock of the Company will not be
entitled to preemptive rights with respect to any shares which may be issued.
The Common Stock is not subject to redemption.
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PREFERRED STOCK
None of the shares of the Company's authorized Preferred Stock will be
issued in the Reorganization or the Public Offering. Such stock may be issued
with such preferences and designations as the Board of Directors may from time
to time determine. The Board of Directors can, without stockholder approval,
issue preferred stock with voting, dividend, liquidation and conversion rights
which could dilute the voting strength of the holders of the Common Stock and
may assist management in impeding an unfriendly takeover or attempted change
in control.
DESCRIPTION OF CAPITAL STOCK OF THE BANK
GENERAL
The Federal Stock Charter of the Bank authorizes the issuance of capital
stock consisting of 10,000,000 shares of common stock, stated value $8.00 per
share. Each share of Common Stock of the Bank will have the same relative
rights as, and will be identical in all respects with, each other share of
common stock. Currently, 1,070,572 shares of Common Stock are issued and
outstanding, held of record as of April 22, 1997 by approximately 406
stockholders.
COMMON STOCK
Dividends. The holders of the Bank's common stock will be entitled to
receive and to share equally in such dividends as may be declared by the Board
of Directors of the Bank out of funds legally available therefor. See
"Dividend Policy" for certain restrictions on the payment of dividends.
Voting Rights. Holders of the Bank's common stock will possess exclusive
voting rights in the Bank. Each holder of Common Stock will be entitled to one
vote for each share held of record on each matter submitted to a vote, subject
to the right of stockholders to cumulate their votes for the election of
directors.
Liquidation. In the event of any liquidation, dissolution, or winding up of
the Bank, the holders of common stock will be entitled to receive, after
payment of all debts and liabilities of the Bank (including all deposit
accounts and accrued interest thereon), all assets of the Bank available for
distribution in cash or in kind. Holders of Common Stock have no conversion,
preemptive or other subscription rights, and there are no redemption or
sinking fund provisions with respect to the Common Stock.
TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services, L.L.C., Los Angeles, California is the
transfer agent and registrar for the Company's Common Stock.
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SHARES ELIGIBLE FOR FUTURE SALE
The Company's Certificate of Incorporation authorizes the issuance of
25,000,000 shares of Common Stock. Upon completion of the Reorganization and
the Public Offering, there will be outstanding 6,111,716 shares of Common
Stock (6,546,716 shares if the Underwriter's over-allotment option is
exercised in full).
All shares of Common Stock issued in the Offerings will be available for
resale in the public market without restriction or further registration under
the Securities Act, except for shares purchased by affiliates of the Company
(in general, any person who has a control relationship with the Company) or
shares exchanged by affiliates in the Reorganization, which shares will be
subject to the resale limitations of Rule 144. After the Offerings, shares of
Common Stock held by affiliates will be considered to be "control shares" and
611,172 shares of Common Stock (654,672 shares if the Underwriter's over-
allotment option is exercised in full) issuable upon the exercise of options
that the Company has granted or agreed to grant will be "restricted
securities" within the meaning of Rule 144, and are eligible for sale in the
public market in compliance with Rule 144. At the first meeting of
stockholders of the Company, the Company intends to file a registration
statement on Form S-8 under the Securities Act registering approximately
611,172 shares of Common Stock (654,672 shares if the Underwriter's over-
allotment option is exercised in full) issuable upon the exercise of options
granted or to be granted pursuant to the Company's Option Plan. Upon
effectiveness of the registration statement, shares issued to nonaffiliates
upon the exercise of the options generally will be freely tradeable without
restriction or further registration under the Securities Act. All officers and
directors of the Company have agreed, subject to certain exceptions, that they
will not offer, sell or otherwise dispose of any shares of Common Stock owned
by them for a period of 180 days after the date of this Prospectus without the
prior written consent of Keefe, Bruyette & Woods, Inc. The Company has agreed,
subject to certain exceptions, that it will not offer, sell or otherwise
dispose of any shares of Common Stock for a period of 180 days after the date
of this Prospectus without the prior written consent of Keefe, Bruyette &
Woods, Inc.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including a person who may be deemed to be an
"affiliate" of the Company as that term is defined under the Securities Act,
is entitled to sell, within any three-month period, a number of restricted
shares as to which at least one year has elapsed from the later of the
acquisition of such shares from the Company or an affiliate of the Company in
an amount that does not exceed the greater of (i) one percent of the then
outstanding shares of Common Stock (61,117 shares based upon 6,111,716 shares
to be outstanding immediately after the Offerings), or (ii) if the Common
Stock is quoted on the National Market System of the Nasdaq Stock Market or a
stock exchange, the average weekly trading volume of the Common Stock during
the four calendar weeks preceding such sale. Sales under Rule 144 are also
subject to certain requirements as to the manner of sale, notice, and the
availability of current public information about the Company. However, a
person who is not deemed to have been an affiliate of the Company during the
90 days preceding a sale by such person and who has beneficially owned shares
as to which at least two years has elapsed from the later of the acquisition
of such shares from the Company or an affiliate of the Company is entitled to
sell them without regard to the volume, manner of sale, or notice requirements
of Rule 144.
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UNDERWRITING
Subject to the terms and conditions of the underwriting agreement (the
"Underwriting Agreement"), Keefe, Bruyette & Woods, Inc. (the "Underwriter")
has agreed to purchase from the Company 2,900,000 shares of Common Stock at
the initial public offering price less the underwriting discounts and
commissions set forth on the cover page of the Prospectus.
The Underwriting Agreement provides that the obligations of the Underwriter
are subject to certain conditions precedent, and that the Underwriter will
purchase all of the Common Stock offered hereby if any of such shares are
purchased.
The Company has been advised by the Underwriter that it proposes initially
to offer the Common Stock to the public at the initial public offering price
set forth on the cover page of this Prospectus and to certain dealers at such
price less a concession not in excess of $0.45 per share. The Underwriter may
allow, and such dealers may re-allow, a discount not in excess of $0.10 per
share to certain other dealers. After the initial public offering of the
Common Stock, the offering price and other selling terms may be changed by the
Underwriter.
The Underwriter has reserved 86,500 shares of Common Stock offered in the
Public Offering for sale at the initial public offering price to directors,
officers and employees of the Company and the Bank and to certain other
persons.
The Company has granted the Underwriter an option, exercisable not later
than 30 days after the date of this Prospectus, to purchase up to an aggregate
of 435,000 additional shares of Common Stock at the initial public offering
price, less the underwriting discounts and commissions, set forth on the cover
page of this Prospectus. The Underwriter may exercise such option, in part or
in full, only to cover over-allotments, if any, made in connection with the
sale of shares of Common Stock offered hereby. If purchased, the Underwriter
will offer such additional shares of Common Stock on the same terms as the
2,900,000 shares of Common Stock are being offered. To the extent that the
Underwriter exercises such option, the Underwriter will be obligated, subject
to certain conditions, to purchase the number of shares of Common Stock
covered by such exercise and the Company will be obligated to sell such shares
of Common Stock to the Underwriter.
The Company has agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the federal securities laws, or to
contribute to payments the Underwriter may be required to make in respect
thereof.
The Company, its directors and officers have agreed not to offer, sell or
otherwise dispose of any shares of Common Stock or any securities convertible
into or exchangeable for shares of Common Stock of the Company for a period of
180 days after the date of this Prospectus without the prior written consent
of the Underwriter except for: (i) the issuance by the Company of Common Stock
pursuant to the exercise of options under the Company's Option Plans disclosed
in the Prospectus; (ii) the granting by the Company of stock options after the
date of this Prospectus under the Option Plans; or (iii) as a bona fide gift
to a third party or as a distribution to the partners or stockholders of a
Company stockholder, provided that the recipient(s) thereof agree in writing
to be bound by the terms of the Lock-Up Agreement to which such stockholder is
bound.
In connection with the Public Offering, the Underwriter and selling group
members and their respective affiliates may engage in transactions that
stabilize, maintain or otherwise affect the market price of the Common Stock.
Such transactions may include stabilization transactions effected in
accordance with Rule 104 of Regulation M, pursuant to which such persons may
bid for or purchase Common Stock for the purpose of stabilizing its market
price. The Underwriter also may create a short position for the account of the
Underwriter by selling more Common Stock in connection with the Public
Offering than it is committed to purchase from the Company, and in such case
may purchase Common Stock in the open market following completion of the
Offering to cover all or a portion of such short position. The Underwriter may
also cover all or a portion of such short position up to 435,000 shares of
Common Stock, by exercising the Underwriter's over-allotment option
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referred to above. In addition, the Underwriter, may impose "penalty bids"
under contractual arrangements whereby it may reclaim from dealers
participating in the Public Offering for the account of the Underwriter, the
selling concession with respect to Common Stock that is distributed in the
Public Offering but subsequently purchased for the account of the Underwriter
in the open market. Any of the transactions described in this paragraph may
result in the maintenance of the price of the Common Stock at a level above
that which might otherwise prevail in the open market. None of the
transactions described in this paragraph is required, and, if they are
undertaken, they may be discontinued at any time.
Neither the Company nor the Underwriter makes any representation or
prediction as to the direction or magnitude of, or any effect that the
transactions described above may have on, the price of the Common Stock. In
addition, neither the Company nor the Underwriter makes any representation
that the Underwriter will engage in such transactions or, once commenced, will
not be discontinued without notice.
Prior to the Public Offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price of the Common Stock was
determined by negotiations between the Company and the Underwriter. Among the
factors considered in such negotiations were the history of, and prospects for
the Company and the industry in which it competes, an assessment of
management, the Company's past and present operations, its past and present
earnings and the trend of such earnings, the prospects for future earnings of
the Company, the general condition of the securities markets at the time of
the Public Offering and the market prices of publicly-traded common stocks of
comparable companies in recent periods.
The Underwriter does not intend to confirm sales to any accounts over which
it exercises discretionary authority.
EXPERTS
The financial statements of Life Savings Bank, Federal Savings Bank as of
December 31, 1996 and for the year then ended included in this Prospectus,
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their report appearing herein, and are included in reliance upon the report of
such firm given upon their authority as experts in accounting and auditing.
The financial statements of Life Savings Bank, Federal Savings Bank as of
December 31, 1995 and for the year ended December 31, 1995 included in this
Prospectus have been audited by Grant Thornton LLP, independent auditors, as
stated in their report appearing herein, and are included in reliance upon
such report given the authority of such firm as experts in accounting and
auditing.
The financial statements of Life Savings Bank, Federal Savings Bank for the
year ended December 31, 1994 included in this Prospectus, have been audited by
Price Waterhouse LLP, independent accountants, as stated in their report
appearing herein, and are included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
LEGAL MATTERS
The legality of the Common Stock will be passed upon for the Bank and the
Company by Muldoon, Murphy & Faucette, Washington, D.C., special counsel to
the Bank and the Company. Muldoon, Murphy & Faucette will rely as to certain
matters of Delaware law on the opinion of Morris, Nichols, Arsht & Tunnell.
Certain legal matters will be passed upon for the Underwriters by Brobeck,
Phleger & Harrison LLP, Newport Beach, California.
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CHANGES IN ACCOUNTANTS
Prior to the year ended December 31, 1996 the Bank's financial statements
were audited by Grant Thornton LLP. Grant Thornton LLP was replaced on October
24, 1996 and Deloitte & Touche LLP was engaged and continues as the
independent auditors of the Bank. The decision to change auditors was
recommended by the Audit Committee and was approved by the Board of Directors.
