<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K/A
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Commission File No.: 0-22193
LIFE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 33-0743196
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10540 Magnolia Avenue, Suite B, Riverside, California 92505
(Address of principal executive offices)
(909) 637-4000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
The registrant (1) has filed all reports required to be filed by Section 13
or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes [_] No [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, i.e., persons other than directors and executive officers of the
registrant is $119,140,640 and is based upon the last sales price as quoted on
The Nasdaq Stock Market for March 17, 1998.
As of March 17, 1998, the Registrant had 6,546,716 shares outstanding
(excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1998 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-K.
<PAGE>
INTRODUCTORY NOTE
This Amendment on Form 10-K/A amends the Registrant's Annual Report on Form
10-K for the year ended December 31, 1997, as filed by the Registrant on March
30, 1998, and is being filed to reflect the restatement of the Registrant's
consolidated financial statements (the "Restatement"). The Restatement reflects
the revaluation of residual assets retained in certain of the Company's 1997 and
1996 securitization transactions. See Note 21 of Notes to Consolidated Financial
Statements.
INDEX
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Page
PART I
<S> <C> <C>
Item 1. Business................................................................................. 1
Additional Item. Executive Officers of the Registrant.................................... 47
Item 2. Properties............................................................................... 48
Item 3. Legal Proceedings........................................................................ 49
Item 4. Submission of Matters to a Vote of Security Holders...................................... 49
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 50
Item 6. Selected Financial Data.................................................................. 50
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 52
Item 8. Financial Statements and Supplementary Data.............................................. 68
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..... 108
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 108
Item 11. Executive Compensation................................................................... 108
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 108
Item 13. Certain Relationships and Related Transactions........................................... 108
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 108
SIGNATURES.............................................................................................. 110
</TABLE>
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ITEM 1. BUSINESS
General
LIFE Financial Corporation (the "Company") is a Delaware chartered savings
and loan holding company, headquartered in Riverside, California. The Company
became the parent company of Life Bank (formerly "Life Savings Bank, Federal
Savings Bank") (the "Bank") pursuant to the holding company reorganization of
the Bank (the "Reorganization") undertaken in connection with the Company's
initial public offering of its Common Stock (the "IPO"). The Company completed
the IPO on June 30, 1997. Together with shares issued subsequent to that date
pursuant to the exercise of the underwriter's overallotment option, the Company
issued a total of 3,335,000 shares of Common Stock in the IPO at a price of
$11.00 per share. Net proceeds from the IPO amounted to $32.8 million.
The Company originates, purchases, sells, securitizes and services primarily
non-conventional mortgage loans principally secured by first and second
mortgages on one- to four-family residences. The Company makes Liberator Series
loans, which are for the purchase or refinance of residential real property by
borrowers who generally would not qualify for Fannie Mae ("FNMA") or Freddie
Mac ("FHLMC") loans ("sub-prime borrowers"), and Portfolio Series loans,
which are debt consolidation loans for borrowers whose credit history qualifies
them for FNMA and FHLMC loans ("Agency-Qualified Borrowers") with loan-to-
value ratios generally up to 125%. While the Company is currently emphasizing
the origination of Portfolio Series loans, it intends to market both products as
demand permits. Liberator Series and Portfolio Series loans are the Company's
"core products." In addition, to a much lesser extent, the Company originates
multi-family residential and commercial loans.
The Company conducts its business from thirteen locations: the Company's
corporate headquarters and Western regional lending center in Riverside,
California, two additional regional lending centers, one in Jacksonville,
Florida and one in the Denver, Colorado metropolitan area, the national
servicing center located in Riverside, California, and two bank branch offices
in San Bernardino and Riverside, California. In addition, the Company has
recently opened eight low-cost retail lending offices, and intends to enter into
leases for an additional six retail lending offices by the end of 1998, located
in the Southern California area. Such offices are expected to become operational
in 1998.
At December 31, 1997, the Company had consolidated total assets of $397.1
million, total deposits of $211.8 million and total stockholders' equity of
$50.9 million. During the year ended December 31, 1997, the Company originated
or purchased, through a network of approved correspondents and independent
mortgage brokers (the "Originators"), $773.1 million of non-conventional
mortgage products, and sold or securitized $510.1 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 Company's headquarters are located at 10540 Magnolia
Avenue, Suite B, Riverside, California 92505, and its telephone number at that
location is (909) 637-4000.
On March 11, 1998, the Company entered into an Agreement and Plan of Merger
("Merger Agreement") with FIRSTPLUS Financial Group, Inc. ("FIRSTPLUS"),
pursuant to which the Company will be acquired by and become a wholly-owned
subsidiary of FIRSTPLUS. The Merger Agreement is subject to the receipt of
regulatory approval and the approval of shareholders of the Company. Under the
Merger Agreement, at the effective date of the merger, each outstanding share of
common stock of the Company will be converted into the right to receive between
0.500 and 0.667 shares of FIRSTPLUS common stock, as calculated pursuant to the
Exchange Ratio outlined in the Merger Agreement.
Historical Strategy of the Company
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During the early 1990's, as a result of reduced employment levels and
corporate relocations in Southern California and the general weakness of the
national economy, the Company's market area experienced a weakening of real
estate values and a reduction in home sales and construction. When confronted
with increased competition and nominal growth during this same period, the
Company's results of operations were adversely impacted and the Company began to
experience increases in total non-performing loans held for investment. In
response, in 1994, the Company retained new management experienced in 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 Company 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 Company also adopted revised
underwriting policies and instituted more aggressive procedures for resolving
problem loans and for reducing the level of non-performing assets. As a result
of these steps, the Company improved its profitability.
As part of the Company's strategic plan, the Bank developed an internal
structure of operating divisions, each with distinct objectives and management
focus. The 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.
Corporate Structure
The Company and the Bank consummated the Reorganization in June of 1997
whereby the Bank became a wholly-owned subsidiary of the Company. Management
believes that the holding company form of organization provides the Company with
more flexibility and a greater ability to compete with other financial services
companies in the market place. In addition, due to regulatory capital
limitations, the Bank is limited in the amount of investments in residuals
resulting from securitizations that it can retain. The Company is not subject to
such limitations, and thus will reduce the restrictions on the Bank's regulatory
capital by acquiring loans and creating the residuals as part of a
securitization.
Core Lending Products
General. The Company originates, purchases, sell, securitizes and services
primarily non-conventional mortgage loans principally secured by first and
second mortgages on one- to four-family residences. The Company makes Liberator
Series loans, which are for the purchase or refinance of residential real
property by sub-prime borrowers, and Portfolio Series loans, which are debt
consolidation loans for Agency-Qualified Borrowers with loan-to-value ratios
generally up to 125%. While the Company is currently emphasizing the origination
of Portfolio Series loans, it intends to market both products as demand permits.
In addition, to a much lesser extent, the Company originates multi-family
residential and commercial loans.
The Company purchases and originates mortgage loans and other real estate
secured loans primarily through a network of Originators on a nationwide basis.
In addition, the Company has begun to open low-cost retail lending offices.
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 Company's regional lending centers are generally
originated for sale in the secondary mortgage market and, since the fourth
quarter of 1996, in asset securitizations with servicing retained by the
Company.
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Adjustable-Rate Mortgages. The Company's adjustable rate mortgage ("ARM")
products consist of both first and second mortgages. The repayment and
amortization terms on first mortgage ARMs are 360 months. The repayment and
amortization terms on second mortgage ARMs may be 300, 240 or 180 months.
Interest rates adjust every six or twelve months, and are tied to the six-month
LIBOR or to the 1-Year U.S. Treasury Index, respectively. The periodic rate caps
vary between 1% and 3% on each rate change date. All ARM products are assumable,
subject to new borrower qualification, assumption agreements and fees. The
lifetime rate cap on ARMs is 6% to 7% above the initial rate. None of the ARM
products permit negative amortization. There are no fixed-rate conversion
options on any of the ARM products. Certain ARM products impose prepayment
penalties and others do not.
Marketing. The Company's primary means of marketing its products is direct
contact between its account executives and Originators. Each of the Company's 27
account executives is responsible for maintaining and expanding existing
Originator relationships within the account executive's assigned territory
through personal contact and promotional materials. Each account executive is
typically responsible for approximately 20 key Originators and is expected to
have weekly contact with each of these Originators. In addition, each account
executive is responsible for up to 30 additional Originators with whom the
account executive will have frequent contact. Each account executive also works
to develop Originator relationships through "cold calls" and following up on
inquiries made by Originators to the Company's toll-free number. Each account
executive works as part of a team with one of the Company's loan coordinators
and assistant coordinators. Each loan coordinator and assistant loan coordinator
works with three or four account executives. The loan coordinators and their
assistants are responsible for inputting the new loans into the Company's data
systems and for shepherding the loans from the point of origination through
funding. After origination, the whole loan coordinators and their assistants are
available to talk to Originators on a daily basis. Whole loan coordinators and
their assistants are located in each of the Company's regional lending centers.
The Company believes that the key element in developing, maintaining and
expanding its relationships with Originators is to provide the highest possible
level of product knowledge and customer service. Each account executive receives
comprehensive training prior to being assigned to a territory. In most cases,
training includes experience in the loan production department so that the
account executive will be familiar with all phases of loan origination and
production and will also become acquainted with the whole loan coordination
team. This training enables the account executive to quickly review a loan
application in order to identify the borrower's probable risk classification and
then assist the Originator in identifying the appropriate product for the
borrower, thereby enhancing the likelihood that the loan will be approved at the
rate and on the terms anticipated by the borrower. After a loan package is
submitted to the Company, the loan coordination team provides assistance to the
Originator throughout the process to complete the loan transaction. Account
executives, loan coordinators and assistant coordinators are compensated based
on the number and the dollar volume of loans funded. A significant portion of a
regional manager's compensation is tied to the profitability of his or her
regional lending center and includes a component based on loan performance.
Origination and Purchase of Loans. Loans are originated both through the
Company's wholesale network of Originators and on a retail basis through the
Company's Retail Lending Division. The Company has also made bulk purchases of
loans from time to time and has recently hired a senior management employee
experienced in bulk purchases to gradually expand the Company's loan purchases.
The Company's mortgage financing and servicing operations are conducted
primarily through regional lending centers located in Riverside, California,
Jacksonville, Florida and the Denver, Colorado metropolitan area. Over the next
nine months, the Company intends to open an additional low cost regional lending
center to better serve its Originators. This regional lending center will be
located in the Northeast sector of the United States. From its present
locations, the Company is able to originate or purchase its core products in the
District of Columbia and all 50 states with the exception of Louisiana,
Mississippi and Alaska.
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The following table sets forth for the periods shown the aggregate dollar
amounts and the percentage of core products originated or purchased by the
Company in each state where 5.0% or more of the loans were originated or
purchased during the year ended December 31, 1997:
<TABLE>
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December 31, December 31,
1997 1996
------------------------- -----------------------
$ % $ %
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<S> <C> <C> <C> <C>
(Dollars in thousands)
California............................ $159,385 22.3% $ 70,196 33.3%
Virginia.............................. 42,722 6.0 7,633 3.6
Maryland.............................. 39,545 5.5 9,178 4.4
North Carolina........................ 38,011 5.3 5,388 2.6
Florida............................... 37,009 5.2 15,557 7.4
Utah.................................. 35,735 5.0 25,846 12.3
Colorado.............................. 22,013 3.0 15,979 7.6
Other................................. 341,132 47.7 60,910 28.8
-------- ----- -------- -----
Total............................... $715,552 100.0% $210,687 100.0%
======== ===== ======== =====
</TABLE>
The Company's geographic markets are currently divided into three regions,
with a completely self-contained mortgage banking team assigned to each region.