Accordingly, the statement of financial condition as of December 31, 1995 and
related statements of operations, stockholders' equity and cash flows for the
year ended December 31, 1995, and included in this Prospectus, were audited by
Grant Thornton LLP.
For the year ended December 31, 1995 and up to the date of replacement of
Grant Thornton LLP, there were no disagreements with Grant Thornton LLP on any
matter of accounting principles or practices, financial statement disclosure
or auditing scope or procedure which, if not resolved to the satisfaction of
Grant Thornton LLP, would have caused it to make reference to the subject
matter of the disagreement in connection with its report. The independent
auditors' report on the financial statements for the year ended December 31,
1995 did not contain an adverse opinion or a disclaimer of opinion, and was
not qualified or modified as to uncertainty, audit scope or accounting
principles.
Prior to the year ended December 31, 1995 the Bank's financial statements
were audited by Price Waterhouse LLP. Price Waterhouse LLP was replaced on
October 26, 1995 and Grant Thornton LLP was engaged as independent auditors of
the Bank for the year ended December 31, 1995. The decision to change auditors
was recommended by the Audit Committee and was approved by the Board of
Directors. Accordingly, the Bank's statements of operations, stockholders'
equity and cash flows for the year ended December 31, 1994, included in this
Prospectus, were audited by Price Waterhouse LLP.
For the year ended December 31, 1994 and up to the date of the replacement
of Price Waterhouse LLP, there were no disagreements with Price Waterhouse LLP
on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure which, if not resolved to the
satisfaction of Price Waterhouse LLP, would have caused it to make a reference
to the subject matter of the disagreement in connection with its reports. The
independent accountants' report on the financial statements for the year ended
December 31, 1994 did not contain an adverse opinion or a disclaimer of
opinion, and was not qualified or modified as to uncertainty, audit scope or
accounting principles.
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ADDITIONAL INFORMATION
The Company has filed with the SEC a registration statement under the
Securities Act with respect to the Common Stock offered hereby. As permitted
by the rules and regulations of the SEC, this Prospectus does not contain all
the information set forth in the registration statement. This Prospectus
contains a description of the material terms and features of all material
contracts, reports or exhibits to the registration statement required to be
described; however, the statements contained in this Prospectus as to the
contents of any contract or other document filed as an exhibit to the
registration statement are, of necessity, brief descriptions thereof and are
not necessarily complete; each such statement is qualified by reference to
such contract or document. Such information and all exhibits to the
Registration Statement can be examined without charge at the public reference
facilities of the SEC located at 450 Fifth Street, N.W., Washington, D.C.
20549; and at the Pacific Regional Office of the Commission at 5670 Wilshire
Blvd., 11th Floor, Los Angeles, California 90036-3648, and copies of such
material can be obtained from the SEC at prescribed rates. In addition, the
SEC maintains a website (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the SEC, including the Company.
The Company has registered its Common Stock with the SEC under Section 12(g)
of the Exchange Act and the Company and the holders of its stock are subject
to the proxy solicitation rules, reporting requirements and restrictions on
stock purchases and sales by directors, officers and greater than 10%
stockholders, the annual and periodic reporting and certain other requirements
of the Exchange Act.
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LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Accountants for the year ended December 31, 1994.... F-1
Independent Auditors' Report as of and for the year ended December 31,
1995..................................................................... F-2
Independent Auditors' Report as of and for the year ended December 31,
1996..................................................................... F-3
Statements of Financial Condition as of March 31, 1997 (unaudited) and De-
cember 31, 1996 and 1995................................................. F-4
Statements of Operations for the three months ended March 31, 1997 and
1996 (unaudited) and for each of the three years in the period ended De-
cember 31, 1996.......................................................... F-5
Statements of Stockholders' Equity for the three months ended March 31,
1997 (unaudited) and for each of the three years in the period ended De-
cember 31, 1996.......................................................... F-6
Statements of Cash Flows for the three months ended March 31, 1997 and
1996 (unaudited) and for each of the three years in the period ended De-
cember 31, 1996.......................................................... F-7
Notes to Financial Statements............................................. F-8
</TABLE>
All schedules are omitted because they are not required or applicable, or
the required information is shown in the financial statements or notes
thereto.
The financial statements of Life Financial Corp. have been omitted because
Life Financial Corp. has not yet issued any stock, has no assets and no
liabilities, and has not conducted any business other than of an
organizational nature.
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Life Savings Bank, Federal Savings Bank
In our opinion, the accompanying statements of operations, of cash flows and
of stockholders' equity present fairly, in all material respects the results
of operations and cash flows of Life Savings Bank, Federal Savings Bank for
the year ended December 31, 1994, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Bank's management; our responsibility is to express an opinion on these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statements presentation. We believe that
our audit provides a reasonable basis for the opinion expressed above. We have
not audited the financial statements of Life Savings Bank, Federal Savings
Bank for any period subsequent to December 31, 1994.
/s/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
Los Angeles, California
January 31, 1995
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Life Savings Bank, Federal Savings Bank
We have audited the accompanying statement of financial condition of Life
Savings Bank, Federal Savings Bank as of December 31, 1995, and the related
statements of operations, stockholders' equity and cash flows for the year
then ended. These financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the 1995 financial statements referred to above present
fairly, in all material respects, the financial position of Life Savings Bank,
Federal Savings Bank as of December 31, 1995, and the results of its
operations and its cash flows for the year then ended in conformity with
generally accepted accounting principles.
As discussed in Note 1 to the financial statements, in 1995 the Bank changed
its method of accounting for mortgage servicing rights to conform with
Statement of Financial Accounting Standards No. 122.
/s/ Grant Thornton LLP
Grant Thornton LLP
Irvine, California
February 8, 1996 (except for the "Earnings Per Share" paragraph of Note 1, as
to which the date is March 29, 1996)
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Life Savings Bank, Federal Savings Bank
We have audited the accompanying statement of financial condition of Life
Savings Bank, Federal Savings Bank as of December 31, 1996, and the related
statements of operations, stockholders' equity and cash flows for the year
then ended. These financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such 1996 financial statements present fairly, in all material
respects, the financial position of Life Savings Bank, Federal Savings Bank as
of December 31, 1996, and the results of its operations and its cash flows for
the year then ended in conformity with generally accepted accounting
principles.
As discussed in Note 1 to the financial statements, in 1995, the Bank changed
its method of accounting for mortgage servicing rights to conform with
Statement of Financial Accounting Standards No. 122, Accounting for Mortgage
Servicing Rights.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Costa Mesa, California
February 7, 1997 (March 14, 1997 as to Note 16)
F-3
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, -----------------
1997 1996 1995
----------- -------- -------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents........................ $ 45,987 $ 13,265 $ 3,932
Restricted cash.................................. 6,898 1,636
Securities held to maturity, estimated fair value
of $7,992 (1997), $7,981 (1996) and $1,985
(1995).......................................... 8,023 8,023 1,985
Residual assets, at fair value................... 12,519 5,700
Loans held for sale.............................. 38,296 31,018 21,688
Loans held for investment, net of allowance for
estimated loan losses of $1,801 (1997), $1,625
(1996) and $1,177 (1995)........................ 34,671 36,895 41,693
Mortgage servicing rights........................ 4,071 2,645 683
Accrued interest receivable...................... 666 537 507
Foreclosed real estate, net...................... 1,183 561 827
Premises and equipment, net...................... 1,660 1,579 976
Federal Home Loan Bank stock..................... 998 814 715
Deferred income taxes............................ 387 397 138
Other assets..................................... 2,348 940 992
-------- -------- -------
TOTAL ASSETS................................. $157,707 $104,010 $74,136
======== ======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposit accounts............................... $130,808 $ 85,711 $67,535
Other borrowings............................... 3,278
Subordinated debentures........................ 10,000
Accounts payable and other liabilities......... 5,384 5,748 2,333
-------- -------- -------
Total liabilities............................ 146,192 94,737 69,868
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $8 stated value; 10,000,000
shares authorized; 1,070,572 (1997 and 1996)
and 311,036 (1995) shares issued and
outstanding................................... 8,565 8,565 2,488
Additional paid-in capital..................... 825 825 914
Retained earnings (deficit), partially
restricted.................................... 2,125 (117) 866
-------- -------- -------
Total stockholders' equity................... 11,515 9,273 4,268
-------- -------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY... $157,707 $104,010 $74,136
======== ======== =======
</TABLE>
See notes to financial statements.
F-4
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
----------------- -----------------------
1997 1996 1996 1995 1994
--------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
INTEREST INCOME:
Loans............................ $ 1,872 $ 1,598 $ 6,542 $ 5,433 $ 4,530
Securities held to maturity...... 106 25 56 159 138
Other interest-earning assets.... 326 39 331 233 156
--------- ------- ------- ------- -------
Total interest income.......... 2,304 1,662 6,929 5,825 4,824
--------- ------- ------- ------- -------
INTEREST EXPENSE:
Deposit accounts................. 1,317 826 3,514 3,192 2,534
Federal Home Loan Bank advances
and other borrowings............ 173 103 252 256 187
Subordinated debentures.......... 71
--------- ------- ------- ------- -------
Total interest expense......... 1,561 929 3,766 3,448 2,721
--------- ------- ------- ------- -------
NET INTEREST INCOME BEFORE
PROVISION FOR ESTIMATED LOAN
LOSSES............................ 743 733 3,163 2,377 2,103
PROVISION FOR ESTIMATED LOAN
LOSSES............................ 500 68 963 1,194 1,306
--------- ------- ------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR ESTIMATED LOAN LOSSES......... 243 665 2,200 1,183 797
NONINTEREST INCOME:
Loan servicing and other fees.... 120 101 496 231 164
Service charges on deposit
accounts........................ 30 33 128 111 84
Net gains from mortgage financing
operations...................... 5,877 887 8,352 3,575 1,428
Other income..................... 58 19 136 103 12
--------- ------- ------- ------- -------
Total noninterest income....... 6,085 1,040 9,112 4,020 1,688
NONINTEREST EXPENSE:
Compensation and benefits........ 1,582 814 5,233 2,544 1,575
Premises and occupancy........... 223 166 746 471 418
Data processing.................. 135 87 390 208 167
Net loss on foreclosed real
estate.......................... 63 91 158 53 280
FDIC insurance premiums.......... 18 44 174 184 186
SAIF special assessment.......... 448
Marketing........................ 68 39 189 65 55
Telephone........................ 85 40 246 143 128
Professional services............ 58 27 218 92 86
Other expense.................... 260 213 879 629 561
--------- ------- ------- ------- -------
Total noninterest expense...... 2,492 1,521 8,681 4,389 3,456
--------- ------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAX
PROVISION (BENEFIT)............... 3,836 184 2,631 814 (971)
INCOME TAX PROVISION (BENEFIT)..... 1,594 79 1,126 294 (300)
--------- ------- ------- ------- -------
NET INCOME (LOSS).................. $ 2,242 $ 105 $ 1,505 $ 520 $ (671)
========= ======= ======= ======= =======
EARNINGS (LOSS) PER SHARE.......... $ 2.09 $ 0.17 $ 1.90 $ 0.84 $ (1.08)
========= ======= ======= ======= =======
WEIGHTED AVERAGE SHARES
OUTSTANDING....................... 1,070,572 622,072 790,260 622,072 622,072
========= ======= ======= ======= =======
</TABLE>
See notes to financial statements.
F-5
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED TOTAL
---------------- PAID-IN EARNINGS STOCKHOLDERS'
SHARES AMOUNT CAPITAL (DEFICIT) EQUITY
--------- ------ ---------- --------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE, January 1, 1994.. 311,036 $2,488 $914 $ 1,017 $ 4,419
Net loss.................. (671) (671)
--------- ------ ---- ------- -------
BALANCE, December 31,
1994..................... 311,036 2,488 914 346 3,748
Net income................ 520 520
--------- ------ ---- ------- -------
BALANCE, December 31,
1995..................... 311,036 2,488 914 866 4,268
Stock split effected in
the form of a dividend... 311,036 2,488 (2,488)
Net proceeds from issuance
of common stock.......... 448,500 3,589 (89) 3,500
Net income................ 1,505 1,505
--------- ------ ---- ------- -------
BALANCE, December 31,
1996..................... 1,070,572 8,565 825 (117) 9,273
Net income (unaudited).... 2,242 2,242
--------- ------ ---- ------- -------
BALANCE, March 31, 1997
(unaudited).............. 1,070,572 $8,565 $825 $ 2,125 $11,515
========= ====== ==== ======= =======
</TABLE>
See notes to financial statements.
F-6
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
------------------ ------------------------------
1997 1996 1996 1995 1994
-------- -------- --------- --------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss).......... $ 2,242 $ 105 $ 1,505 $ 520 $ (671)
Adjustments to reconcile
net income (loss) to net
cash used in operating
activities:
Depreciation and
amortization............. 100 67 301 166 179
Provision for estimated
loan losses.............. 500 68 963 1,194 1,306
Accretion of deferred
fees..................... (1) (2) (41) (11) (20)
Provision for estimated
losses on foreclosed real
estate................... 26 72 145 104 187
Gain on sale of foreclosed
real estate, net......... (3) (1) (41) (137) (39)
Gain on sale and
securitization of loans
held for sale............ (5,358) (887) (7,868) (3,549) (1,014)
Gain on bulk sale of
mortgage servicing
rights................... (26) (414)
Unrealized gain on
residual asset........... (519) (484)
Net accretion of residual
asset.................... (202) (29)
Valuation allowance on
mortgage servicing
rights................... 3 (12) 13
Amortization of mortgage
servicing rights......... 172 39 320 268 20
Purchase and origination
of loans held for sale,
net of loan fees......... (93,866) (51,929) (227,156) (135,552) (72,613)
Proceeds from sales and
securitization of loans
held for sale............ 80,016 39,323 212,226 130,086 66,408
Increase in restricted
cash..................... (5,262) (1,636)
Increase in accrued
interest receivable...... (129) (9) (30) (76) (2)
Deferred income taxes..... 10 (259) (81) 51
Decrease (increase) in
income taxes receivable.. 479 (64)
Increase (decrease) in
accounts payable and
other liabilities........ (364) (262) 3,415 1,618 86
Federal Home Loan Bank
stock dividend........... (13) (8) (34) (30) (20)
Decrease (increase) in
other assets............. (1,052) (230) 52 (315) (271)
-------- -------- --------- --------- --------
Net cash used in
operating activities.... (23,703) (13,651) (18,663) (5,329) (6,891)
CASH FLOWS FROM INVESTING
ACTIVITIES:
Net decrease in loans...... 4,470 2,060 8,578 6,428 8,133
Proceeds from sale of
foreclosed real estate.... 35 318 1,471 1,097 1,424
Purchase of securities held
to maturity............... (1,000) (996) (8,013) (8,969) (991)
Proceeds from maturities of
securities held to
maturity.................. 1,000 1,000 1,975 9,241 2,042
Purchase of mortgage
servicing rights.......... (706) (128)
Proceeds from bulk sales of
servicing rights.......... 632 522
Additions to premises and
equipment, net............ (181) (90) (904) (523) (33)
Purchase of Federal Home
Loan Bank stock........... (171) (17) (65) (82) (8)
Cash received on residual
assets.................... 809
-------- -------- --------- --------- --------
Net cash provided by
investing activities.... 4,962 2,275 3,042 7,118 10,961
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net increase (decrease) in
deposit accounts.......... 45,097 3,063 18,176 1,846 (6,319)
(Decrease) increase in
Federal Home Loan Bank
advances.................. 9,800 (1,250) 50
Proceeds from (repayments
of) other borrowings...... (3,278) 3,278
Net proceeds from issuance
of common stock........... 3,500
Net proceeds from issuance
of subordinated
debentures................ 9,644
-------- -------- --------- --------- --------
Net cash provided by
(used in) financing
activities.............. 51,463 12,863 24,954 596 (6,269)
-------- -------- --------- --------- --------
NET INCREASE (DECREASE) IN
CASH AND CASH
EQUIVALENTS............... 32,722 1,487 9,333 2,385 (2,199)
CASH AND CASH EQUIVALENTS,
beginning of period....... 13,265 3,932 3,932 1,547 3,746
-------- -------- --------- --------- --------
CASH AND CASH EQUIVALENTS,
end of period............. $ 45,987 $ 5,419 $ 13,265 $ 3,932 $ 1,547
======== ======== ========= ========= ========
SUPPLEMENTAL CASH FLOW
DISCLOSURES:
Interest paid.............. $ 1,507 $ 930 $ 3,773 $ 3,418 $ 2,729
======== ======== ========= ========= ========
Income taxes paid
(refunded)................ $ 1,240 $ 208 $ 267 $ 191 $ (290)
======== ======== ========= ========= ========
NONCASH INVESTING
ACTIVITIES DURING THE
PERIOD:
Transfers from loans held
for sale to loans held for
investment................ $ -- $ -- $ 856 $ -- $ --
======== ======== ========= ========= ========
Transfers from loans held
for investment to loans
held for sale............. $ -- $ -- $ -- $ -- $ 10,090
======== ======== ========= ========= ========
Transfers from loans to
foreclosed real estate.... $ 846 $ 700 $ 2,070 $ 1,983 $ 1,871
======== ======== ========= ========= ========
Loans to facilitate sales
of foreclosed real
estate.................... $ 166 $ 163 $ 761 $ 647 $ 1,516
======== ======== ========= ========= ========
NONCASH FINANCING
ACTIVITIES DURING THE
PERIOD--
Stock dividends paid...... $ -- $ 2,488 $ 2,488 $ -- $ --
======== ======== ========= ========= ========
</TABLE>
See notes to financial statements.
F-7
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED)
AND THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Insofar as these financial statements and notes relate to information at
March 31, 1997 and for the three month periods ended March 31, 1997 and 1996,
they are unaudited. In the opinion of management, such unaudited financial
statements and notes thereto reflect all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of financial
position, results of operations and cash flows for such periods. The financial
position at March 31, 1997 and results of operations for the three months then
ended are not necessarily indicative of the financial position that may be
expected at December 31, 1997 or results of operations that may be expected
for the year ending December 31, 1997.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business--Life Savings Bank, Federal Savings Bank (the Bank)
is a federally chartered savings bank which commenced operations in 1983. The
Bank has one branch in San Bernardino County and its deposit accounts are
insured by the Federal Deposit Insurance Corporation (FDIC).
The Bank originates, purchases, sells and services nonconventional mortgage
loans principally secured by first and second mortgages on one- to four-family
residences. The Bank focuses on loans for the purchase or refinance of
residential real property by borrowers who, because of prior credit problems
or the absence of a credit history, are considered "subprime borrowers." The
Bank also originates debt consolidation loans for up to 125% of the loan to
value ratio of such loans for borrowers whose credit history qualifies for
loans under federal agency programs. The Bank purchases and originates
mortgage loans and other real estate secured loans through a network of
approved correspondents and mortgage brokers on a nationwide basis, as well as
through the Bank's retail lending division. Except for a limited number of
loans specifically originated for retention in the Bank's portfolio as loans
held for investment, since 1994, loans originated or purchased are generally
originated for sale in the secondary mortgage market or in asset
securitizations. The Bank generally retains the majority of the servicing
rights to the loans sold or securitized and may sell servicing rights at a
later date depending on market opportunities. In addition, the Bank purchases
and originates for resale in the secondary market, smaller commercial real
estate and multi-family loans. The Bank funds substantially all of the loans
which it purchases or originates through deposits from customers concentrated
in the communities surrounding its home office in San Bernardino County,
internally generated funds and advances from the Federal Home Loan Bank.
The Bank has recently begun to focus efforts on the origination of multi-
family and commercial real estate as well as consumer-oriented loans secured
by real estate, primarily home equity lines of credit and second trust deeds.
Specifically, the Bank has targeted borrowers seeking loans secured by multi-
family properties or properties used for commercial business purposes such as
small office buildings or light industrial or retail facilities. Such loans
are generally originated for sale.
Securities Held to Maturity--Investments in debt securities that management
has the positive intent and ability to hold to maturity are reported at cost,
adjusted for premiums and discounts that are recognized in interest income
using the interest method over the period to maturity.
Loans--The Bank's real estate loan portfolio consists primarily of long-term
loans secured by first trust deeds on single-family residences. The adjustable
rate mortgage (ARM) is the Bank's primary loan investment.
The Bank originates mortgage loans for both portfolio investment and sale in
the secondary market. At origination or purchase, mortgage loans are
designated as held for sale or held for investment. Loans held for
F-8
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
sale are carried at the lower of cost or estimated market value determined on
an aggregate basis by outstanding investor commitments or current investor
requirements and include related loan origination costs and fees, as well as
premiums or discounts for purchased loans. Net unrealized losses, if any, are
recognized in a valuation allowance by charges to operations. Any transfers of
loans held for sale to the investment portfolio are recorded at the lower of
cost or estimated market value on the transfer date. At March 31, 1997 and
December 31, 1996, respectively, the principal balance of loans held for sale
consist of $23,581,000 and $25,414,000 in single family residential mortgage
loans, $7,829,000 and $2,628,000 in multi-family residential mortgage loans,
$3,180,000 and $2,412,000 in commercial mortgage loans and $3,229,000 and $0
in other loans. At December 31, 1995, all loans held for sale are single
family residential mortgage loans.
Loans held for investment are carried at amortized cost and net of deferred
loan origination fees and costs and allowance for estimated loan losses. Net
deferred loan origination fees and costs on loans are amortized or accreted
using the interest method over the expected lives of the loans. Amortization
of deferred loan fees is discontinued for nonperforming loans. Loans held for
investment are not adjusted to the lower of cost or estimated market value
because it is management's intention, and the Bank has the ability to, hold
these loans to maturity.
Interest on loans is credited to income as earned. Interest receivable is
accrued only if deemed collectible. Generally, allowances are established for
uncollected interest on loans on which payments are more than 90 days past
due.
On January 1, 1995, the Bank adopted Statement of Financial Accounting
Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, as
amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan--
Income Recognition and Disclosures. SFAS No. 114 generally requires all
creditors to account for impaired loans, except those loans that are accounted
for at fair value or at the lower of cost or fair value, at the present value
of the expected future cash flows discounted at the loan's effective interest
rate or, as a practical expedient, at the loan's observable market price or
the fair value of the collateral if the loan is collateral dependent. SFAS No.
114 indicates that a creditor should evaluate the collectibility of both
contractual interest and contractual principal when assessing the need for a
loss accrual. The adoption of these statements did not have a material impact
on the results of operations or the financial position of the Bank, taken as a
whole.