Each team is headed up by a regional manager and includes dedicated account
executives, loan coordinators and assistant coordinators, underwriters, and
other production personnel so that the team can originate and produce loans in
that region. This concept of regional processing teams, which the Company
believes is efficient but quite rare in the industry, enables the Company to
more effectively anticipate and respond to Originator and borrower needs in each
region. Management believes that the concept also appeals to independent brokers
who may be reluctant to deal with a larger, more remote lender. Each regional
team is connected to senior management in Riverside, California by a computer
link that enables senior management to monitor all regional functions on a real
time basis.
Management personnel staffing a regional lending center are trained in the
Company's Riverside office. For a period of six to twelve months after the
establishment of a regional lending center all loans originated through that
office are reunderwritten by staff at the Riverside office to assure quality
control. In addition, the quality control department and the Company's internal
auditor regularly visit the regional lending centers for quality control
purposes.
In recent years, the Company has focused on both Liberator Series loans and
Portfolio Series loans. While the Company is currently emphasizing the
origination of Portfolio Series loans, it intends to originate both types of
loans as demand permits.
Liberator Series loans are loans for the purchase or refinance of one- to
four-family residential real property by 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 Company because they generally have higher interest rates and origination
and servicing fees and generally lower loan-to-value ratios than conforming
loans. In addition, management believes the Company has the resources to
adequately service loans acquired pursuant to this program as well as the
experience to resolve loans that become non-performing. The Company has
established specific underwriting policies and procedures, invested in
facilities and systems and developed correspondent relationships with
Originators throughout the country enabling it to develop its niche as an
originator and purchaser of one-to four-family residential loans to sub-prime
borrowers. Since the beginning of 1997, the Company 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 Company 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. 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
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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. While the Company believes that the underwriting
procedures and appraisal processes it employs enable it to somewhat mitigate the
higher risks inherent in loans made to these borrowers, no assurance can be
given that such procedures or processes will afford adequate protection against
such risks.
Portfolio Series loans, which are debt consolidation loans for Agency
Qualified Borrowers, are originated both on a wholesale basis through the
Company's Life Financial Services Division, and through its Retail Lending
Division. These loans are consumer-oriented loans secured by real estate,
primarily home equity lines of credit and second deeds of trust, generally for
up to 125% of the appraised value of the real estate underlying the aggregate
loans on the property. Although the loan-to-value ratio on Portfolio Series
loans is higher than that offered by other mortgage products, management
believes that the higher yield and the low level of credit risk of the borrowers
offsets the risks involved. In the event of a default on a Portfolio Series loan
by a borrower, there generally would be insufficient collateral to pay off the
balance of such loan and the Company, as holder of a second position on the
property, would likely lose a substantial portion, if not all, of its
investment. While the Company believes that the underwriting procedures it
employs enable it to somewhat mitigate the higher risks inherent in such loans,
no assurance can be given that such procedures will afford adequate protection
against such risks.
The following table sets forth the principal balance of each of the Company's
core loan products originated during the periods shown:
<TABLE>
<CAPTION>
For the Three Months Ended
----------------------------------------------------------------------
December 31, March 31, June 30, September 30, December 31,
1996 1997 1997 1997 1997
------------ --------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
(In thousands)
Liberator Series (full documentation)... $39,465 $39,629 $ 39,589 $ 44,484 $ 63,262
Liberator Series (NINA)(1).............. -- -- 7,803 21,410 26,719
Portfolio Series........................ 29,695 49,010 87,815 104,243 231,588
------- ------- -------- -------- --------
Total................................. $69,160 $88,639 $135,207 $170,137 $321,569
======= ======= ======== ======== ========
</TABLE>
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(1) The Company did not originate a material amount of Liberator Series (NINA)
loans during the three months ended December 31, 1996 and March 31, 1997.
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The following table sets forth selected information relating to originations
of Liberator Series loans during the periods shown:
<TABLE>
<CAPTION>
For the Three For the Three For the Three
Months Ended Months Ended Months Ended
December 31, March 31, June 30,
1996 1997 1997
-------------- ------------- -------------------------
Full Full
Documentation NINA Documentation NINA
-------------- -------------- ------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Principal balance............. $39,465 $39,629 $39,589 $7,803
Average principal balance
per loan..................... 85 100 81 103
Combined weighted
average initial loan-to-
value ratio.................. 73.4% 72.8% 78.2% 69.0%
Percent of first mortgage
loans........................ 85.4 91.8 88.8 100.0
Property securing loans:
Owner occupied.............. 86.4 77.3 90.5 92.9
Non-owner occupied.......... 13.6 22.7 9.5 7.1
Percentage fixed-rate......... 44.2 35.6 42.4 24.1
Percentage ARMs............... 55.8 64.4 57.6 75.9
Weighted average interest
rate:
Fixed-rate.................. 11.3 10.8 10.9 11.2
ARMs........................ 9.6 9.1 10.0 10.0
</TABLE>
<TABLE>
<CAPTION>
For the Three Months For the Three Months
Ended Ended
September 30, 1997 December 31, 1997
-------------------------- --------------------------
Full Full
------------- --------------
Documentation NINA Documentation NINA
------------- --------- -------------- ---------
<S> <C> <C> <C> <C>
Principal balance............. $44,484 $21,410 $63,262 $26,719
Average principal balance
per loan..................... 91 114 88 118
Combined weighted
average initial loan-to-
value ratio.................. 77.3% 73.1% 78.2% 74.4%
Percent of first mortgage
loans........................ 87.4 98.5 90.4 99.6
Property securing loans:
Owner occupied.............. 91.5 93.6 94.8 96.5
Non-owner occupied.......... 8.5 6.4 5.2 3.5
Percentage fixed-rate......... 33.4 23.1 42.5 26.7
Percentage ARMs............... 66.6 76.9 57.5 73.3
Weighted average interest
rate:
Fixed-rate.................. 11.2 11.2 10.3 10.6
ARMs........................ 9.4 9.3 9.4 9.1
</TABLE>
The following table sets forth selected information relating to originations
of Portfolio Series loans during the periods shown:
<TABLE>
<CAPTION>
For the For the For the For the For the
Three Months Three Months Three Months Three Months Three Months
Ended Ended Ended Ended Ended
December 31, March 31, June 30, September 30, December 31,
1996 1997 1997 1997 1997
------------- ------------- ------------- -------------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Principal balance..................... $29,695 $49,010 $87,815 $104,243 $231,588
Average principal balance per loan.... 31 32 33 32 34
Combined weighted average initial
loan-to-value ratio.................. 108.4% 107.7% 110.0% 109.5% 108.4%
Percent of first mortgage loans....... 0.1 0.5 0.1 -- 0.2
Property securing loans:
Owner occupied...................... 99.5 99.8 100.0 100.0 100.0
Non-owner occupied.................. 0.5 0.2 -- -- --
Percentage fixed-rate................. 96.3 96.0 98.0 94.5 92.9
Percentage ARMs....................... 3.7 4.0 2.0 5.5 7.1
Weighted average interest rate:
Fixed-rate.......................... 14.1 13.8 14.0 13.8 14.1
ARMs................................ 11.2 10.3 11.3 11.3 11.0
</TABLE>
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Use and Qualifications of Originators. The Company purchases loans from select
Originators throughout the country. Such Originators must be approved by the
Company prior to submitting loans to the Company. Pursuant to the Company's
approval process, each Originator is generally required to have a specified
minimum level of experience in originating non-conforming loans, and provide
representations, warranties, and buy-back provisions to the Company.
The Company provides clear and concise criteria regarding its well-defined
core products to Originators with whom it may do business. If, following a
period of training and relationship building, Originators consistently fail to
present a high level of loans meeting the Company's underwriting criteria, the
Company will cease to do business with them. As a result, the Company has
developed, since 1994, a core group of Originators who form its nationwide
network of Originators. The Company generally classifies the Originators with
which it does business into four classes with descending priority with regard to
the terms and the pricing of the loans the Company purchases from such
Originators.
<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 No No No
Number Doing Business with the Company at
December 31, 1997............................... 133 56 81 950
</TABLE>
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(1) Mortgage brokers are those persons who do not meet the specific foregoing
criteria but have demonstrated to the Company, or have a reputation for, the
ability to originate real estate secured loans and have acceptable credit
and finance industry references.
(2) Correspondents provide audited financial statements prepared in accordance
with GAAP from which net worth is determined. Junior Correspondents and
Third Party Originators provide unaudited financial information from which
net worth is obtained.
The Company purchases substantially all loans on an individual basis from
qualified Originators. No single Originator accounted for more than 3.1% of the
loans originated by the Company for the year ended December 31, 1997. It is the
Company's general policy to limit the percentage of loans closed by any single
Originator to approximately 5.0% of loans closed in any given period.
Underwriting. The underwriting and quality control functions are managed
through the Company's administrative offices in Riverside, California. The
Company believes that its underwriting process begins with the experience of its
staff, the education of its network of Originators, the quality of its
correspondent relationships and its loan approval procedures. As an integral
part of its lending operation, the Company ensures that its underwriters assess
each loan application and subject property against the Company's underwriting
guidelines.
Personnel in the Company's regional lending centers review in its entirety
each loan application submitted by the Company, Originators or through bulk
purchases for approval. The Company conducts its own underwriting review of each
loan, including those loans originated for or purchased by it from its
Originators. Loan files are reviewed for completeness, accuracy and compliance
with the Company's underwriting criteria and applicable governmental
regulations. This underwriting process is intended to assess both the
prospective borrower's ability to repay the loan and the adequacy of the real
property security as collateral for the loan granted, tailored to the general
nature of the Portfolio Series and the Liberator Series loans, respectively.
Based on the initial review, the personnel in the regional lending center will
inform the Originators of additional requirements that must be fulfilled to
complete the loan file. The Company strives to process each loan application
received from its network of
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Originators as quickly as possible in accordance with the Company's loan
application approval procedures. Accordingly, most loan applications receive
decisions within 48 hours of receipt and generally are funded within one day
following satisfaction of all conditions for approval of the loan which is
typically seven business days after the initial approval.
Each prospective borrower is required to complete a mortgage loan application
that may include (depending on the program requirement) information detailing
the applicant's liabilities, income, credit history, employment history and
personal information. Since most of the loan applications are presented through
the Company's network of Originators, the Company completes an additional credit
report on all applications received. Such report typically contains information
relating to such matters as credit history with local and national merchants and
lenders, installment debt payments and any record of defaults, bankruptcies,
repossessions or judgments. This credit report is obtained through a
sophisticated computer program that accesses what management believes to be the
most appropriate credit bureau in a particular zip code and combines that
information with the Company's own credit risk score.
This application and review procedure is used by the Company to analyze the
applicant's creditworthiness (i.e., a determination of the applicant's ability
to repay the loan). Creditworthiness is assessed by examination of a number of
factors, including calculating a debt-to-income ratio obtained by dividing a
borrower's fixed monthly debt by the borrower's gross monthly income. Fixed
monthly debt generally includes (i) the monthly payment under any related senior
mortgages which will include calculations for insurance and real estate taxes,
(ii) the monthly payment on the loan applied for and (iii) other installment
debt, including, for revolving debt, the required monthly payment thereon, or,
if no such payment is specified, 3% of the balance as of the date of
calculation. Fixed monthly debt may not include any debt (other than revolving
credit debt) described above that matures within less than 10 months of the date
of calculation.