The Bank considers a loan impaired when it is probable that the Bank will be
unable to collect all contractual principal and interest payments under the
terms of the original loan agreement. Loans are evaluated for impairment as
part of the Bank's normal internal asset review process. However, in
determining when a loan is impaired, management also considers the loan
documentation, current loan to value ratios, and the borrower's current
financial position. Included as impaired loans are all loans delinquent 90
days or more and all loans that have a specific loss allowance applied to
adjust the loan to fair value. The accrual of interest on impaired loans is
discontinued after a 90-day delinquent period or when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
the interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments
are received. Where impairment is considered other than temporary, a charge-
off is recorded; where impairment is considered temporary, an allowance is
established. Impaired loans which are performing under the contractual terms
are reported as performing loans, and cash payments are allocated to principal
and interest in accordance with the terms of the loans. The Bank uses the fair
value of collateral method for measuring impaired loans. The Bank applies such
measurement provision to all loans in its portfolio except for one- to four-
family residential mortgage loans and unsecured consumer loans, which are
collectively evaluated for impairment.
F-9
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Allowances for Estimated Loan and Real Estate Losses--It is the policy of
the Bank to maintain allowances for estimated loan and real estate losses at
levels deemed appropriate by management to provide for known or inherent risks
in the portfolio. Specific loss allowances are established for loans that are
deemed impaired if the fair value of the loan or the collateral is estimated
to be less than the gross carrying value of the loan. In estimating losses,
management considers the estimated sales price, cost of refurbishment, payment
of delinquent taxes, cost of holding the property (if an extended period is
anticipated) and cost of disposal. Additionally, general valuation allowances
for loan and real estate losses have been established. Management's
determination of the adequacy of the loan and real estate loss allowances is
based on an evaluation of the composition of the portfolio, actual loss
experience, current and prospective economic conditions, industry trends and
other relevant factors, such as the recent adverse economic conditions
experienced (including declining real estate values) in the area in which the
Bank's lending and real estate activities are based, which may affect the
borrower's ability to pay and the value of the underlying collateral. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additions to the allowance
based on judgments different from those of management.
Although management uses the best information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory and other conditions that may be beyond the
Bank's control.
Mortgage Financing Operations--The Bank sells and securitizes the majority
of loans held for sale with servicing retained. Under the servicing
agreements, the investor is paid its share of the principal collections
together with interest at an agreed-upon rate, which generally differs from
the loans' contractual interest rate. Such differences result in a "loan
servicing spread."
Effective July 1, 1995, the Bank adopted SFAS No. 122, Accounting for
Mortgage Servicing Rights, which amended SFAS No. 65, Accounting for Certain
Mortgage Banking Activities. SFAS No. 122 requires an institution that
purchases or originates mortgage loans and sells or securitizes those loans
with servicing rights retained to allocate the total cost of the mortgage
loans to the mortgage servicing rights and the loans (without the mortgage
servicing rights) based on their relative fair values. The impact of adopting
SFAS No. 122 was an increase in pretax income of $594,000, net income of
$438,000 and earnings per share of $.70 for the year ended December 31, 1995.
In addition, SFAS No. 122 requires that all capitalized mortgage servicing
rights (MSRs) be evaluated for impairment based on the fair value of those
rights. The Bank's periodic evaluation is performed on a disaggregated basis
whereby MSRs are stratified based upon type of interest rate (variable or
fixed), loan type and original loan term. Impairment is recognized in a
valuation allowance for each pool in the period of impairment. The Bank
determines fair value based on the present value of estimated net future cash
flows related to servicing income. In estimating fair values at December 31,
1996, the Bank utilized a weighted average prepayment assumption of 23% and a
weighted average discount rate of 16.5%. The cost allocated to servicing
rights is amortized in proportion to and over the period of estimated net
future servicing fee income.
Prior to adoption of SFAS No. 122, the Bank used the methodology set forth
in Emerging Issues Task Force No. 88-11, Allocation of Recorded Investment
When a Loan or Part of a Loan is Sold, in accounting for loan sales.
Gains on bulk sales of mortgage loan servicing rights are recognized when
title and all risks and rewards have irrevocably passed to the buyer and there
are no significant unresolved contingencies.
F-10
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Residual Asset--In March 1997 and December 1996, the Bank completed the
securitization and sale of approximately $83,200,000 and $51,900,000,
respectively, in loans held for sale in the form of mortgage pass-through
certificates and recognized gains of approximately $5,900,000 and $4,300,000,
respectively. These certificates are held in a trust independent of the Bank.
The Bank will act as servicer for the trust and receive a stated servicing
fee. The Bank has also retained a beneficial interest in the form of an
interest-only strip which represents the subordinated right to receive cash
flows from the pool of securitized loans after payment of the required amounts
to the holders of the securities and the costs associated with the
securitization. This interest-only strip receivable is classified as a trading
security and recorded at fair value with any unrealized gains or losses
recorded in the results of operations in the period of the change in fair
value. For the three months ended March 31, 1997 and the year ended December
31, 1996, a net unrealized gain of $519,000 and $484,000, respectively,
resulting from changes in fair value is included in results of operations.
Valuations at origination and at each reporting period are based on
discounted cash flow analyses. The cash flows are estimated as the excess of
the weighted average coupon on each pool of loans sold over the sum of the
pass-through interest rate, a servicing fee, a trustee fee, an insurance fee
and an estimate of annual future credit losses related to the prepayment,
default, loss, and interest rate assumptions that market participants would
use for similar financial instruments subject to prepayment, credit and
interest rate risk and are discounted using an interest rate that a purchaser
unrelated to the seller of such a financial instrument would demand. At
origination, the Bank utilized a prepayment assumption ranging from 17.0% to
25.0%, an estimated loss factor assumption ranging from 0.5% to 1.5% and a
weighted average discount rate of 13.5% to value the residual assets. The
valuation includes consideration of characteristics of the loans including
loan type and size, interest rate, origination date, term and geographic
location. The Bank also uses other available information such as externally
prepared reports on prepayment rates, collateral value, economic forecasts and
historical default and prepayment rates of the portfolio under review. To the
Bank's knowledge, there is no active market for the sale of residual assets.
The range of values attributable to the factors used in determining fair value
is broad. Accordingly, the Bank's estimate of fair value is subjective.
In connection with its securitization transactions, the Bank initially
deposited cash with a trustee and will subsequently deposit a portion of the
servicing spread collected on the related loans. Such amounts serve as credit
enhancement for the related trust. The amount set aside is available for
distribution to investors in the event of certain shortfalls in amounts due to
investors. These amounts are subject to increase up to a reserve level as
specified in the related securitization documents. Cash amounts on deposit are
invested in certain instruments as permitted by the related securitization
documents. To the extent amounts on deposit exceed specified levels,
distributions are made to the Bank; and, at the termination of the related
trust, any remaining amounts on deposit are distributed to the Bank. The
amount on deposit at March 31, 1997 and December 31, 1996 is classified as
restricted cash in the accompanying statement of financial condition.
Foreclosed Real Estate--Real estate properties acquired through or in lieu
of loan foreclosure are initially recorded at the lower of fair value or the
balance of the loan at the date of foreclosure through a charge to the
allowance for estimated loan losses. After foreclosure, valuations are
periodically performed by management and an allowance for losses is
established by a charge to operations if the carrying value of a property
exceeds its fair value less estimated cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in net gain
(loss) on foreclosed real estate in the statement of operations.
Premises and Equipment--Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
computed using both the straight-line and accelerated methods over the
estimated useful lives of the assets, which range from 15 years for leasehold
improvements, 7 years for furniture, fixtures and equipment, and 3 years for
computer equipment.
F-11
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Income Taxes--The Bank accounts for income taxes under SFAS No. 109,
Accounting for Income Taxes. SFAS No. 109 requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been recognized in the Bank's financial statements or tax returns.
In estimating future tax consequences, all expected future events other than
enactments of changes in the tax law or rates are considered. If necessary, a
valuation allowance is established based on management's determination of the
likelihood of realization of deferred tax assets.
Derivative Financial Instruments--The Bank has entered into various interest
rate exchange agreements (swaps) to manage exposure to changes in interest
rates. Net interest income (expense) on the swaps resulting from the
differential between exchanging floating and fixed rate interest payments is
recorded using the accrual method. No interest rate exchange agreements were
outstanding as of March 31, 1997 and December 31, 1996 and 1995 (Note 13).
In the ordinary course of business, the Bank has entered into other off-
balance sheet financial instruments consisting of commitments to extend
credit. Such financial instruments are recorded in the financial statements
when they are funded or related fees are incurred or received.
Earnings Per Share--Earnings per share is based on the weighted average
number of shares outstanding adjusted retroactively to reflect the stock split
effected in the form of a dividend during 1996. The 1995 and 1994 per share
amounts and weighted average shares outstanding included in the accompanying
financial statements have been restated to reflect such stock split.
Presentation of Cash Flows--For purposes of reporting cash flows, cash and
cash equivalents include cash and federal funds sold. Generally, federal funds
are sold for one-day periods. At March 31, 1997 and December 31, 1996 and
1995, federal funds sold approximated $35,500,000, $10,335,000 and $1,600,000,
respectively.
Use of Estimates--In preparing the Bank's financial statements, management
is required to make estimates and assumptions that affect the reported amounts
of assets and liabilities, the disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
Stock-Based Compensation--In 1995, the Financial Accounting Standards Board
(FASB) issued SFAS No. 123, Accounting for Stock-Based Compensation, which
encourages companies to account for stock compensation awards based on their
fair value at the date the awards are granted. SFAS No. 123 does not require
the application of the fair value method and allows for the continuance of
current accounting methods, which require accounting for stock compensation
awards based on their intrinsic value as of the grant date. However, SFAS No.
123 requires pro forma disclosure of net income and, if presented, earnings
per share, as if the fair value based method of accounting defined in this
Statement had been applied. The accounting and disclosure requirements of this
Statement are effective for financial statements for fiscal years beginning
after December 15, 1995. The Bank did not adopt the accounting method in SFAS
No. 123 with respect to its stock option plan and will account for such plan
in accordance with Accounting Principles Board Opinion No. 25.
Recent Accounting Developments--In June 1996, the Financial Accounting
Standards Board issued SFAS No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, which was amended by SFAS
No. 127. This statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities
based on consistent application of a financial-components approach that
focuses on control. It distinguishes transfers of financial assets that are
sales from transfers that are secured borrowings. Under the financial-
components approach, after a transfer of financial
F-12
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
assets, an entity recognizes all financial and servicing assets it controls
and liabilities it has incurred and derecognizes financial assets it no longer
controls and liabilities that have been extinguished. The financial-components
approach focuses on the assets and liabilities that exist after the transfer.
Many of these assets and liabilities are components of financial assets that
existed prior to the transfer. If a transfer does not meet the criteria for a
sale, the transfer is accounted for as a secured borrowing with pledge of
collateral. The statement is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after December
31, 1996. Retroactive application of this statement is not permitted.
Implementation of SFAS No. 125 did not have a material impact on the Bank's
results of operations or financial condition.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share" which
is effective for financial statements issued for periods ending after December
15, 1997. It replaces the presentation of primary earnings per share with a
presentation of basic earnings per share. It also requires the presentation of
diluted earnings per share for entities with complex capital structures.
Diluted earnings per share takes into account the potential dilution that
could occur if securities or other contracts to issue common stock, such as
options, were exercised or converted into common stock. The Bank does not
believe that SFAS No. 128 will have a material impact on its financial
statements.
Reclassifications--Certain reclassifications have been made to the 1995 and
1994 financial statements to conform to the 1996 presentation.
2. REGULATORY CAPITAL REQUIREMENTS AND OTHER REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions
by regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors. Management believes, as of March 31, 1997 and
December 31, 1996, that the Bank meets all capital adequacy requirements to
which it is subject.
Qualitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined).
As of March 31, 1997 and December 31, 1996, management believes that the
Bank is considered as adequately capitalized under the regulatory framework
for prompt corrective action. As of December 31, 1995, the most recent
notification from the Office of Thrift Supervision (OTS) categorized the Bank
as well-capitalized under the regulatory framework for prompt corrective
action. To be categorized as well-capitalized or adequately capitalized, the
Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1
leverage ratios as set forth in the table. There are no conditions or events
since March 31, 1997 and December 31, 1996 that management believes have
changed the Bank's category.
F-13
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Bank's actual capital amounts and ratios are also presented in the
table:
<TABLE>
<CAPTION>
TO BE ADEQUATELY TO BE WELL
CAPITALIZED UNDER CAPITALIZED UNDER
PROMPT CORRECTIVE PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS: ACTION PROVISIONS:
------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
AS OF MARCH 31, 1997
(UNAUDITED):
Total capital (to risk-
weighted assets)....... $21,487 10.51% $ 16,361 8.00% $ 20,451 10.00%
Tier 1 capital (to risk-
weighted assets)....... 11,515 5.63% 8,180 4.00% 12,271 6.00%
Tier 1 capital (to
average assets)........ 11,515 7.19% 6,407 4.00% 8,009 5.00%
<CAPTION>
TO BE ADEQUATELY TO BE WELL
CAPITALIZED UNDER CAPITALIZED UNDER
PROMPT CORRECTIVE PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS: ACTION PROVISIONS:
------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1996:
Total capital (to risk-
weighted assets)....... $10,446 9.43% $ 8,865 8.0% $ 11,081 10.0%
Tier 1 capital (to risk-
weighted assets)....... 9,273 8.37% 4,432 4.0% 6,649 6.0%
Tier 1 capital (to
average assets)........ 9,273 8.90% 4,169 4.0% 5,211 5.0%
<CAPTION>
TO BE ADEQUATELY TO BE WELL
CAPITALIZED UNDER CAPITALIZED UNDER
PROMPT CORRECTIVE PROMPT CORRECTIVE
ACTUAL ACTION PROVISIONS: ACTION PROVISIONS:
------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1995:
Total capital (to risk-
weighted assets)....... $ 4,871 10.17% $ 3,832 8.0% $ 4,789 10.0%
Tier 1 capital (to risk-
weighted assets)....... 4,268 8.91% 1,916 4.0% 2,874 6.0%
Tier 1 capital (to
average assets)........ 4,268 5.69% 3,003 4.0% 3,753 5.0%
</TABLE>
The Bank has been required by the OTS since the Bank's examination completed
August 9, 1996 to compute its regulatory capital ratios based upon the higher
of (1) the average of total assets based on month-end results or (2) total
assets as of the quarter-end.
Under the framework, the Bank's capital levels at March 31, 1997 and
December 31, 1996 do not allow the Bank to accept brokered deposits without
prior approval from the regulators. The Bank had approximately $792,000 and
$2,200,000 of brokered deposits at March 31, 1997 and December 31, 1996,
respectively. This is not expected to materially impact the Bank as it has
other sources of funds.
In accordance with the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 (FIRREA), the OTS established regulations requiring
the Bank to maintain (i) tangible capital equal to 1.5% of adjusted total
assets, (ii) core capital equal to 3% of adjusted total assets, and (iii)
risk-based capital equal to 8% of risk-weighted assets.
F-14
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following table summarizes the OTS regulatory capital requirements under
FIRREA for the Bank at March 31, 1997 (unaudited) and December 31, 1996. As
indicated in the table, the Bank's capital levels exceed all three of the
currently applicable minimum capital requirements.
<TABLE>
<CAPTION>
MARCH 31, 1997 (UNAUDITED)
---------------------------------------------
TOTAL RISK-
TANGIBLE CAPITAL CORE CAPITAL BASED CAPITAL
---------------- ------------ -------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------ ------- ---- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at end of period:
Equity per Bank financial
statements................... $ 11,515 $11,515 $11,515
Adjustments for regulatory
capital purposes:
Qualifying subordinated
debentures.................. 8,600
General valuation allowance.. 1,372
--------- ------ ------- ---- ------- -----
Regulatory capital.............. 11,515 7.19% 11,515 7.19% 21,487 10.51%
Minimum capital requirement..... 2,403 1.50 4,805 3.00 16,361 8.00
--------- ------ ------- ---- ------- -----
Excess regulatory capital....... $ 9,112 5.69% $ 6,710 4.19% $ 5,126 2.51%
========= ====== ======= ==== ======= =====
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
------------------------------------------------
TOTAL RISK-
TANGIBLE CAPITAL CORE CAPITAL BASED CAPITAL
----------------- ------------- --------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------- ------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at end of year:
Equity per Bank financial
statements................ $ 9,273 $ 9,273 $ 9,273
Adjustments for regulatory
capital purposes--general
valuation allowance....... 1,173
--------- ------- ------- ----- -------- -----
Regulatory capital........... 9,273 8.90% 9,273 8.90% 10,446 9.43%
Minimum capital requirement.. 1,563 1.50 3,127 3.00 8,865 8.00
--------- ------- ------- ----- -------- -----
Excess regulatory capital.... $ 7,710 7.40% $ 6,146 5.90% $ 1,581 1.43%
========= ======= ======= ===== ======== =====
</TABLE>
The OTS issued regulations which set forth the methodology for calculating
an interest rate risk component that is being incorporated into the OTS
regulatory capital rules. Under the new regulations, only savings institutions
with above normal interest rate risk exposure are required to maintain
additional capital. This additional capital would increase the amount of a
savings institution's otherwise required risk-based capital requirement. The
final rule became effective January 1, 1994, and implementation will not begin
until the Bank has been notified by the OTS.
Management believes that, under current regulations, the Bank will continue
to meet its minimum capital requirements in the foreseeable future. However,
events beyond the control of the Bank, such as changing interest rates or a
further downturn in the economy in areas where the Bank has most of its loans,
could adversely affect future earnings and, consequently, the ability of the
Bank to meet its future minimum capital requirements.
At periodic intervals, both the OTS and the FDIC routinely examine the
Bank's financial statements as part of their legally prescribed oversight of
the savings and loan industry. Based on these examinations, the regulators can
direct that the Bank's financial statements be adjusted in accordance with
their findings.
F-15
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The OTS concluded an examination of the Bank in June 1996. Examination
results have been reflected in the financial statements presented herein.
Future examinations by the OTS or FDIC could include a review of certain
transactions or other amounts reported in the 1997 and 1996 financial
statements. Adjustments, if any, cannot presently be determined.
On September 30, 1996, the President signed into law the Deposit Insurance
Funds Act of 1996 (the Funds Act), which, among other things, imposes a
special one-time assessment on Savings Association Insurance Fund (SAIF)
member institutions, including the Bank, to recapitalize the SAIF. As required
by the Funds Act, the FDIC imposed a special assessment of 65.7 basis points
on SAIF-assessable deposits held as of March 31, 1995, payable November 27,
1996. The special assessment was recognized as an expense in the third quarter
of 1996 and is tax deductible. The Bank took a pretax charge of $448,000 as a
result of the SAIF special assessment.
The Funds Act also spreads the obligations for payment of the Financing
Corporation (FICO) bonds across all SAIF and Bank Insurance Fund (BIF)
members. Beginning on January 1, 1997, BIF deposits will be assessed for FICO
payments at a rate of 20% of the rate assessed on SAIF deposits. Based on
current estimates by the FDIC, BIF deposits will be assessed a FICO payment of
1.3 basis points, while SAIF deposits will pay an estimated 6.5 basis points
on the FICO bonds. Full pro rata sharing of the FICO payments between BIF and
SAIF members will occur on the earlier of January 1, 2000 or the date the BIF
and SAIF are merged. The Funds Act specifies that the BIF and SAIF will be
merged on January 1, 1999 provided no savings associations remain as of that
time.
As a result of the Funds Act, the FDIC recently proposed to lower SAIF
assessments to 0 to 27 basis points effective January 1, 1997, a range
comparable to that of BIF members. However, SAIF members will continue to make
the higher FICO payments described above. Management cannot predict the level
of FDIC insurance assessments on an ongoing basis, whether the savings
association charter will be eliminated or whether the BIF and SAIF will
eventually be merged.
F-16
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
3. SECURITIES HELD TO MATURITY
The amortized cost and estimated fair value of securities held to maturity
are summarized as follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, 1997
-----------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- -------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
U.S. Treasury and other agency
securities..................... $8,014 $-- $ (32) $7,982
Mortgage-backed securities...... 9 1 10
------ -------- -------- ------
$8,023 $ 1 $ (32) $7,992
====== ======== ======== ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- -------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury and other agency
securities..................... $8,013 $ -- $(42) $7,971
Mortgage-backed securities...... 10 10
------ -------- -------- ------
$8,023 $ -- $(42) $7,981
====== ======== ======== ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1995
----------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- -------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury and other agency
securities...................... $1,974 $ -- $ -- $1,974
Mortgage-backed securities....... 11 11
------ -------- -------- ------
$1,985 $ -- $ -- $1,985
====== ======== ======== ======
</TABLE>
The maturity distribution of securities held to maturity is as follows (in
thousands):
<TABLE>
<CAPTION>
MARCH 31, 1997
-------------------
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
(UNAUDITED)
<S> <C> <C>
Due in one year or less.................................. $4,006 $3,999
Due from one to five years............................... 4,008 3,983
Mortgage-backed securities............................... 9 10
------ ------
$8,023 $7,992
====== ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
Due in one year or less.................................. $5,000 $4,976
Due from one to five years............................... 3,013 2,995
Mortgage-backed securities............................... 10 10
------ ------
$8,023 $7,981
====== ======
</TABLE>
F-17
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The weighted average yield on securities held to maturity was 5.92%, 5.47%
and 5.41% at March 31, 1997 and December 31, 1996 and 1995, respectively.
4. LOANS HELD FOR INVESTMENT
Loans held for investment consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, ----------------
1997 1996 1995
----------- ------- -------
(UNAUDITED)
<S> <C> <C> <C>
Mortgage loans:
Residential:
One- to four-family..... $26,962 $28,861 $32,517
Multi-family............ 2,110 2,124 2,412
Commercial and land...... 7,106 7,247 7,615
------- ------- -------
36,178 38,232 42,544
Other loans:
Loans secured by deposit
accounts................ 156 177 186
Unsecured commercial
loans................... 66 67 70
Unsecured consumer
loans................... 92 65 63
------- ------- -------
314 309 319
------- ------- -------
36,492 38,541 42,863
Less:
Deferred loan origination
fees (costs)............ 20 21 (7)
Allowance for estimated
loan losses............. 1,801 1,625 1,177
------- ------- -------
1,821 1,646 1,170
------- ------- -------
$34,671 $36,895 $41,693
======= ======= =======
Weighted average interest
rate at end of period.... 8.50% 8.06% 8.91%
======= ======= =======
</TABLE>
The Bank grants residential and commercial loans held for investment to
customers located primarily in Southern California. Consequently, a borrower's
ability to repay may be impacted by economic factors in the region.
At March 31, 1997 and December 31, 1996, included in loans held for
investment and loans held for sale are adjustable rate loans with principal
balances of $49,125,000 and $58,648,000, respectively. Adjustable rate loans
are indexed primarily to COFI.