Prior to funding a loan, several procedures are used to verify information
obtained from an applicant. The applicant's outstanding balance and payment
history on any senior mortgage may be verified by calling the senior mortgage
lender. If the senior mortgage lender cannot be reached by telephone to verify
this information, the Originators may rely upon information provided by the
applicant, such as a recent statement from the senior lender and verification of
payment, such as canceled checks, or upon information provided by national
credit bureaus. In order to verify an applicant's employment status, the
Originators may obtain from the applicant recent tax returns or other tax forms
(e.g., W-2 forms) or current pay stubs or may telephone the applicant's employer
or obtain written verification from the employer. As in the case of the senior
mortgage lender verification procedures, if the employer will not verify
employment history over the telephone, the Company or other Originators may rely
solely on the other information provided by the applicant. The Company does
offer NINA loans at reduced loan-to-value ratios in lieu of documenting cash
flow and/or assets of the borrower. See "--Liberator Series (NINA)" for
further information on NINA loans.
Debt to income ratios for Portfolio Series mortgage loans generally do not
exceed 45%, but in certain instances where deemed appropriate by the Company,
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.
-8-
<PAGE>
The general criteria currently used by the Company in classifying prospective
borrowers of its core loan products are summarized in the charts below.
Liberator Series (Full documentation)
<TABLE>
<CAPTION>
"Ax" Risk "A-" Risk "B" Risk
-------------------- -------------------- ---------------------
Maximum Loan-to-Value
Ratio:
<S> <C> <C> <C>
Primary residence............. 95% 95% 80%
Secondary residence........... 90% 90% 70%
Investor property............. 90% 85% 70%
Home equity line of
credit....................... 90% 90% 80%
Debt Service to Income
Ratio........................ 42-50% 42-50% 50-55%
Mortgage Credit................. Maximum one 30-day Maximum two 30- Maximum four 30-
late payment in the day late payments in day late payments
last 12 months the last 12 months and/or one 60-day
late payment in the
last 12 months
Installment Credit.............. Maximum one 30-day No more than 30 No more than 60
late payment in the days late in last 12 days late on any
last 12 months; months; overall good account in last 12
maximum two 30-day credit; maximum 25% months; overall
late payments in the of credit accounts average credit
last 24 months delinquent in last 24
months
Revolving Credit................ Maximum two 30- No more than 30 No more than 60
day late payments in days late in last 12 days late on any
the last 12 months; months; isolated 60- account in last 12
maximum three 30- day late payment months; isolated
day late payments in allowed with minor 90-day late
last 24 months compensating factors; payment allowed with
maximum 25% compensating factors
of credit accounts
delinquent in last 24
months
Bankruptcy Filings.............. No bankruptcy in last No bankruptcy in last No bankruptcy in last
36 months 24 months 18 months
Minimum Credit Score............ 670/650 620 550
</TABLE>
<TABLE>
<CAPTION>
"C" Risk "CX" Risk
-------------------- --------------------
Maximum Loan-to-Value
Ratio:
<S> <C> <C>
Primary residence............. 75% 65%
Secondary residence........... 70% 65%
Investor property............. 70% 65%
Home equity line of
credit....................... -- --
Debt Service to Income
Ratio........................ 50-60% 60%
Mortgage Credit................. Maximum six 30-day Currently delinquent
late payments, two
60-day late payments
and/or one 90-day
late payment in last
12 months
Installment Credit.............. No more than 90 Sporadic payment
days late on any pattern; apparent
account in last 12 disregard toward
months; overall fair timely payments or
credit credit standing
Revolving Credit................ No more than 90 Sporadic payment
days late on any pattern; apparent
account in last 12 disregard toward
months; isolated late timely payments or
payment over 90 days credit standing
allowed with
compensating factors
Bankruptcy Filings.............. No bankruptcy in last Discharged within 12
12 months months preceding
application; current
Chapter 13 or
foreclosure
acceptable when paid
in full or cured from
loan proceeds
Minimum Credit Score............ 500 greater than 500
</TABLE>
-9-
<PAGE>
Liberator Series (NINA)
<TABLE>
<CAPTION>
"Ax" Risk "A-" Risk "B" Risk
------------------------- ---------------------- -----------------------
Loan-to-Value Ratio:
<S> <C> <C> <C>
Primary residence.......... 90%(1) 75% 70%
Secondary residence........ 75% 70% 65%
Investor property.......... 75% 70% 65%
Mortgage Credit.............. Maximum one 30-day Maximum two 30- Maximum four 30-
late payment in the day late payments in day late payments
last 12 months; no 30 the last 12 months and/or one 60-day
days late payments in late payment in the
last 24 months for last 12 months
90%
Installment Credit........... Maximum one 30-day No more than 30 No more than 60
late payment in the days late in last 12 days late on any
last 12 months; months; overall good account within last 12
maximum two 30-day credit; maximum months; overall
late payments in the 25% of credit average credit
last 24 months; no 30 accounts delinquent
days late payments in in last 24 months
last 12 months for
90%
Revolving Credit............. Maximum two 30- No more than 30 No more than 60
day late payments in days late in last 12 days late on any
the last 12 months; months, isolated 60- account in last 12
maximum three 30- day late payment months; isolated
day late payments in allowed with minor 90-day late
last 24 months; no 30 compensating factors; payment allowed with
days late payments in maximum 25% of compensating factors
last 24 months for credit accounts
90% delinquent in last 24
months
Bankruptcy Filings........... No bankruptcy in last No bankruptcy in last No bankruptcy within
36 months, none in 24 months last 18 months
last 7 years for 90%
LTV
Minimum Credit Score......... 670/650 620 550
</TABLE>
<TABLE>
<CAPTION>
"C" Risk "CX" Risk
---------------------- ----------------------
Loan-to-Value Ratio:
<S> <C> <C>
Primary residence.......... 70% 65%
Secondary residence........ 65% 60%
Investor property.......... 65% 60%
Mortgage Credit.............. Maximum six 30-day Currently delinquent
late payments, two
60-day late payments
and/or one 90-day
late payment in last
12 months
Installment Credit........... No more than 90 Sporadic payment
days late on any patterns; apparent
account in last 12 disregard toward
months; overall fair timely payments or
credit credit standing
Revolving Credit............. No more than 90 Sporadic payment
days late on any patterns; apparent
account in last 12 disregard toward
months; isolated late timely payments or
payment over 90 days credit standing
allowed with
compensating factors
Bankruptcy Filings........... No bankruptcy in last Discharged within 12
12 months months preceding
application; current
Chapter 13 or
foreclosure
acceptable when paid
in full or cured from
loan proceeds
Minimum Credit Score......... 500 greater than 500
</TABLE>
- --------------
(1) Purchase or rate term only, A+ credit required, credit score minimum of 670;
all others maximum LTV at 80%.
-10-
<PAGE>
PORTFOLIO SERIES
<TABLE>
<CAPTION>
"A+" Risk "AX" Risk "A-" Risk
--------------------- --------------------- ---------------------
Loan-to-Value Ratio:
<S> <C> <C> <C>
100% Second Mortgage...................................... 100% 100% 100%
125% Second Mortgage...................................... 125% 135% 135%
100% Home Equity Line of Credit........................... 100% 100% 100%
Debt Service to Income Ratio: 100% Second Mortgage......... 45-50% 45-50% 45-50%
125% Second Mortgage...................................... 45-50% 45-50% 45-50%
100% Home Equity Line of Credit........................... 45-50% 45-50% 45-50%
Mortgage History:
100% Second Mortgage...................................... No 30-day late No 30-day late No 30-day late
payments in last 36 payments in last 36 payments in last 12
months months months; one 30-day
late payment in last
24 months
125% Second Mortgage...................................... No 30-day late No 30-day late No 30-day late
payments in last 36 payments in last 36 payments in last 24
months months months
100% Home Equity Line of Credit........................... No 30-day late No 30-day late No 30-day late
payments in last 36 payments in last 36 payments in last 12
months months months; one 30-day
late payment in last
24 months
Bankruptcy Filings:
100% Second Mortgage...................................... None in last 5 years None in last 5 years None in last 3 years
125% Second Mortgage...................................... None in last 5 years None in last 5 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
Minimum Credit Score:
100% Second Mortgage...................................... 700 670 640
125% Second Mortgage...................................... 700 670 640
100% Home Equity Line of Credit........................... 700 670 640
</TABLE>
-11-
<PAGE>
Loan Production by Borrower Risk Classification. The Company classifies
borrowers according to credit risk from A+ to Cx; however, the predominant
amount of its lending is to borrowers in categories A- or higher. The following
table sets forth information concerning the Company's principal balance of fixed
rate and adjustable rate loan production by borrower risk classification for the
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 Volume Total Rate(1) Margin(2) Volume Total Rate(1) Margin(2)
- -------------------------- ------- ------ ----------- ----------- ------- ------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
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
------- ----- ------- -----
Total A- or better...... 27,715 70.3 -- -- 26,400 66.6 -- --
------- ----- ------- -----
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
------- ----- ------- -----
Total................... $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
------- ----- ------- -----
Total A- or better...... 26,987 .9 -- -- 43,906 89.6 -- --
------- ----- ------- -----
B+........................ 2,708 9.1 14.10 3.73 5,104 10.4 14.07 2.70
------- ----- ------- -----
Total................... $29,695 100.0% 14.03 2.74 $49,010 100.0% 13.68 2.32
======= ===== ======= =====
</TABLE>
(Continued on following page.)