F-18
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following summarizes activity in the allowance for estimated loan losses
(in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
-------------------- -------------------------
1997 1996 1996 1995 1994
--------- --------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance, beginning of
period...................... $ 1,625 $ 1,177 $ 1,177 $ 832 $ 436
Provision for estimated loan
losses...................... 500 68 963 1,194 1,306
Recoveries................... 8 219 65 3
Charge offs.................. (332) (73) (734) (914) (913)
--------- --------- ------- ------- -------
Balance, end of period....... $ 1,801 $ 1,172 $ 1,625 $ 1,177 $ 832
========= ========= ======= ======= =======
</TABLE>
The Bank had nonaccrual loans at March 31, 1997 and December 31, 1996, 1995
and 1994 of $1,738,000, $2,416,000, $1,397,000 and $1,889,000, respectively.
If nonaccrual loans had been performing in accordance with their original
terms, the Bank would have recorded interest income of $1,925,000, $1,639,000,
$6,692,000, $5,500,000 and $4,637,000, respectively, instead of interest
income actually recognized of $1,872,000, $1,598,000, $6,542,000, $5,434,000,
and $4,531,000, respectively, for the three months ended March 31, 1997 and
1996 and for the years ended December 31, 1996, 1995 and 1994.
At March 31, 1997 and December 31, 1996 and 1995, the Bank had impaired
loans totaling $1,845,000, $2,878,000 and $1,397,000, respectively, with
specific reserves of $456,000, $452,000 and $382,000, respectively. During the
three months ended March 31, 1997 and 1996 and the years ended December 31,
1996 and 1995, the average recorded investment in impaired loans was
$3,373,000, $2,570,000, $2,300,000 and $1,980,000, respectively. Total cash
collected on impaired loans during the three months ended March 31, 1997 and
1996 and the years ended December 31, 1996 and 1995 was $210,000, $491,000,
$1,339,000 and $1,079,000, respectively, of which $163,000, $452,000,
$1,249,000 and $960,000, respectively, was credited to principal. Interest
income of $47,000, $39,000, $90,000 and $119,000 on impaired loans was
recognized for cash payments received in the three months ended March 31, 1997
and 1996 and the years ended December 31, 1996 and 1995, respectively.
At March 31, 1997 and December 31, 1996 and 1995, troubled debt restructured
loans amounted to $131,000. There were no troubled debt restructurings
effected during the three months ended March 31, 1997 and the year ended
December 31, 1996.
The Bank is not committed to lend additional funds to debtors whose loans
have been modified.
The Bank is subject to numerous lending-related regulations. Under FIRREA,
the Bank may not make real estate loans to one borrower in excess of 15% of
its unimpaired capital and surplus except for loans not to exceed $500,000.
This 15% limitation results in a dollar limitation of approximately $1,941,000
and $1,567,000 at March 31, 1997 and December 31, 1996, respectively.
During 1996, the Bank originated a loan for $154,500 to an executive
officer. Immediately subsequent to origination, the loan was sold servicing
released.
5. MORTGAGE FINANCING OPERATIONS
Loans serviced for others at March 31, 1997 and December 31, 1996, 1995 and
1994 totaled $242,263,000, $168,963,000, $189,451,000 and $48,204,000,
respectively.
F-19
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
In connection with mortgage servicing activities, the Bank held funds in
trust for others totaling approximately $1,201,000, $957,000, and $934,000 at
March 31, 1997 and December 31, 1996 and 1995, respectively. At March 31, 1997
and December 31, 1996 and 1995, $37,000, $266,000 and $19,000, respectively,
of these funds are included in deposit accounts of the Bank (subject to FDIC
insurance limits).
For the three months ended March 31, 1997 and the year ended December 31,
1996, 26.2% and 34.0%, respectively, of the properties securing loans funded
by the Bank were located in California, 9.2% and 11.9%, respectively, were
located in Utah, 2.8% and 7.6%, respectively, were located in Colorado, 4.2%
and 6.8% were located in Florida and the remainder were dispersed throughout
the country. At March 31, 1997 and December 31, 1996, 40% of the loan
servicing portfolio was collateralized by real estate properties located in
California. No other state accounted for more than 10%.
Although the Bank sells without recourse, substantially all of the mortgage
loans it originates or purchases the Bank retains some degree of risk on
substantially all of the loans it sells. In addition, during the period of
time that the loans are held for sale, the Bank is subject to various business
risks associated with the lending business, including borrower default,
foreclosure and the risk that a rapid increase in interest rates would result
in a decline of the value of loans held for sale to potential purchasers.
In connection with its securitizations, the Bank is required to repurchase
or substitute loans in the event of a breach of a representation or warranty
made by the Bank. While the Bank may have recourse to the sellers of loans it
purchased, there can be no assurance of the seller's abilities to honor their
respective obligations to the Bank. Likewise, in connection with its whole
loan sales, the Bank enters agreements which generally require the Bank to
repurchase or substitute loans in the event of a breach of a representation or
warranty made by the Bank to the loan purchaser, any misrepresentation during
the mortgage loan origination process or, in some cases, upon any fraud or
early default on such mortgage loans. The remedies available to a purchaser of
mortgage loans from the Bank are generally broader than those available to the
Bank against the sellers of such loans, and if a loan purchaser enforces its
remedies against the Bank, the Bank may not be able to enforce whatever
remedies the Bank may have against such sellers. If the loans were originated
directly by the Bank, the Bank will be solely responsible for any breaches of
representations or warranties.
In addition, borrowers, loan purchasers, monoline insurance carriers and
trustees in the Bank's securitizations may make claims against the Bank
arising from alleged breaches of fiduciary obligations, misrepresentations,
errors and omissions of employees, officers and agents of the Bank, including
appraisers, incomplete documentation and failure by the Bank to comply with
various laws and regulations applicable to its business. Any claims asserted
in the future may result in liabilities or legal expenses that could have a
material adverse effect on the Bank's results of operations, financial
condition and business prospects.
The following is a summary of activity in mortgage servicing rights (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
--------------------- -----------------------
1997 1996 1996 1995 1994
---------- --------- ------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period... $ 2,645 $ 683 $ 683 $ -- $ --
Additions through originations. 1,598 179 2,270 864
Additions through purchase of
servicing rights.............. 706 128
Amortization................... (172) (39) (320) (268) (20)
Sales.......................... (606) (108)
Change in valuation allowance.. (3) 12 (13)
---------- -------- ------- ------ ------
Balance, end of period......... $ 4,071 $ 820 $ 2,645 $ 683 $ --
========== ======== ======= ====== ======
</TABLE>
F-20
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
At March 31, 1997, the valuation allowance on mortgage servicing rights is
$1,000, unchanged from December 31, 1996. The valuation allowance on mortgage
servicing rights decreased by $12,000 from $13,000 at December 31, 1995 to
$1,000 at December 31, 1996. There were no direct write-downs charged against
the allowance for the three months ended March 31, 1997 and the years ended
December 31, 1996 and 1995.
Net gains from mortgage financing operations consisted of the following (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
------------------- --------------------
1997 1996 1996 1995 1994
---------- -------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Gains on sale and securitization of
loans held for sale................. $ 5,358 $ 887 $7,868 $3,549 $1,014
Unrealized gain on residual assets... 519 484
Gains on bulk sale of mortgage
servicing rights.................... 26 414
---------- -------- ------ ------ ------
$ 5,877 $ 887 $8,352 $3,575 $1,428
========== ======== ====== ====== ======
</TABLE>
6. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, ----------------
1997 1996 1995
----------- ------- -------
(UNAUDITED)
<S> <C> <C> <C>
Premises.................................... $ 569 $ 569 $ --
Leasehold improvements...................... 530 530 614
Furniture, fixtures and equipment........... 1,930 1,787 1,430
------- ------- -------
3,029 2,886 2,044
Less accumulated depreciation and
amortization............................... (1,369) (1,307) (1,068)
------- ------- -------
$ 1,660 $ 1,579 $ 976
======= ======= =======
</TABLE>
The adoption of SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, did not have a material
impact on the results of operations or the financial condition of the Bank.
F-21
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
7. FORECLOSED REAL ESTATE
Activity in the allowance for estimated real estate losses is as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
-------------- ------------------
1997 1996 1996 1995 1994
------ ------ ----- ---- -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period.............. $ 65 $ 44 $ 44 $ 29 $ 94
Provision for estimated real estate
losses................................... 26 72 145 104 187
Recoveries................................ 2
Charge offs............................... (8) (65) (126) (89) (252)
----- ------ ----- ---- -----
Balance, end of period.................... $ 83 $ 51 $ 65 $ 44 $ 29
===== ====== ===== ==== =====
</TABLE>
Net loss on foreclosed real estate is summarized as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
--------------- -----------------
1997 1996 1996 1995 1994
------ ------ ---- ----- ----
<S> <C> <C> <C> <C> <C>
Net gain on sales of foreclosed real
estate.................................... $ (3) $ (1) $(41) $(137) $(39)
Other expenses, net........................ 40 20 54 86 132
Provision for estimated real estate
losses.................................... 26 72 145 104 187
------ ------ ---- ----- ----
Net loss on foreclosed real estate......... $ 63 $ 91 $158 $ 53 $280
====== ====== ==== ===== ====
</TABLE>
8. DEPOSIT ACCOUNTS
Deposit accounts are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------
MARCH 31, 1997 1996 1995
---------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
INTEREST RATE AMOUNT INTEREST RATE AMOUNT INTEREST RATE AMOUNT
------------- -------- ------------- ------- ------------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Checking accounts....... 2.63% $ 10,209 2.22% $ 8,947 1.37% $ 6,735
Passbook accounts....... 2.10 4,115 2.10 4,117 2.10 4,842
Money market accounts... 2.98 3,032 2.99 3,217 2.76 4,156
Certificate accounts:
Under $100,000........ 5.83 80,386 5.66 49,437 5.70 39,989
$100,000 and over..... 5.83 33,066 5.63 19,993 5.80 11,813
-------- ------- -------
5.39% $130,808 5.02% $85,711 4.84% $67,535
======== ======= =======
</TABLE>
F-22
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The aggregate annual maturities of certificate accounts are approximately as
follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
----------- ------------
(UNAUDITED)
<S> <C> <C>
Within one year..................................... $103,450 $59,438
One to two years.................................... 6,537 6,197
Two to three years.................................. 1,946 1,700
Three to four years................................. 480 925
Four to five years.................................. 582 613
Thereafter.......................................... 457 557
-------- -------
$113,452 $69,430
======== =======
</TABLE>
Interest expense is summarized as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
------------- -----------------------
1997 1996 1996 1995 1994
------- ----- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Checking accounts.................. $ 61 $ 24 $ 112 $ 92 $ 95
Passbook accounts.................. 20 24 92 127 157
Money market accounts.............. 23 29 118 144 163
Certificate accounts............... 1,213 749 3,192 2,829 2,119
------- ----- ------- ------- -------
$ 1,317 $ 826 $ 3,514 $ 3,192 $2,534
======= ===== ======= ======= =======
</TABLE>
9. ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
As of March 31, 1997 and December 31, 1996, the Bank had an available line
of credit with the Federal Home Loan Bank of San Francisco (FHLB) of
$14,219,000 and $17,346,000, respectively, which is contingent upon continued
compliance with the Advances and Security Agreement and other eligibility
requirements established by the FHLB. Advances and/or the line of credit are
collateralized by pledges of certain real estate loans with an aggregate
principal balance of $19,434,000, $20,474,000 and $24,426,000 at March 31,
1997 and December 31, 1996 and 1995, respectively.
There were no FHLB advances outstanding at March 31, 1997 and December 31,
1996 and 1995.