-12-
<PAGE>
<TABLE>
<CAPTION>
For the Three Months Ended For the Three Months Ended
June 30, 1997 September 30, 1997
-------------------------------------------- --------------------------------------------
Weighted Weighted
Average Weighted Average Weighted
Product/Risk % of Interest Average % of Interest Average
Classifications Volume Total Rate(1) Margin(2) Volume Total Rate(1) Margin(2)
- -------------------------- ------- ------ ----------- ----------- ------- ------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Liberator Series (Full documentation)
A+.................................. $ 47 0.1% 12.38% 7.00% $ 120 0.3% 9.67% 4.63%
Ax.................................. 18,778 47.4 9.88 5.47 15,797 35.5 9.48 5.77
A-.................................. 9,663 24.4 10.03 6.05 16,059 36.1 9.76 6.17
------- ----- -------- -----
Total A- or better................ 28,488 71.9 -- -- 31,976 71.9 -- --
------- ----- -------- -----
B+.................................. 119 0.3 9.75 -- 24 0.1 13.75 --
B................................... 4,303 10.9 10.82 6.06 5,911 13.3 10.31 6.32
C................................... 2,776 7.0 11.48 6.53 3,297 7.4 10.64 6.41
Cx.................................. 3,903 9.9 12.59 8.15 3,276 7.3 12.18 7.28
------- ----- -------- -----
Totals............................ $39,589 100.0% 10.40 6.08 $ 44,484 100.0% 9.98 6.14
======= ===== ======== =====
Liberator Series (NINA)(3)
Ax.................................. $ 3,772 48.3% 9.56 5.33 $ 13,789 64.4% 9.20 5.54
A-.................................. 2,325 29.8 10.14 6.05 3,188 14.9 9.81 6.30
------- ----- -------- -----
Total A- or better................ 6,097 78.1 -- -- 16,977 79.3 -- --
------- ----- -------- -----
B................................... 1,102 14.1 11.78 6.35 2,088 9.7 10.20 5.97
C................................... 332 4.3 12.27 6.83 592 2.8 11.09 7.07
Cx.................................. 272 3.5 12.49 6.92 1,753 8.2 12.72 6.43
------- ----- -------- -----
Totals............................ $ 7,803 100.0% 10.27 5.82 $ 21,410 100.0% 9.73 5.77
======= ===== ======== =====
Portfolio Series
A+.................................. $19,086 21.7% 13.30 8.02 $ 23,250 22.3% 12.98 5.79
Ax.................................. 27,954 31.8 13.85 6.50 31,914 30.6 13.49 6.50
A-.................................. 31,234 35.6 14.28 7.22 38,521 37.0 14.00 6.99
------- ----- -------- -----
Total A- or better................ 78,274 89.1 -- -- 93,685 89.9 -- --
------- ----- -------- -----
B+.................................. 9,435 10.8 14.69 7.18 10,472 10.0 14.38 7.51
B................................... 106 0.1 13.99 -- 86 0.1 12.27 6.88
------- ----- -------- -----
Total............................. $87,815 100.0% 13.98 7.38 $104,243 100.0% 13.66 6.64
======= ===== ======== =====
</TABLE>
<TABLE>
<CAPTION>
For the Three Months Ended
December 31, 1997
--------------------------------------------
Weighted
Average Weighted
Product/Risk % of Interest Average
Classifications Volume Total Rate(1) Margin(2)
- -------------------------- ------- ------ ----------- -----------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Liberator Series (Full documentation)
A+........................................ $ 797 1.3% 9.07% 5.13%
Ax........................................ 29,972 47.4 9.26 2.82
A-........................................ 17,525 27.7 9.59 3.79
-------- -----
Total A- or better...................... 48,294 76.4 -- --
-------- -----
B+........................................ -- -- -- --
B......................................... 7,217 11.4 10.31 3.22
C......................................... 2,601 4.1 10.98 3.57
Cx........................................ 5,150 8.1 12.50 5.66
-------- -----
Totals.................................. $ 63,262 100.0% 9.81 3.42
======== =====
Liberator Series (NINA)(3)
Ax........................................ $ 20,843 78.0 9.14 5.44
A-........................................ 2,947 11.0 9.89 6.14
-------- -----
Total A- or better...................... 23,790 89.0 -- --
-------- -----
B......................................... 1,135 4.3 10.71 6.72
C......................................... 985 3.7 11.20 6.86
Cx........................................ 809 3.0 12.23 7.66
-------- -----
Totals.................................. $ 26,719 100.0% 9.46 5.63
======== =====
Portfolio Series
A+........................................ $ 49,461 21.3 13.03 4.12
Ax........................................ 92,605 40.0 13.79 5.15
A-........................................ 76,164 32.9 14.37 5.97
-------- -----
Total A- or better...................... 218,230 94.2 -- --
-------- -----
B+........................................ 13,156 5.7 14.11 6.40
B......................................... 202 0.1 12.88 3.38
-------- -----
Total................................... $231,588 100.0% 13.84 5.31
======== =====
</TABLE>
- --------------
(1) Weighted average interest rate includes both ARM loan products and fixed
rate loan products.
(2) Weighted average margin is based solely on ARM products.
(3) The Company did not originate a material amount of Liberator Series (NINA)
loans during the three months ended December 31, 1996 and March 31, 1997.
-13-
<PAGE>
Appraisal. All mortgaged properties relating to mortgage loans where
collateral assessment is an integral part of the evaluation process are
appraised by state licensed or certified appraisers. All of the appraisals are
either performed or reviewed by appraisers or appraisal firms approved by the
Company's senior management. These appraisers are screened and actively reviewed
on a regular basis. Each approved appraiser must have a minimum of $1.0 million
of errors and omissions insurance. All appraisers are required to assess the
valuation of the property pursuant to U.S. Government Property Analysis
guidelines and conduct an economic analysis of the geographic region in which
the property is located. Once a loan application file is complete, the file is
reviewed to determine whether the property securing the loan should undergo a
desk or field review. This determination is made based on the loan-to-value
ratio of the underlying property and the type of loan or loan program. If after
the initial desk review, the underwriter requires additional information with
regard to the appraised value of the property, a field review may also be
conducted. The Company requires the appraiser to address neighborhood
conditions, site and zoning status and the condition and valuation of
improvements. Following each appraisal, the appraiser prepares a report which
(when appropriate) includes a reproduction cost analysis based on the current
cost of constructing a similar building and a market value analysis based on
recent sales of comparable homes in the area. Title insurance policies are
required on all first mortgage liens and second liens $100,000 and over, with a
limited judgment lien report required on all second lien loans under $100,000.
For Liberator Series loans, because of the 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.
The value of the mortgaged property has lesser importance with respect to the
Portfolio Series loans in light of their high loan-to-value ratios. As a result,
Portfolio Series loans generally have little or no equity in the mortgaged
property available to repay the loan if it is in default. For Portfolio Series
loans, the Company 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
Company requires a current tax assessment, a statistical appraisal or a HUD-1
conformed closing statement where purchase of the subject property has occurred
within the previous 12 months. For loans in excess of $50,000, a drive-by
appraisal including comparable analysis on a FHLMC Form 704 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 Company and delegates authority and responsibility for
loan approvals to the Loan Committee and specified officers of the Company. All
real estate loans must be approved by a quorum of the designated committee or by
the designated individual or individuals.
All loans underwritten by the Company require the approval and signature of
two underwriters. Where there are exceptions to the Company's underwriting
criteria, the loan must be unanimously approved by the underwriter, supervisory
underwriter and the Senior Vice President of the Company or, if not unanimously
approved, by the Company's President and Chief Executive Officer. It has been
the Bank's policy to adhere strictly to its underwriting standards with few
exceptions. Additionally, the following committees, groups of officers and
individual officers are granted the authority to approve and commit the Company
to the funding of the following categories of loans:
-14-
<PAGE>
<TABLE>
<CAPTION>
Level of Approval
----------------------------------------------------------------------------------
Loan Committee
One Staff Two Staff Loan and Board of
Type of Loan Underwriter Underwriters Committee Directors
- --------------------------------------- --------------- ------------------- --------------------- ------------------
<S> <C> <C> <C> <C>
Mortgage loans held for sale........... -- $1.0 million -- More than $1.0
or less(1) million
Mortgage loans held for investment..... -- $250,000 or less More than $250,000 $550,000 or more
but less than
$550,000
Other loans............................ Personal loans All other loans All other loans more All other loans in
secured by Bank $25,000 or less than $25,000 but less excess of $50,000
deposits than $50,000
</TABLE>
- --------------
(1) Loans in excess of $500,000 require approval by an executive officer in
addition to approval by two underwriters.
The Bank will not make loans-to-one borrower that are in excess of regulatory
limits. Pursuant to Office of Thrift Supervision ("OTS") regulations, loans-
to-one borrower cannot exceed 15% of the Bank's unimpaired capital and surplus.
At December 31, 1997, the Bank's loans to one borrower limit equaled $3.6
million. See "--Regulation--Federal Savings Institution Regulation--Loans-to-
One Borrower."
Loan Sales and Asset Securitizations
Loans are sold by the Company through securitizations and whole loan sales.
With the exception of customary provisions relating to breaches of
representations and warranties, loans securitized or sold by the Company are
sold without recourse to the Company and generally are sold with servicing
retained. For the years ended December 31, 1997, 1996 and 1995, the Company sold
$94.7 million, $154.6 million, and $126.9 million in loans, respectively. For
the years ended December 31, 1997 and 1996, the Company securitized $415.4
million and $51.9 million, respectively. No loans were securitized for the year
ended December 31, 1995.
In a securitization, the Company will generally transfer a pool of loans to a
trust with the Company retaining the excess cash flows, known as residuals, from
the securitization which consist of the difference between the interest rate of
the mortgages and the coupon rate of the securities after adjustment for
servicing and other costs such as trustee fees and credit enhancement fees. The
cash generally will be used to repay advances on lines of credit used to finance
the pool of loans that were acquired by the Company. Generally, the holders of
the securities from the asset securitization are entitled to receive scheduled
principal collected on the pool of securitized loans and interest at the pass-
through interest rate on the certificate balance. The residual asset represents
the subordinated right to receive cash flows from the pool of securitized loans
after payment of the required amounts to the holders of the securities and the
costs associated with the securitization. The Company recognizes gain on sale of
the loans in the securitization, which represents the excess of the estimated
fair value of the residuals, net of closing and underwriting costs, less the
allocated cost basis of the loans sold in the fiscal quarter in which such loans
are sold. Management believes that it has made reasonable estimates of the fair
value of the residual interests on its balance sheets. Concurrent with
recognizing such gain on sale, the Company records the residual interests as
assets on its balance sheet. The recorded value of these residual
-15-
<PAGE>
interests are amortized as cash distributions are received from the trust
holding the respective loan pool and are marked to market on a quarterly basis.
The fair values of such residuals are based in part on market interest rates and
projected loan prepayment and credit loss rates. Increases in interest rates or
higher than anticipated rates of loan prepayments or credit losses of these or
similar securities may require the Company to write down the value of such
residuals and result in a material adverse effect on the Company's results of
operations and financial condition. During the year ended December 31, 1997, the
Company revalued the 1997-1 residual and recorded a pre-tax unrealized loss of
$966,000 due to higher-than-expected prepayment speeds. The Company is not aware
of an active market for the residuals. No assurance can be given that the
residuals could in fact be sold at their carrying value, if at all.
The Company may arrange for credit enhancement for a transaction to achieve an
improved credit rating on the securities issued if this improves the level of
profitability or cash flow generated by such transaction. This credit
enhancement may take the form of an insurance and indemnity policy, insuring the
holders of the securities of timely payment of the scheduled pass-through of
interest and principal. In addition, the pooling and servicing agreements that
govern the distribution of cash flows from the loan pool included in a
transaction typically require over-collateralization as an additional means of
credit enhancement. Over-collateralization may in some cases also require an
initial deposit, the sale of loans at less than par or retention in the trust of
collections from the pool until a specified over-collateralization amount has
been attained. The purpose of the over-collateralization is to provide a source
of payment to investors in the event of certain shortfalls in amounts due to
investors. These amounts are subject to increase up to a reserve level as
specified in the related securitization documents. Cash amounts on deposit are
invested in certain instruments as permitted by the related securitization
documents. To the extent amounts on deposit exceed specified levels,
distributions are made to the holders of the residual interest; and at the
termination of the related trust, any remaining amounts on deposit are
distributed to the holders of the residual interest. Losses resulting from
defaults by borrowers on the payment of principal or interest on the loans in a
securitization will reduce the over-collateralization to the extent that funds
are available and may result in a reduction in the value of the residual
interest.
The Company has completed four securitizations, one during the fourth quarter
of 1996, one during the first quarter of 1997, one during the third quarter of
1997 and one during the fourth quarter of 1997 --- See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Restatement of
Financial Statements". The characteristics and results of these securitizations
are as follows:
-16-
<PAGE>
<TABLE>
<CAPTION>
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 Series Liberator Series Series and Portfolio Series
Weighted average coupon........ 13.32% 9.45% 13.02%
Amount of certificates issued.. $55.0 million $38.5 million $61.5 million
Pass-through rate.............. 6.95% 1 month LIBOR plus 21 bp 7.49%
Amount of loans
Securitized................... $55.0 million $38.5 million $61.5 million
Credit enhancement............. MBIA Insurance MBIA Insurance MBIA Insurance
Corporation Corporation Corporation
Initial funding of reserve
accounts...................... $1.6 million $ 941,000 $3.1 million
Required reserve level to be
funded........................ 9.0% of original 5.5% of original 10.6% of original
outstanding balance of outstanding balance of outstanding balance of
loans loans loans
Gain on sale of loans.......... $1.4 million (7) $1.6 million(1) (7) $1.6 million(1) (7)
Gain on sale of loans as a
percent of loans sold......... 2.55% (7) 1.60%(1) (7) 1.60%(1) (7)
Estimated prepayment speed..... 17.0% H.E.P. (2) 25.0% C.P.R. (2)(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 loans sold
months and 1.00% thereafter twelve months and 1.00%
thereafter
Rating......................... AAA/Aaa (S&P/Moody's) AAA/Aaa (S&P/Moody's) AAA/Aaa (S&P/Moody's)
</TABLE>
<TABLE>
<CAPTION>
1997-2 1997-3
------------------------------ ---------------------------
<S> <C> <C>
Type of loan securitized....... Fixed Rate Portfolio Fixed Rate
Series Portfolio Series
Weighted average coupon........ 13.64% 13.86%
Amount of certificates issued.. $123.8 million $187.5 million
Pass-through rate.............. 7.12%(4) 7.62%
Amount of loans
Securitized................... $125.0 million $187.4 million
Credit enhancement............. Loan overcollateralization Loan overcollateralization
Initial funding of reserve
accounts...................... $1.3 million None
Required reserve level to be
funded........................ 7.0% of original 6.3% of original
outstanding outstanding
balance of loans balance of loans
Gain on sale of loans.......... $10.8 million $10.0 million
Gain on sale of loans as a
percent of loans sold......... 8.64% 5.34%
Estimated prepayment speed..... 12.0% H.E.P. 14.0% H.E.P.
Discount factor................ 13.5% 13.5%
Annual estimated loss
assumption.................... 2.0% 2.5%
Servicing fees................. 1.00% 1.00%
Rating......................... (5) (6)
</TABLE>
- --------------
(1) The combined gain on sales of loans for 1997-1A and 1997-1B was $1.6
million. The percentages are based on the combined 1997-1A and 1997-1B
securitizations.
(2) Home Equity Prepayment ("H.E.P.") and Constant Prepayment Rate
("C.P.R.") are methods of estimating prepayment speeds.
(3) This prepayment assumption was revised during the third quarter of 1997 to
60.0% C.P.R. resulting in an unrealized loss to the Company of $966,000.
(4) Weighted average rate.
(5) Each of the Senior Notes were rated AAA/Aaa (Fitch/Moody's), the Class M-1
Notes were rated AA/A2, the Class M-2 Notes were rated A/A2 and the Class B
notes were rated BBB/Baa3.
(6) Each of the Senior Notes were rated AAA/Aaa (Fitch/Moody's), the Class M-1
Notes were rated AA/Aa2, the Class M-2 Notes were rated A/A2 and the Class
B Notes were rated BBB/Baa2.
(7) As restated, see Note 21 of Notes to Consolidated Financial Statements
-17-
<PAGE>
The following table presents the actual loss and prepayment history as of
December 31, 1997 for the securitizations conducted by the Company, except for
the 1997-3 securitization, which was completed during December 1997 and for
which meaningful data was not available as of that date:
<TABLE>
<CAPTION>
1996-1 1997-1A 1997-1B 1997-2
---------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Lifetime actual loss percentage................................ 0.75% -- % 0.43% 0.08%
Lifetime prepayments as a percentage of loans securitized
annualized................................................... 14.45 43.72 8.18 5.53
</TABLE>
The actual loss and prepayment history information provided above are not
necessarily indicative of loss and prepayment results that may be experienced
over the duration of the securitization.
Although the Company will continue to sell whole loans, it plans to sell a
significant portion of its loans in the future through securitizations.
Securitizations are expected to increase the Company's cash flow thereby
allowing the Company 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 Company
currently intends to conduct regular securitizations either through private
placements or in public offerings. There can be no assurance that the Company
will be able to successfully implement this strategy in the future.
To the extent that loans are not sold in securitizations, whole loans will be
sold pursuant to purchase, sale and servicing agreements negotiated with Loan
Purchasers to purchase loans meeting the Company's underwriting criteria. At
December 31, 1997 there were outstanding commitments to deliver mortgage loans
in the amount of $62.6 million. The Company retains the servicing rights on the
majority of loans sold. However, the Company also sells loans on a servicing
released basis and may continue to subservice the loans for a fee for a period
of time. The Company sells loans to a number of different investors with which
it does business. As such, management believes that no one relationship with a
Loan Purchaser constitutes the predominant source of sales for the Company and
the Company does not rely on any specific entities for sales of its loans.
Commercial Real Estate and Multi-Family Real Estate Lending
Consistent with its strategy of developing niche lending markets, the Company
has begun to increase its efforts to originate and purchase multi-family and
commercial real estate loans both in its primary market area and throughout the
United States. Specifically, the Company has begun to target the market for
borrowers seeking loans in the range of $50,000 to $1.5 million, subject to the
Bank's loans-to-one borrower limit, currently $3.6 million, which are secured by
multi-family properties or properties used for commercial business purposes such
as small office buildings, light industrial or retail facilities. Since the
Company has been able to acquire such loans at a discount and expects to be able
to continue to acquire such loans at a discount or low premium, management
believes that the origination and subsequent sale of commercial and multi-family
real estate loans will increase the Company's cash flow. The Company has
streamlined and standardized its processing of commercial and multi-family real
estate loans with a view to sale in the secondary market or securitization.
Since 1994, substantially all commercial and multi-family real estate loans
originated by the Company have been sold in the secondary market without
recourse. Although there can be no assurances in this regard, management intends
to gradually expand these operations, thereby adding a source of revenue for the
Company as well as providing loans for future securitizations. There can be no
assurances, however, that any such securitization will be completed in the
future. Securitization of commercial and multi-family real estate loans is
significantly less standardized and streamlined than securitization of one- to
four-family residential mortgage loans.
-18-
<PAGE>
Management believes that it has the infrastructure in place to safely
diversify its product line into this niche market. Two of the Company's senior
executive officers, Daniel L. Perl and Joseph R. L. Passerino, have combined
experience of approximately 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
Company works primarily with a select group of approximately 100 mortgage
brokers nationwide with specifically delineated credentials. The Company also
works with four correspondents and expects to expand that number of approved
correspondents to 15 in the near future. Commercial and multi-family real estate
loan correspondents in the Company's network must have a net worth of at least
$1.0 million, a two to three year history of funding and servicing multi-family
and commercial real estate loans and errors and omissions insurance of at least
$1.0 million. In addition, an on-site inspection of the facilities of each of
these correspondents is conducted by the Bank's Senior Vice President. Where
loans are originated by other than this pre-approved group of correspondents,
the Company will underwrite the loan. The Company also works with a contract
appraiser with nationwide experience in appraising commercial and multi-family
real estate loans who appraises or reviews the appraisals on all such
properties.
The Company's policy is to not make commercial or multi-family real estate
loans to borrowers who are in bankruptcy, foreclosure, have loans more than 30
days delinquent or other combinations of credit weaknesses unacceptable to the
Company. The Company targets high to medium credit quality borrowers. The
Company's underwriting procedures provide that commercial real estate loans may
be made in amounts up to 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 Company considers the net operating income of the property and the
borrower's expertise, credit history and personal cash flows. The Company has
generally required that the properties securing commercial real estate and
multi-family real estate loans have debt service coverage ratios (the ratio of
net operating income to debt service) of at least 120%. The largest commercial
real estate loan in the Company's held for sale portfolio at December 31, 1997
was $776,000 and is secured by a five-unit office building in Venice, California
while the largest multi-family real estate loan in the Company's held for sale
portfolio at December 31, 1997 was $1.2 million secured by a 39 unit multi-
family property located in Yucaipa, California. At December 31, 1997 the
Company's commercial real estate portfolio was $16.8 million, or 5.36% of total
gross loans, $10.7 million of which were held for sale. The Company's multi-
family real estate portfolio at that same date was $10.7 million, or 3.41% of
total gross loans, $8.6 million of which were held for sale.
Repayment of multi-family and commercial real estate loans generally is
dependent, in large part, on sufficient income from the property to cover
operating expenses and debt service. The Company attempts to offset the risks
associated with multi-family and commercial real estate lending by primarily
lending to individuals who will be actively involved in the management of the
property and generally to individuals who have proven management experience, and
by making such loans with lower loan-to-value ratios than one- to four-family
loans.
Historical and Local Lending Portfolio
The Company'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 Company's gross historical loan
portfolio has decreased in size from $48.0 million at December 31, 1994 to $31.7
million at December 31, 1997. The largest loan in the Company's held for
investment portfolio at December 31, 1997 was $582,000 secured by a hotel
located in San Bernardino, California. At December 31, 1997, substantially all
-19-
<PAGE>
of the Company's historical loan portfolio was secured by properties located in
California. For a discussion of loss experience on the historical and local
lending portfolio, see "--Lending Overview--Allowance for Loan Losses" and
"--Non-Accrual and Past Due Loans."
Consumer and Other Lending
The Company's consumer and other loans generally consist of overdraft lines of
credit, commercial business loans and unsecured personal loans. At December 31,
1997, the Company's consumer and other loan portfolio was $6.9 million or 2.21%
of total gross loans. Of this amount, $6.3 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 Company's loan servicing portfolio consisted
solely of loans originated directly by the Company and retained for investment
or sold, primarily as participations, to others. Commencing in January of 1994
through June of 1995, the Company purchased mortgage servicing rights on FNMA
and FHLMC loans in order to expand the size of its loan servicing department and
to further develop its loan servicing capabilities. The entire FHLMC servicing
portfolio was resold in December 1995. Effective July 1, 1995, with the adoption
of Statement of Financial Accounting Standards ("SFAS") No. 122, which
required the Company to capitalize the value of originated mortgage servicing
rights, the Company began to retain substantially all servicing rights on loans
sold. In addition, the Company intends to retain the servicing rights to the
loans it securitizes. The pooling and servicing agreements related to the
securitizations completed to date contain provisions with respect to the maximum
permitted loan delinquency rates and loan default rates which, if exceeded,
would allow the termination of the Company's right to service the related loans.
Servicing rights were $8.5 million at December 31, 1997. At December 31, 1997,
the Company serviced $832.4 million of loans of which $536.7 million were
serviced for others. There can be no assurance that the Company's estimates used
to determine the fair value of mortgage servicing rights will remain appropriate
for the life of the loans sold or the securitizations. If actual loan
prepayments or delinquencies exceed the Company's estimates, the carrying value
of the Company's mortgage servicing rights may have to be written down through a
charge against earnings. The Company cannot write up such assets to reflect
slower than expected prepayments, although slower prepayments may increase
future earnings as the Company will receive cash flows in excess of those
anticipated. Fluctuations in interest rates may also result in a write-down of
the Company's mortgage servicing rights in subsequent periods. During 1997 the
Company recorded a write-down of $1.3 million on mortgage servicing rights as a
result of higher than anticipated prepayment speeds on adjustable rate mortgage
loans.
The loan servicing and collections department has increased in size from four
persons at December 31, 1994 to 28 persons at December 31, 1997. Within this
department, personnel have experience in both sub-prime lending and also in
managing the Company's non-performing loans in its historical local lending
portfolio. This experience was gained in part during the economic downturn in
Southern California and resulted in a low loss experience for the Company. See
"--Lending Overview--Allowance for Loan Losses." The head of the servicing
department has more than 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. During the first quarter
of 1998, substantial space in Riverside, California has been leased for the loan
servicing and collections operations. The Company has enhanced its telephonic
systems by purchasing a power dialing system, which became operational in the
first quarter of 1998. In addition, the Company intends to enhance its computer
systems by adding document imaging, which creates an image of each document in a
loan file accessible through the Company's wide area network. This system is
expected to become operational in the second quarter of 1998.
-20-
<PAGE>
The Company's loan servicing activities include (i) the collection and
remittance of mortgage loan payments, (ii) accounting for principal and interest
and other collections and expenses, (iii) holding and disbursing escrow or
impounding funds for real estate taxes and insurance premiums, (iv) inspecting
properties when appropriate, (v) contacting delinquent borrowers, and (vi)
acting as fiduciary in foreclosing and disposing of collateral properties. The
Company receives a servicing fee for performing these services for others.