F-23
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The following summarizes activities in advances from the FHLB (dollars in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
-------------------- --------------------------
1997 1996 1996 1995 1994
--------- --------- -------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Average balance
outstanding............ $11,824 $ 6,889 $ 4,259 $ 3,112 $ 1,863
Maximum amount
outstanding at any
month-end during the
period................. 19,950 13,900 13,900 7,600 7,000
Balance outstanding at
end of period.......... -- 9,800 -- -- 1,250
Weighted average
interest rate during
the period............. 5.63% 5.98% 5.93% 6.55% 4.87%
</TABLE>
At December 31, 1996, the Bank had a borrowing of $3,278,000 with an interest
rate of 8.43% from a financial institution. The borrowing was collateralized by
certain real estate loans with an aggregate principal balance of $3,278,000.
The borrowing was repaid on January 17, 1997.
10. INCOME TAXES
Income taxes are summarized as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
--------------- -----------------------
1997 1996 1996 1995 1994
------- ------- ------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Current provision (benefit):
Federal............................. $ 1,304 $ 62 $ 1,073 $ 374 $ (352)
State............................... 280 17 312 1 1
------- ------- ------- ------ ------
1,584 79 1,385 375 (351)
------- ------- ------- ------ ------
Deferred (benefit) provision:
Federal............................. 8 (235) (81) 10
State............................... 2 (24) 41
------- ------- ------- ------ ------
10 (259) (81) 51
------- ------- ------- ------ ------
Total income tax provision
(benefit)......................... $ 1,594 $ 79 $ 1,126 $ 294 $ (300)
======= ======= ======= ====== ======
</TABLE>
A reconciliation from the statutory federal income tax rate to the Bank's
effective income tax rate is as follows:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
---------------- -----------------------
1997 1996 1996 1995 1994
------- ------- ------ ------ -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Statutory federal income tax
rate.......................... 35.0% 35.0% 35.0% 35.0% (35.0)%
State taxes, net of federal
income tax benefit............ 7.0 7.0 7.2 3.1
Other.......................... (0.4) 0.9 0.6 1.1 1.0
------- ------- ------ ------ -------
41.6% 42.9% 42.8% 36.1% (30.9)%
======= ======= ====== ====== =======
</TABLE>
F-24
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Deferred tax assets (liabilities) were comprised of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, --------------
1997 1996 1995
----------- ------ ------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets:
Allowance for loan losses....................... $ 465 $ 479 $ 258
Capital loss carryforward....................... 63 63 63
Loans held for sale............................. 167 115 201
Other........................................... 273 301 23
----- ------ ------
968 958 545
----- ------ ------
Deferred tax liabilities:
Depreciation.................................... (61) (61) (82)
Purchased servicing rights...................... (14)
Originated servicing rights..................... (378) (358) (179)
Federal Home Loan Bank dividends................ (106) (106) (85)
----- ------ ------
(545) (525) (360)
----- ------ ------
423 433 185
Less valuation allowance......................... (36) (36) (47)
----- ------ ------
Net deferred tax asset........................... $ 387 $ 397 $ 138
===== ====== ======
</TABLE>
Gross deferred tax assets are expected to be realized during 1997 through
2001.
At December 31, 1996, the Bank has approximately $555,000 of net capital
loss carryforwards available to offset future capital gains for state tax
purposes. If not utilized, the losses would expire in 1998. A valuation
allowance has been placed against the portion of this capital loss
carryforward for which realization is not assured.
The Bank's financial statement equity includes tax bad debt deductions for
which no provision for federal income taxes has been made. If distributions to
shareholders are made in excess of current or accumulated earnings and profits
or if stock of the Bank is partially redeemed, this tax bad debt reserve,
which approximates $330,000 at December 31, 1996, will be recaptured into
income at the then prevailing federal income tax rate. The related
unrecognized deferred tax liability is approximately $116,000. It is not
contemplated that the Bank will make any disqualifying distributions that
would result in the recapture of these reserves.
11. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK
The Bank is involved in various legal proceedings associated with normal
operations. In the opinion of management, based on the advice of legal
counsel, such litigation and claims are expected to be resolved without
material effect on the financial position of the Bank.
F-25
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Bank leases a portion of its facilities from nonaffiliates under
operating leases expiring at various dates through 2001. The following
schedule shows the minimum annual lease payments, excluding property taxes and
other operating expenses, due under these agreements (in thousands):
<TABLE>
<S> <C>
1997................................................................. $215
1998................................................................. 185
1999................................................................. 179
2000................................................................. 116
2001................................................................. 82
Thereafter...........................................................
----
$777
====
</TABLE>
Rental expense under all operating leases totaled $48,000, $39,000,
$232,000, $124,000, and $118,000 for the three months ended March 31, 1997 and
1996, and for the years ended December 31, 1996, 1995 and 1994, respectively.
The Bank has negotiated an employment agreement with its chief executive
officer. This agreement provides for the payment of a base salary, a bonus
based upon performance of the Bank and the payment of severance benefits upon
termination.
Lending Activities--Loans to subprime borrowers present a higher level of
risk of default than conforming loans because of the increased potential for
default by borrowers who may have had previous credit problems or who do not
have any credit history. Loans to subprime borrowers also involve additional
liquidity risks, as these loans generally have a more limited secondary market
than conventional loans. The actual rates of delinquencies, foreclosures and
losses on loans to subprime borrowers could be higher under adverse economic
conditions than those currently experienced in the mortgage lending industry
in general. While the Bank believes that the underwriting procedures and
appraisal processes it employs enable it to somewhat mitigate the higher risks
inherent in loans made to these borrowers, no assurance can be given that such
procedures or processes will afford adequate protection against such risks.
The debt consolidation loans the Bank originates for agency qualified
borrowers are primarily home equity lines of credit and second deeds of trust
generally up to 125% of the appraised value of the real estate underlying the
loans. In the event of a default on such a loan by a borrower, there generally
would be insufficient collateral to pay off the balance of such loan and the
Bank, as holder of a second position on the property, would likely lose a
substantial portion, if not all, of its investment. While the Bank believes
that the underwriting procedures it employs enable it to somewhat mitigate the
higher risks inherent in such loans, no assurance can be given that such
procedures will afford adequate protection against such risks. Approximately
65% of the loans included in the securitization transaction completed in 1996
consisted of this type of loan.
The Bank has been actively involved in the origination, purchase and sale to
institutional investors of real estate secured loans and, more recently, in
asset securitizations. Generally, the profitability of such mortgage financing
operations depends on maintaining a sufficient volume of loans for sale and
the availability of purchasers. Changes in the level of interest rates and
economic factors affect the amount of loans originated or available for
purchase by the Bank, and thus the amount of gains on sale of loans and
servicing fee income. Changes in the purchasing policies of institutional
investors or increases in defaults after funding could substantially reduce
the amount of loans sold to such investors or sold through asset
securitizations. Any such changes could have a material adverse effect on the
Bank's results of operations and financial condition.
F-26
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The Bank's ability to originate, purchase and sell loans through its
mortgage financing operations is also significantly impacted by changes in
interest rates. Increases in interest rates may also reduce the amount of loan
and commitment fees received by the Bank. A significant decline in interest
rates could also decrease the size of the Bank's servicing portfolio and the
related servicing income by increasing the level of prepayments. The Bank does
not currently utilize any specific hedging instruments to minimize exposure to
fluctuations in the market price of loans and interest rates with regard to
loans held for sale in the secondary mortgage market. Therefore, between the
time the Bank originates the loans or purchase commitments are issued or asset
securitizations are completed, the Bank is exposed to downward movements in
the market price of such loans due to upward movements in interest rates.
The Bank depends largely on mortgage brokers and correspondents for its
purchases and originations of new loans. The Bank's competitors also seek to
establish relationships with the Bank's mortgage brokers and correspondents.
The Bank's future results may become increasingly exposed to fluctuations in
the volume and cost of its wholesale loans resulting from competition from
other purchasers of such loans.
Availability of Funding Sources--The Bank funds substantially all of the
loans which it originates or purchases through deposits, internally generated
funds or FHLB advances. The Bank competes for deposits primarily on the basis
of rates, and, as a consequence, the Bank could experience difficulties in
attracting deposits to fund its operations if the Bank does not continue to
offer deposit rates at levels that are competitive with other financial
institutions. The Bank also uses the proceeds generated by the Bank in selling
loans in the secondary market or pools of loans in asset securitizations to
fund subsequent originations or purchases. On an ongoing basis, the Bank
explores opportunities to access credit lines as an additional source of
funds. To the extent that the Bank is not able to maintain its currently
available funding sources or to access new funding sources, it would have to
curtail its loan production activities or sell loans earlier than is optimal.
Any such event would have a material adverse effect on the Bank's results of
operations and financial condition.
Dependence on Securitizations--In December 1996, the Bank completed its
first sale of loans through securitization. The Bank derived a significant
portion of its income in 1996 by recognizing such gain on sale. The Bank's
ability to complete securitizations is affected by several factors, including
conditions in the securities markets generally and in the asset-backed
securities markets specifically, the credit quality of the Bank's loan
portfolio and the Bank's ability to obtain credit enhancements. Although the
Bank obtained a credit enhancement in its first securitization which
facilitated a "AAA" rating for the securitization interests, there can be no
assurance that the Bank will be able to obtain future credit enhancements on
acceptable terms or that future securitizations will be similarly rated. Any
substantial reduction in the ability of the Bank to complete asset
securitizations could have a material adverse effect on the Bank's results of
operations and financial condition.
12. BENEFIT PLANS
401(k) Plan--The Bank maintains an Employee Savings Plan (the Plan) which
qualifies under section 401(k) of the Internal Revenue Code. Under the Plan,
employees may contribute from 1% to 15% of their compensation. The Bank will
match, at its discretion, 25% of the amount contributed by the employee up to
a maximum of 8% of the employee's salary. The amount of contributions made to
the Plan by the Bank were not material for the years ended December 31, 1996,
1995 and 1994.
Cash Bonus Plan--The Bank adopted a cash bonus plan (the Bonus Plan)
effective February 1996. All employees except for commissioned employees and
employees with employment contracts are eligible to participate. Approximately
$201,000 and $100,000 was accrued pursuant to the Bonus Plan at March 31, 1997
F-27
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
and December 31, 1996, respectively. For 1997, the Bonus Plan will pay bonuses
in the aggregate of 15% of the after tax profits of the Bank in excess of a
15% return on average equity, as defined in the Bonus Plan.
Stock Option Plan--On November 21, 1996, the Board of Directors of the Bank
adopted the Life Savings Bank 1996 Stock Option Plan (the Option Plan). The
Option Plan authorizes the granting of options equal to 107,200 shares of
common stock for issuance to executives, key employees, officers and
directors. The Option Plan will be in effect for a period of ten years from
the adoption by the Board of Directors. Options granted under the Option Plan
will be made at an exercise price equal to the fair market value on the date
of grant. Awards granted to officers and employees may include incentive stock
options, nonstatutory stock options and limited rights which are exercisable
only upon change in control of the Bank. Awards granted to nonemployee
directors are nonstatutory options. All 1996 options were granted at an
exercise price of $10.00 per share. Stock options will become vested and
exercisable in the manner specified by the Bank. The options granted by the
Bank will vest at a rate of 33.3% per year, beginning on November 21, 1999. No
options were exercisable at December 31, 1996.
The following is a summary of activity in the Option Plan during 1996:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------- ----------------
<S> <C> <C>
Options granted.................................. 107,180 $10.00
======= ======
Options outstanding at December 31, 1996......... 107,180 $10.00
======= ======
</TABLE>
There was no activity in the Option Plan during the three months ended March
31, 1997.