While most of the Company's servicing portfolio is generated through its
origination and purchase activities, when economically attractive, the Company
has, from time to time, made bulk purchases of mortgage servicing rights from
financial institutions. The Company does not intend to make significant bulk
purchases of servicing rights in the near future but may do so depending on
market opportunities. The mortgage loans underlying the servicing rights
retained by the Company have been historically underwritten by the Company.
These servicing rights were either originated by mortgage brokers or purchased
through various programs from correspondents or junior correspondents. The costs
to acquire servicing are based on the present value of the estimated future
servicing revenues, net of the expected servicing expenses, for each
acquisition. Major factors impacting the value of servicing rights include
contractual service fee rates, projected mortgage prepayment speed, projected
delinquencies and foreclosures, projected escrow, agency and fiduciary funds to
be held in connection with such servicing and the projected benefit to be
realized from such funds.
In addition to weekly loan delinquency meetings which are attended by members
of senior management, the loan committee of the Board of Directors generally
performs a monthly review of all delinquent loans 90 days or more past due. In
addition, management reviews on an ongoing basis all delinquent loans. The
procedures taken by the Company with respect to delinquencies vary depending on
the nature of the loan and period of delinquency. When a borrower fails to make
a required payment on a loan, the Company takes a number of steps to have the
borrower cure the delinquency and restore the loan to current status. The
Company generally sends the borrower a written notice of non-payment within ten
days after the loan is first past due. In the event payment is not then
received, additional letters and phone calls generally are made. If the loan is
still not brought current, the Company generally sends a notice of the intent to
foreclose 25 days after the loan is first past due. If the borrower does not
cure the delinquency and it becomes necessary for the Company to take legal
action, which typically occurs after a loan is delinquent at least 30 days or
more, the Company will commence foreclosure proceedings against any 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 Company's procedures for repossession
and sale of consumer collateral are subject to various requirements under state
consumer protection laws.
Regulation and practices in the United States regarding the liquidation of
properties (e.g., foreclosure) and the rights of the mortgagor in default vary
greatly from state to state. Loans originated or purchased by the Company are
secured by mortgages, deeds of trust, trust deeds, security deeds or deeds to
secure debt, depending upon the prevailing practice in the state in which the
property securing the loan is located. Depending on local law, foreclosure is
effected by judicial action and/or non-judicial sale, and is subject to various
notice and filing requirements. If foreclosure is effected by judicial action,
the foreclosure proceedings may take several months.
In general, the borrower, or any person having a junior encumbrance on the
real estate, may cure a monetary default by paying the entire amount in arrears
plus other designated costs and expenses incurred in enforcing the obligation
during a statutorily prescribed reinstatement period. Generally, state law
controls the amount of foreclosure expenses and costs, including attorneys'
fees, which may be recovered by a lender.
-21-
<PAGE>
There are a number of restrictions that may limit the Company's ability to
foreclose on a property. A lender may not foreclose on the property securing a
junior mortgage loan unless it forecloses subject to each senior mortgage, in
which case the junior lender or purchaser at such a foreclosure sale will take
title to the property subject to the lien securing the amount due on the senior
mortgage. Moreover, if a borrower has filed for bankruptcy 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.
-22-
<PAGE>
Credit Quality of Servicing Portfolio. The following table illustrates the
Company's delinquency and default experience with respect to its loan servicing
portfolio:
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------------------------------------
1997 1996
----------------------------------------------- -----------------------------------------------
Number Number
of % of % of of % of % of
Loans/ Loans Principal Servicing Loans/ Loans Principal Servicing
Properties Serviced Balance Portfolio Properties Serviced Balance Portfolio
---------- --------- --------- ---------- ---------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
Delinquency percentage(1)(2)
30-59 days................ 282 1.46% $ 9,356 1.12% 10 0.26% $ 860 0.36%
60-89 days................ 148 0.76 3,664 0.44 -- -- -- --
90 days and over.......... 333 1.72 3,128 0.38 3 0.08 143 0.06
------ ---- -------- ---- ----- ---- -------- ----
Total delinquency......... 763 3.94% $ 16,148 1.94% 13 0.34% $ 1,003 0.42%
====== ==== ======== ==== ===== ==== ======== ====
Default percentage(3)
Foreclosure............... 52 0.27% $ 6,269 0.75% 56 1.48% $ 6,279 2.64%
Bankruptcy................ 49 0.25 2,814 0.34 9 0.24 778 0.33
Real estate owned(4)...... 33 0.17 3,509 0.42 9 0.24 1,197 0.50
------ ---- -------- ---- ----- ---- -------- ----
Total default............. 134 0.69% $ 12,592 1.51% 74 1.96% $ 8,254 3.47%
====== ==== ======== ==== ===== ==== ======== ====
Total servicing portfolio... 19,359 $832,393 3,781 $237,958
====== ======== ===== ========
</TABLE>
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------
1995
-------------------------------------------------
Number
of % of % of
Loans/ Loans Principal Servicing
Properties Serviced Balance Portfolio
---------- --------- --------- ----------
<S> <C> <C> <C> <C>
(dollars in thousands)
Delinquency percentage(1)(2)
30-59 days................ 22 0.74% $ 2,118 0.83%
60-89 days................ 9 0.30 482 0.19
90 days and over.......... 10 0.33 762 0.30
----- ---- -------- ----
Total delinquency......... 41 1.37% $ 3,362 1.32%
===== ==== ======== ====
Default percentage(3)
Foreclosure............... 7 0.23% $ 793 0.32%
Bankruptcy................ 2 0.07 288 0.11
Real estate owned(4)...... 8 0.27 1,221 0.48
----- ---- -------- ----
Total default............. 17 0.57% $ 2,302 0.91%
===== ==== ======== ====
Total servicing portfolio... 2,986 $253,711
===== ========
</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.
-23-
<PAGE>
Lending Overview
Loan Portfolio Composition. At December 31, 1997, the Company's gross loans
outstanding totaled $312.5 million, of which $280.9 million, or 89.9%, were held
for sale and $31.7 million, or 10.1%, were held for investment. The types of
loans that the Company may originate are subject to federal and state law and
regulations. Interest rates charged by the Company on loans are affected by the
demand for such loans and the supply of money available for lending purposes and
the rates offered by competitors. These factors are, in turn, affected by, among
other things, economic conditions, monetary policies of the federal government,
including the Federal Reserve Board, and legislative tax policies.
The following table sets forth the composition of the Company's loan portfolio
in dollar amounts and as a percentage of the portfolio at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
--------------------- ------------------ -------------------- ------------------- -------------------
Percent Percent Percent Percent Percent
of of of of of
Amount Total Amount Total Amount Total Amount Total Amount Total
---------- -------- --------- -------- --------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Real estate(1):
Residential:
One- to four-
family............... $278,205 89.02% $54,275 78.67% $54,007 84.04% $53,755 82.62% $55,841 83.01%
Multi-family.......... 10,653 3.41 4,752 6.89 2,412 3.75 2,685 4.12 2,296 3.41
Commercial............. 16,763 5.36 9,659 14.00 7,522 11.71 8,131 12.50 8,389 12.47
Other loans:
Loans secured by
deposit accounts...... 165 0.05 177 0.25 186 0.29 213 0.33 396 0.59
Unsecured commercial
loans................. 63 0.02 67 0.10 70 0.11 197 0.30 190 0.28
Unsecured consumer
loans................. 6,675 2.14 65 0.09 63 0.10 84 0.13 162 0.24
-------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total gross
loans.............. 312,524 100.00% 68,995 100.00% 64,260 100.00% 65,065 100.00% 67,274 100.00%
-------- ====== ------- ====== ------- ====== ------- ====== ------- ======
Less (plus):
Deferred loan
origination (costs)
fees and (premiums)
discounts............. (8,393) (543) (298) 56 109
Allowance for
estimated loan
losses................ 2,573 1,625 1,177 832 436
-------- ------- ------- ------- -------
Loans
receivable, net.... $318,344 $67,913 $63,381 $64,177 $66,729
======== ======= ======= ======= =======
</TABLE>
- --------------
(1) Includes second trust deeds.
-24-
<PAGE>
Loan Maturity. The following table shows the contractual maturity of the
Bank's gross loans at December 31, 1997. There were $280.9 million of loans held
for sale, gross, at December 31, 1997. The table does not reflect prepayment
assumptions.
<TABLE>
<CAPTION>
At December 31, 1997
------------------------------------------------------------------
One- to Total
Four- Multi- Other Loans
Family Family Commercial Loans Receivable
------------ ---------- ----------- -------- ------------
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
Amounts due:
One year or less.............................. $ 17,675 $ -- $ 310 $ 248 $ 18,233
After one year:
More than one year to three years............ 1,025 61 1,359 455 2,900
More than three years to five years.......... 475 503 4,674 2,496 8,148
More than five years to 10 years............. 1,388 2,383 3,166 3,577 10,514
More than 10 years to 20 years............... 63,566 2,696 1,063 -- 67,325
More than 20 years........................... 194,076 5,010 6,191 127 205,404
-------- ------- ------- ------ --------
Total amount due.......................... 278,205 10,653 16,763 6,903 312,524
-------- ------- ------- ------ --------
Less (plus):
Unamortized discounts (premiums), net........ (6,813) -- -- -- (6,813)
Deferred loan origination fees (costs)....... (1,849) 121 148 -- (1,580)
Allowance for estimated loan losses.......... 1,206 66 150 1,151 2,573
-------- ------- ------- ------ --------
Total loans, net.......................... 285,661 10,466 16,465 5,752 318,344
-------- ------- ------- ------ --------
Loans held for sale, net..................... 264,954 8,513 10,601 5,200 289,268
-------- ------- ------- ------ --------
Loans held for investment, net............... $ 20,707 $ 1,953 $ 5,864 $ 552 $ 29,076
======== ======= ======= ====== ========
</TABLE>
The following table sets forth at December 31, 1997, the dollar amount of
gross loans receivable contractually due after December 31, 1998, and whether
such loans have fixed interest rates or adjustable interest rates. The Company's
adjustable-rate mortgage loans require that any payment adjustment resulting
from a change in the interest rate be made to both the interest and payment in
order to result in full amortization of the loan by the end of the loan term,
and thus, do not permit negative amortization.
Due After December 31, 1998
---------------------------------------
Fixed Adjustable Total
----------- ----------- -----------
(Dollars in thousands)
Real estate loans:
Residential:
One- to four-family............. $112,369 $148,161 $260,530
Multi-family.................... 4,711 5,942 10,653
Commercial....................... 6,435 10,018 16,453
Other loans...................... 6,655 -- 6,655
-------- -------- --------
Total gross loans receivable. $130,170 $164,121 $294,291
======== ======== ========
-25-
<PAGE>
The following tables set forth the Company's loan originations, purchases,
sales and principal repayments for the periods indicated:
For the Year Ended December 31,
----------------------------------
1997 1996 1995
---------- --------- ----------
(Dollars in thousands)
Gross loans(1):
Beginning balance........................ $ 68,995 $ 64,260 $ 65,065
Loans originated:
One- to four-family(2)................ 341,294 100,745 38,259
Multi-family.......................... 18,019 2,976 --
Commercial............................ 13,631 7,172 --
Other loans........................... 837 126 358
-------- -------- --------
Total loans originated............. 373,781 111,019 38,617
Loans purchased(3)..................... 399,326 111,534 96,155
-------- -------- --------
Total loans originated and purchased.. 773,107 222,553 134,772
-------- -------- --------
Total.............................. 842,102 286,813 199,837
Less:
Principal repayments................... 17,289 9,184 6,719
Sales of loans......................... 94,705 154,620 126,875
Securitizations of loans............... 415,350 51,944 --
Transfer to REO........................ 2,234 2,070 1,983
-------- -------- --------
Total loans........................ 312,524 68,995 64,260
Loans held for sale.................... 280,859 30,454 21,397
-------- -------- --------
Ending balance loans held for investment. $ 31,665 $ 38,541 $ 42,863
======== ======== ========
- --------------
(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
-26-
<PAGE>
activities, but which, unlike specific allowances, has not been allocated to
particular problem assets. When an insured institution classifies one or more
assets, or portions thereof, as "Loss," it is required either to establish a
specific allowance for losses equal to 100% of the amount of the asset so
classified or to charge off such amount.
A savings institution's determination as to the classification of its assets
and the amount of its valuation allowances is subject to review by the OTS which
can order the establishment of additional general or specific loss allowances.
The OTS, in conjunction with the other federal banking agencies, adopted an
interagency policy statement on the allowance for loan and lease losses. The
policy statement provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation allowances. Generally, the policy statement
recommends that institutions have effective systems and controls to identify,
monitor and address asset quality problems; that management has analyzed all
significant factors that affect the collectibility of the portfolio in a
reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
As a result of the declines in local and regional real estate market values and
the significant losses experienced by many financial institutions in prior
years, there has been a greater level of scrutiny by regulatory authorities of
the loan portfolios of financial institutions undertaken as part of the
examination of institutions by the OTS and the FDIC. While the Bank believes
that it has established an adequate allowance for estimated loan losses, there
can be no assurance that regulators, in reviewing the Bank's loan portfolio,
will not request the Bank to materially increase at that time its allowance for
estimated loan losses, thereby negatively affecting the Bank's financial
condition and earnings at that time. Although management believes that an
adequate allowance for estimated loan losses has been established, actual losses
are dependent upon future events and, as such, further additions to the level of
allowances for estimated loan losses may become necessary.
The Bank's Internal Asset Review Committee reviews and classifies the Bank's
assets quarterly and reports the results of its review to the Board of
Directors. The Bank classifies assets in accordance with the management
guidelines described above. REO is classified as Substandard. The following
table sets forth information concerning loans, REO and total assets classified
as substandard at December 31, 1997. At December 31, 1997 the Bank had $4.0
million of assets classified as Special Mention, $6.8 million of assets
classified as Substandard, $560,000 of assets classified as Doubtful and
$171,000 of assets classified as Loss. As of December 31, 1997, assets
classified as Special Mention include 61 loans totaling $4.0 million secured by
one- to four-family residential properties. At December 31, 1997, the largest
loan classified as Special Mention had a loan balance of $226,000 and is secured
by a one- to four-family residential property located in Encinitas, California.
As set forth below, as of December 31, 1997, assets classified as Substandard,
Doubtful and Loss include 334 loans totaling $5.9 million.
<TABLE>
<CAPTION>
At December 31, 1997
-------------------------------------------------------------------------------------------------------
Total Substandard, Doubtful
Loans REO and Loss Assets
-------------------------------- --------------------------------- --------------------------------
Gross Net Number of Gross Net Number of Gross Net Number of
Balance Balance(1) Loans Balance Balance(1) Properties Balance Balance(1) Assets
------- ---------- --------- ------- ---------- ---------- ------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Residential:
One- to four-
family............ $4,831 $4,660 45 $1,471 $1,471 16 $6,302 $6,131 61
Multi-family....... -- -- -- 48 48 1 48 48 1
Commercial.......... 131 131 1 -- -- -- 131 131 1
Other loans......... 1,084 1,084 288 -- -- -- 1,084 1,084 288
------ ------ --- ------ ------ -- ------ ------ ---
Total loans....... $6,046 $5,875 334 $1,519 $1,519 17 $7,565 $7,394 351
====== ====== === ====== ====== == ====== ====== ===
</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
Company's loans held for investment. There was one troubled-debt restructured
loan within the meaning of SFAS 15, and 17 REO properties at December 31, 1997.
Until September
-27-
<PAGE>
30, 1996 it was the policy of the Company to cease accruing interest on loans at
the time foreclosure proceedings commenced, which typically occurred when a loan
is 45 days past due or possibly longer depending on the circumstances, which
period will not exceed 90 days past due. Subsequent to March 31, 1996, the
Company adopted a policy to cease accruing interest on loans 90 days or more
past due. For the years ended December 31, 1997, 1996, 1995, 1994 and 1993,
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 $424,000, $179,000, $67,000, $106,000 and $117,000, none
of which was recognized. For the same periods, the amount of interest income
recognized on troubled debt restructurings was zero, $12,000, $11,000, $10,000
and $1,000.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-accrual loans:
Residential real estate:
One- to four-family............................................. $3,245 $2,361 $1,305 $1,766 $1,919
Multi-family.................................................... -- 45 -- -- --
Commercial....................................................... 131 -- 82 78 197
Other loans...................................................... 1,750 10 10 45 62
------ ------ ------ ------ ------
Total........................................................... 5,126 2,416 1,397 1,889 2,178
REO, net(1)....................................................... 1,440 561 827 555 1,772
------ ------ ------ ------ ------
Total non-performing assets..................................... $6,566 $2,977 $2,224 $2,444 $3,950
====== ====== ====== ====== ======
Restructured loans................................................ $ 131 $ 131 $ 131 $ -- $ 15
Classified assets, gross.......................................... 7,565 4,829 3,929 3,951 4,165
Allowance for estimated loan losses as a percent of gross loans
receivable(2). 0.82% 2.36% 1.83% 1.28% 0.65%
Allowance for estimated loan losses as a percent of total
non-performing loans(3).......................................... 50.20 67.26 84.25 44.04 20.02
Non-performing loans as a percent of gross loans
receivable(2)(3)................................................. 1.64 3.50 2.17 2.90 3.24
Non-performing assets as a percent of total assets(3)............. 1.65 2.93 3.00 3.42 5.05
</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.
-28-
<PAGE>
The following table sets forth delinquencies in the Company's loan portfolio
as of the dates indicated:
<TABLE>
<CAPTION>
At December 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..................... 27 $2,328 33 $3,245 3 $ 354 21 $2,361
Multi-family............................ 1 45
Commercial.............................. 1 131
Other loans............................. 115 583 321 1,750 -- -- 1 10
--- ------ --- ------ ------ --------- ------ ------
Total................................. 142 $2,911 355 $5,126 3 $ 354 23 $2,416
=== ====== === ====== ====== ========= ====== ======
Delinquent loans to total gross loans... 0.93% 1.64% 0.51% 3.50%
====== ====== ========= ======
</TABLE>
At December 31, 1995
---------------------------------------
60-89 Days 90 Days or More
------------------ ------------------
Number Principal Number Principal
of Balance of Balance
Loans of Loans Loans of Loans
------ --------- ------ ---------
(Dollars in thousands)
One- to four-family.................... 8 $ 446 13 $1,305
Multi-family...........................
Commercial............................. 1 82
Other loans............................ 1 10
--- ------ --- ------
Total................................ 8 $ 446 15 $1,397
=== ====== === ======
Delinquent loans to total gross loans.. 0.69% 2.17%
====== ======
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 December 31, 1997, the
Company's allowance for loan losses was 0.82% of gross loans compared to 2.36%
as of December 31, 1996. The Company had non-accrual loans of $5.1 million and
$2.4 million at December 31, 1997 and December 31, 1996, respectively. The
Company will continue to monitor and modify its allowances for loan losses as
conditions dictate.
-29-
<PAGE>
The following table sets forth activity in the Company's allowance for loan
losses for the periods set forth in the table.
<TABLE>
<CAPTION>
At or for the Year Ended December 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Balance at beginning of period..................... $ 1,625 $ 1,177 $ 832 $ 436 $ 308
Provision for loan losses.......................... 1,850 963 1,194 1,306 404
Charge-offs:
Real estate:
One- to four-family........................... 901 668 736 771 301
Multi-family.................................. -- 45 -- -- --
Commercial.................................... -- 11 111 47 --
Other loans...................................... 8 10 67 95 --
-------- ------- ------- ------- -------
Total...................................... 909 734 914 913 301
Recoveries......................................... 7 219 65 3 25
-------- ------- ------- ------- -------
Balance at end of period........................... $ 2,573 $ 1,625 $ 1,177 $ 832 $ 436
======== ======= ======= ======= =======
Average net loans outstanding...................... $191,140 $72,650 $65,521 $65,566 $68,511
======== ======= ======= ======= =======
Net charge-offs to average net loans outstanding... 0.47% 0.71% 1.30% 1.39% 0.40%
</TABLE>
-30-
<PAGE>
The following table sets forth the amount of the Company's allowance for loan
losses, the percent of allowance for loan losses to total allowance and the
percent of gross loans to total gross loans in each of the categories listed at
the dates indicated.
At December 31,
- --------------------------------------------------------------------------------
1997
- --------------------------------------------------------------------------------
Percent of
Gross
Loans in
Each
Percent of Category
Allowance to Total
to Total Gross
Allowance Allowance Loans
--------- ---------- ---------
(Dollars in Thousands)
One- to four- family........ $1,206 46.87% 89.02%
Multi-family................ 66 2.57 3.41
Commercial.................. 150 5.83 5.36
Other....................... 1,151 44.73 2.21
------ ------ ------
Total allowance for loan
losses..................... $2,573 100.00% 100.00%
====== ====== ======
At December 31,
- --------------------------------------------------------------------------------
1996
- --------------------------------------------------------------------------------
Percent of
Gross
Loans in
Each
Percent of Category
Allowance to Total
to Total Gross
Allowance Allowance Loans
--------- ---------- ---------
(Dollars in Thousands)
One- to four- family........ $1,462 89.97% 78.67%
Multi-family............... 20 1.23 6.89
Commercial................. 124 7.63 14.00
Other....................... 19 1.17 0.44
------ ------ ------
Total allowance for loan
losses..................... $1,625 100.00% 100.00%
====== ====== ======
At December 31,
- --------------------------------------------------------------------------------
1995
- --------------------------------------------------------------------------------
Percent of
Gross
Loans in
Each
Percent of Category
Allowance to Total
to Total Gross
Allowance Allowance Loans
--------- ---------- ---------
(Dollars in Thousands)
One- to four- family........ $1,001 85.05% 84.04%
Multi-family............... 14 1.19 3.75
Commercial................. 143 12.15 11.71
Other....................... 19 1.61 0.50
------ ------ ------
Total allowance for loan
losses..................... $1,177 100.00% 100.00%
====== ====== ======
At December 31,
- --------------------------------------------------------------------------------
1994
- --------------------------------------------------------------------------------
Percent of
Gross
Loans in
Each
Percent of Category
Allowance to Total
to Total Gross
Allowance Allowance Loans
--------- ---------- ---------
(Dollars in Thousands)
One- to four- family........ $ 604 72.60% 82.62%
Multi-family............... 10 1.20 4.12
Commercial................. 164 19.71 12.50
Other....................... 54 6.49 0.76
------ ------ ------
Total allowance for loan
losses..................... $ 832 100.00% 100.00%
====== ====== ======
At December 31,
- --------------------------------------------------------------------------------
1993
- --------------------------------------------------------------------------------
Percent of
Gross
Loans in
Each
Percent of Category
Allowance to Total
to Total Gross
Allowance Allowance Loans
--------- ---------- ---------
(Dollars in Thousands)
One- to four- family........ $ 287 65.83% 83.01%
Multi-family............... 10 2.29 3.41
Commercial................. 98 22.48 12.47
Other....................... 41 9.40 1.11
------ ------ ------
Total allowance for loan
losses..................... $ 436 100.00% 100.00%
====== ====== ======
-31-
<PAGE>
REO
At December 31, 1997, the Company had $1.4 million of REO, net of allowances.