All options granted have a remaining contractual life of 10 years.
The estimated fair value of the options granted during 1996 was $4.97 per
share. The Bank applies Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its Option Plan. No compensation cost has
been recognized for its Option Plan. Had compensation cost for the Option Plan
been determined based on the fair value at the grant date for awards under the
plan consistent with the method of SFAS No. 123, Accounting for Stock-Based
Compensation, the Bank's net income and earnings per share for the year ended
December 31, 1996 would have been reduced to the pro forma amounts indicated
below:
Net income to common stockholders:
<TABLE>
<S> <C>
As reported............................................... $1,505,000
Pro forma................................................. $1,489,000
Net income per common share:
As reported............................................... $1.90
Pro forma................................................. $1.88
</TABLE>
The fair value of options granted under the Option Plan during 1996 was
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions used: no dividend yield, no
volatility, risk-free interest rate of 7% and expected lives of 10 years.
F-28
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit in the form
of originating loans or providing funds under existing lines of credit. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the accompanying statement of
financial condition.
During 1988 the Bank entered into agreements to pay fixed-rate interest
payments in exchange for the receipt of variable market-indexed interest
payments (interest rate swaps). The notional principal amount of interest rate
swaps outstanding at December 31, 1994 was $2,000,000, all of which matured in
1995. The weighted average fixed payment rate on such swap was 9.23%. At
December 31, 1994, the weighted average variable market-indexed interest rate
was 5.75%, which is based on LIBOR. The intent of these agreements was to
match the maturities of certain liabilities and convert variable rate
liabilities into fixed rate. The notional amount of interest rate swaps does
not represent exposure to credit loss. No new interest rate swap transactions
were entered into during the three months ended March 31, 1997 and the years
ended December 31, 1996 and 1995.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual or notional amount of those instruments. The
Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates and may require payment of a
fee. Since many commitments are expected to expire, the total commitment
amounts do not necessarily represent future cash requirements. The Bank
evaluates each customer's credit worthiness on a case-by-case basis. The
Bank's commitments to extend credit at March 31, 1997 and December 31, 1996
and 1995 totaled $19,872,000, $9,217,000 and $9,933,000, respectively.
The Bank regularly enters into commitments to sell certain dollar amounts of
loans to third parties under specific, negotiated terms. The terms include the
minimum maturity of the loans, yield to purchaser, servicing spread to the
Bank, and the maximum principal amount of the individual loans.
The Bank typically satisfies these commitments from its current production
of loans. These commitments have fixed expiration dates and may require a fee.
At March 31, 1997 and December 31, 1996 and 1995, the Bank had outstanding
commitments to sell loans of $20,075,000, $3,072,000 and $250,000,
respectively.
F-29
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures About Fair Value of Financial Instruments. The estimated fair
value amounts have been determined by the Bank using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Bank could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
<TABLE>
<CAPTION>
MARCH 31, 1997
-------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
Assets:
Cash and cash equivalents............................... $45,987 $45,987
Restricted cash......................................... 6,898 6,898
Securities held to maturity............................. 8,023 7,992
Residual assets......................................... 12,519 12,519
Loans held for sale..................................... 38,296 38,632
Loans held for investment, net.......................... 34,671 35,200
Mortgage servicing rights............................... 4,071 4,486
FHLB stock.............................................. 998 998
Liabilities:
Deposit accounts........................................ 130,808 130,879
Subordinated debentures................................. 10,000 10,000
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(IN THOUSANDS)
<S> <C> <C>
Assets:
Cash and cash equivalents............................... $13,265 $13,265
Restricted cash......................................... 1,636 1,636
Securities held to maturity............................. 8,023 7,981
Residual asset.......................................... 5,700 5,700
Loans held for sale..................................... 31,018 31,288
Loans held for investment, net.......................... 36,895 37,475
Mortgage servicing rights............................... 2,645 2,984
FHLB stock.............................................. 814 814
Liabilities:
Deposit accounts........................................ 85,711 86,278
Other borrowings........................................ 3,278 3,278
</TABLE>
F-30
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
(IN THOUSANDS)
<S> <C> <C>
Assets:
Cash and cash equivalents............................... $ 3,932 $ 3,932
Securities held to maturity............................. 1,985 1,985
Loans held for sale..................................... 21,688 22,125
Loans held for investment, net.......................... 41,693 41,902
Mortgage servicing rights............................... 683 784
FHLB stock.............................................. 715 715
Liabilities:
Deposit accounts........................................ 67,535 67,688
</TABLE>
The Bank utilized the following methods and assumptions to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
Cash and Cash Equivalents--The carrying amount approximates fair value.
Restricted Cash--The carrying amount approximates fair value.
Securities Held to Maturity--Fair values are based on quoted market prices.
Loans Held for Sale--Fair values are based on quoted market prices or
dealer quotes.
Loans Held for Investment--The fair value of gross loans receivable has
been estimated using the present value of cash flow method, discounted
using the current rate at which similar loans would be made to borrowers
with similar credit ratings and for the same maturities, and giving
consideration to estimated prepayment risk and credit loss factors.
Residual Assets and Mortgage Servicing Rights--Fair values are estimated
using discounted cash flows based on current market values.
FHLB Stock--The fair value is based on its redemption value.
Deposit Accounts--The fair value of checking, passbook and money market
accounts is the amount payable on demand at the reporting date. The fair
value of certificate accounts is estimated using the rates currently
offered for deposits of similar remaining maturities.
Subordinated Debentures and Other Borrowings--The carrying amount
approximates fair value as the interest rate currently approximates market.
Financial Instruments with Off-Balance Sheet Risk--No fair value is
ascribed to the Bank's outstanding commitments to fund loans since
commitment fees are not significant and predominantly all such commitments
are variable-rate loan commitments. There were no significant unrealized
gains and losses on commitments to sell loans.
The fair value estimates presented herein are based on pertinent information
available to management as of March 31, 1997 and December 31, 1996 and 1995.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements since that
date; and, therefore, current estimates of fair value may differ significantly
from the amounts presented herein.
F-31
<PAGE>
LIFE SAVINGS BANK, FEDERAL SAVINGS BANK
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (UNAUDITED) AND
THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
15. SEGMENT INFORMATION
The Bank's operations within the financial services industry principally
focus on banking and mortgage financing activities. Information about these
segments as of or for the years ended December 31, 1996 and 1995 are as
follows (dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------
MORTGAGE
BANKING FINANCING TOTAL
------- --------- --------
<S> <C> <C> <C>
Revenue for the year............................ $ 3,898 $12,143 $ 16,041
Pre-tax operating income (loss) for the year.... (2,325) 4,956 2,631
Assets employed at year-end..................... 59,943 44,067 104,010
Depreciation and amortization for the year...... 120 501 621
Capital expenditures for the year............... 276 628 904
<CAPTION>
DECEMBER 31, 1995
---------------------------
MORTGAGE
BANKING FINANCING TOTAL
------- --------- --------
<S> <C> <C> <C>
Revenue for the year............................ $ 4,207 $ 5,638 $ 9,845
Pre-tax operating income (loss) for the year.... (1,128) 1,942 814
Assets employed at year-end..................... 49,201 24,935 74,136
Depreciation and amortization for the year...... 92 342 434
Capital expenditures for the year............... 56 467 523
</TABLE>
16. SUBSEQUENT EVENTS
Life Financial Corporation (LFC), a Delaware corporation, has been formed to
become the holding company for the Bank. LFC is contemplating an initial
public offering of 2,500,000 shares of its common stock and is also offering
3,211,716 shares of its common stock in connection with the reorganization of
the Bank as a result of which (i) the Bank will become a wholly-owned
subsidiary of LFC, and (ii) all of the outstanding shares of the Bank's common
stock will be converted on the basis of one share of the Bank's common stock
for three shares of common stock of LFC (the Reorganization).
On March 14, 1997, the Bank issued subordinated debentures (Debentures) in
the aggregate principal amount of $10 million through a private placement and
pursuant to a Debenture Purchase Agreement. The Debentures will mature on
March 15, 2004 and bear interest at the rate of 13.5% per annum, payable semi-
annually. The Debentures qualify as supplementary capital under regulations of
the OTS which capital may be used to satisfy the risk-based capital
requirements in an amount up to 100% of the Bank's core capital. The
Debentures are direct, unconditional obligations of the Bank ranking with all
other existing and future unsecured and subordinated indebtedness of the Bank.
They are subordinated on liquidation, as to principal and interest, and
premium, if any, to all claims against the Bank having the same priority as
savings account holders or any higher priority.
The Debentures are redeemable at the option of the Bank, in whole or in
part, at any time after September 15, 1998, at the aggregate principal amount
thereof, plus accrued and unpaid interest, if any. Following the
Reorganization, the Bank may substitute LFC in its place as obligor on the
Debentures (the Substitution). If such Substitution occurs, holders of the
Debentures will have the option at September 15, 1998 or at such later time as
the Substitution occurs to require LFC to purchase all or part of the holder's
outstanding Debentures at a price equal to 100% of the principal amount
repurchased plus accrued interest through the repurchase date. If the
Substitution occurs, upon a change in control of LFC, holders of the Debentures
will have the option to require LFC to purchase all or part of the holder's
outstanding Debentures at a price equal to 101% of the principal amount
repurchased plus accrued interest through the repurchase date.
F-32
<PAGE>
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NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN THIS PRO-
SPECTUS IN CONNECTION WITH THE OFFERING MADE HEREBY, AND, IF GIVEN OR MADE,
SUCH OTHER INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY LIFE FINANCIAL CORP., THE BANK OR KEEFE, BRUYETTE & WOODS,
INC. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF
AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY JU-
RISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH
THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO
ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH
JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE HEREUNDER
SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF LIFE FINANCIAL CORP. OR THE BANK SINCE ANY OF THE
DATES AS OF WHICH INFORMATION IS FURNISHED HEREIN OR SINCE THE DATE HEREOF.
-----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Selected Financial and Other Data of the Bank............................ 9
Quarterly Operating and Other Data of the Bank........................... 11
Risk Factors............................................................. 13
Use of Proceeds.......................................................... 22
Dividend Policy.......................................................... 22
Market for the Common Stock of the Company............................... 22
Market for the Common Stock of the Bank.................................. 23
Dilution................................................................. 23
Capitalization........................................................... 24
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 25
Life Financial Corp. .................................................... 44
Business................................................................. 45
Federal and State Taxation............................................... 82
Regulation............................................................... 83
The Board of Directors and Management of the Company..................... 91
The Board of Directors and Management of the Bank........................ 93
The Reorganization....................................................... 105
Restrictions on Acquisition of the Company............................... 105
Description of Capital Stock of the Company.............................. 110
Description of Capital Stock of the Bank................................. 111
Transfer Agent and Registrar............................................. 111
Shares Eligible for Future Sale.......................................... 112
Underwriting............................................................. 113
Experts.................................................................. 114
Legal Matters............................................................ 114
Changes in Accountants................................................... 115
Additional Information................................................... 116
Financial Statements..................................................... F-1
</TABLE>
-----------
UNTIL JULY 19, 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICI-
PATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING
AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
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- -------------------------------------------------------------------------------
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2,900,000 SHARES
[LOGO OF LIFE FINANCIAL CORP.]
(Proposed Holding Company for
Life Savings Bank, Federal Savings Bank)
COMMON STOCK
-----------
PROSPECTUS
-----------
KEEFE, BRUYETTE & WOODS, INC.
JUNE 24, 1997
- -------------------------------------------------------------------------------
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