Real estate properties acquired through or in lieu of loan foreclosure are
initially recorded at the lower of fair value or the balance of the loan at the
date of foreclosure through a charge to the allowance for estimated loan losses.
After foreclosure, valuations are periodically performed by management and an
allowance for REO losses is established by a charge to operations if the
carrying value of a property exceeds its fair value less estimated cost to sell.
It is the policy of the Company to obtain an appraisal on all REO at the time of
possession and every six months thereafter.
Investment Activities
Federally chartered savings institutions, such as the Bank, have the authority
to invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies, certificates of deposit of
insured banks and savings institutions, bankers' acceptances, and federal funds.
Subject to various restrictions, federally chartered savings institutions may
also invest their assets in commercial paper, investment-grade corporate debt
securities and mutual funds whose assets conform to the investments that a
federally chartered savings institution is otherwise authorized to make
directly. Additionally, the Bank must maintain minimum levels of investments
that qualify as liquid assets under OTS regulations. See "--Regulation--Federal
Savings Institution Regulation--Liquidity." Historically, the Bank has
maintained liquid assets above the minimum OTS requirements and at a level
considered to be adequate to meet its normal daily activities.
The investment policy of the Company as established by the Board of Directors
attempts to provide and maintain liquidity, generate a favorable return on
investments without incurring undue interest rate and credit risk, and
complement the Company's lending activities. Specifically, the Company's
policies generally limit investments to government and federal agency-backed
securities and non-government guaranteed securities, including corporate debt
obligations, that are investment grade. The Company's policies provide the
authority to invest in marketable equity securities meeting the Company's
guidelines and in mortgage-backed securities guaranteed by the U.S. government
and agencies thereof and other financial institutions.
At December 31, 1997 the Company 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 Company may increase its investment in mortgage-backed
securities in the future depending on its liquidity needs and market
opportunities. Investments in mortgage-backed securities involve a risk that
actual prepayments will be greater than estimated prepayments over the life of
the security which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments thereby reducing the net
yield on such securities. There is also reinvestment risk associated with the
cash flows from such securities. In addition, the market value of such
securities may be adversely affected by changes in interest rates.
At December 31, 1997, the residual assets, which resulted from the Company's
asset securitizations, of $45.4 million were classified as trading securities.
For regulatory reasons, the residual assets are held by the Company. Future
residuals and related assets generated by asset securitizations will be held by
the Bank only until they can be sold to the Company or disposed of in some other
transaction. The residual assets and any future residuals generated by future
asset securitizations and held by the Company will be marked to market on a
quarterly basis with unrealized gains and losses recorded in operations. See
"--Loan Sales and Asset Securitizations" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Restatement of
Financial Statements".
-32-
<PAGE>
The following table sets forth certain information regarding the carrying and
fair values of the Company's securities (excluding residual assets) at the dates
indicated. There were no securities available-for-sale at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities:
Held-to-maturity:
U.S. Treasury and other agency securities........ $6,070 $6,088 $8,827 $8,785 $2,689 $2,689
Mortgage-backed securities....................... 9 9 10 10 11 11
------ ------ ------ ------ ------ ------
Total securities held-to-maturity............. $6,079 $6,097 $8,837 $8,795 $2,700 $2,700
====== ====== ====== ====== ====== ======
</TABLE>
The table below sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's securities
(excluding residual assets) as of December 31, 1997. There were no securities
available-for-sale at December 31, 1997.
<TABLE>
<CAPTION>
At December 31, 1997
----------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years
--------------------- -------------------- -----------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- ---------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Securities:
Held-to-maturity:
U.S. Treasury and
other agency securities................... $3,004 5.71% $1,999 6.13% $ -- --
Mortgage-backed securities.................. -- -- -- --
------ ------ --------
Total held-to-maturity................... 3,004 5.71 1,999 6.13 -- --
FHLB stock....................................... 1,067 5.88 -- -- -- --
------ ------
Total securities held-to-maturity........ $4,071 5.76 $1,999 6.13 $ -- --
====== ====== ========
</TABLE>
<TABLE>
<CAPTION>
At December 31, 1997
---------------------------------------------
More than Ten
Years Total
--------------------- ----------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
-------- --------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Securities:
Held-to-maturity:
U.S. Treasury and
other agency securities................... $ -- -- % $ 5,003 5.88 %
Mortgage-backed securities.................. 9 7.50 9 7.50
------ ------
Total held-to-maturity................... 9 7.50 5,012 5.88
FHLB stock....................................... -- -- 1,067 5.88
------ ------
Total securities held-to-maturity........ $ 9 7.50 $6,079 5.88
====== ======
</TABLE>
-33-
<PAGE>
Sources of Funds
General. Deposits, lines of credit, loan repayments and prepayments, proceeds
from sales and securitization of loans, cash flows generated from operations and
borrowings are the primary sources of the Company's funds for use in lending,
investing and for other general purposes.
Deposits. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts, money market savings accounts and certificates of deposit.
For the year ended December 31, 1997, certificates of deposit constituted 87.3%
of total average deposits. The term of the fixed-rate certificates of deposit
offered by the Company vary from 30 days to eighteen years and the offering
rates are established by the Company on a weekly basis. Specific terms of an
individual account vary according to the type of account, the minimum balance
required, the time period funds must remain on deposit and the interest rate,
among other factors. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. At December 31, 1997, the Company had $187.5 million of
certificate accounts maturing in one year or less.
The Company relies primarily on customer service and long-standing
relationships with customers to attract and retain local deposits; however,
market interest rates and rates offered by competing financial institutions
significantly affect the Company's ability to attract and retain deposits. In
addition, the Company seeks to attract deposits from outside of its market area
by using nationwide advertising. In order to meet its liquidity needs for the
purchase of loans, from time to time the Company offers above market interest
rates on short term certificate accounts and may utilize brokered deposits. At
December 31, 1997, the Company had brokered deposits totaling $4.7 million.
Although the Company has a significant portion of its deposits in shorter term
certificates of deposit, management monitors activity on the Company's
certificate of deposit accounts and, based on historical experience, and the
Company's current pricing strategy, believes that it will retain a large portion
of such accounts upon maturity. Further increases in short-term certificate of
deposit accounts, which tend to be more sensitive to movements in market
interest rates than core deposits, may result in the Company's deposit base
being less stable than if it had a large amount of core deposits which, in turn,
may result in further increases in the Company's cost of deposits.
Notwithstanding the foregoing, the Company believes that it will continue to
have access to sufficient amounts of certificates of deposit accounts which,
together with other funding sources, will provide it with the necessary level of
liquidity to continue to implement its business strategies.
The following table presents the deposit activity of the Company for the
periods indicated:
For the Year Ended December 31,
-------------------------------------
1997 1996 1995
----------- --------- -----------
(Dollars in Thousands)
Net deposits (withdrawals)............. $118,078 $15,700 $(1,329)
Interest credited on deposit accounts.. 7,976 2,476 3,175
-------- ------- -------
Total increase (decrease)
in deposit accounts................ $126,054 $18,176 $ 1,846
======== ======= =======
At December 31, 1997, the Company had $52.8 million in certificate accounts in
amounts of $100,000 or more maturing as follows:
Weighted
Maturity Period Amount Average Rate
-------------------------------------- ---------- ---------------
(Dollars in Thousands)
Three months or less................ $14,500 5.90%
Over three through 12 months........ 23,500 6.03
-34-
<PAGE>
Over 12 months...................... 14,809 5.97
-------
Total............................ $52,809 5.98%
=======
The following table sets forth the distribution of the Company's average
deposit accounts for the periods indicated and the weighted average interest
rates on each category of deposits presented.
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------------- --------------------------------- --------------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
--------- --------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Passbook accounts........ $ 4,003 2.73% 2.10% $ 4,401 6.03% 2.09% $ 5,090 7.53% 2.50%
Money market accounts.... 2,971 2.02 2.96 4,233 5.80 2.79 5,493 8.12 2.62
Checking accounts........ 11,756 8.00 2.37 7,048 9.65 1.59 6,434 9.51 1.43
-------- ------ ------- ------ ------- ------
Total.................. 18,730 12.75 2.41 15,682 21.48 2.05 17,017 25.16 2.13
Certificate accounts:
Three months or less... 15,887 10.81 5.54 3,994 5.47 5.66 11,570 17.11 5.09
Four through 12
months................ 88,129 59.97 6.01 36,519 50.01 5.23 20,762 30.71 5.44
13 through 36 months... 18,467 12.57 5.71 10,204 13.98 6.25 11,188 16.54 5.93
37 months or greater... 5,730 3.90 6.28 6,616 9.06 6.36 7,088 10.48 6.32
-------- ------ ------- ------ ------- ------
Total certificate
accounts.............. 128,213 87.25 5.92 57,333 78.52 5.57 50,608 74.84 5.59
-------- ------ ------- ------ ------- ------
Total average deposits. $146,943 100.00% 5.47% $73,015 100.00% 4.81% $67,625 100.00% 4.72%
======== ====== ======= ====== ======= ======
</TABLE>
-35-
<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 December 31, 1997.
<TABLE>
<CAPTION>
Period to Maturity from December 31, 1997 At December 31,
------------------------------------------------------------------------------------ -----------------
Over One Over Over Over
One Year to Two to Three to Four to More Than
or Less Two Years Three Years Four Years Five Years Five Years Total 1996 1995
-------- --------- ----------- ---------- ---------- ---------- -------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Certificate accounts:
0 to 4.00%.......... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 477
4.01 to 5.00%......... 2,060 203 6 4 1 70 2,344 3,504 5,710
5.01 to 6.00%......... 99,343 2,256 448 396 362 115 102,920 60,145 32,298
6.01 to 7.00%......... 85,880 643 373 20 15 78 87,009 3,891 10,676
7.01 to 8.00%......... 218 529 352 169 43 261 1,572 1,890 2,641
-------- ------ ------ ---- ---- ---- -------- ------- -------
Total.............. $187,501 $3,631 $1,179 $589 $421 $524 $193,845 $69,430 $51,802
======== ====== ====== ==== ==== ==== ======== ======= =======
</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 December 31, 1997, the Bank had outstanding advances in the
amount of $9.0 million from the FHLB.
Both the Company and the Bank have the ability to enter into lines of credit
to finance mortgage originations and purchases or for other corporate purposes.
At December 31, 1997, the Bank's warehouse lines of credit consisted of two
separate lines of credit aggregating $250.0 million, of which $84.6 million has
been drawn at December 31, 1997. The lines of credit are secured by loans
originated or purchased by the Company and range in interest rates from LIBOR
plus 50 basis points to LIBOR plus 100 basis points. The Bank is in the process
of negotiating a third warehouse line of credit in the amount of $250.0 million.
In addition, the Company has a line of credit in the amount of $40.0 million
secured by residual assets created by the Company's securitizations of which
$15.5 million has been drawn at December 31, 1997. All of the lines of credit
are uncommitted and may be terminated by the lenders at will. These lines of
credit contain affirmative, negative and financial covenants, with which the
Company was in compliance at December 31, 1997.
On March 14, 1997, the Bank issued subordinated debentures (the
"Debentures") in the aggregate principal amount of $10.0 million through the
Debenture Offering. The Debentures will mature on March 15, 2004 and bear
interest at the rate of 13.5% per annum, payable semi-annually. The Debentures
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. 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
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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.
The following table sets forth certain information regarding the Company's
borrowed funds at or for the periods ended on the dates indicated:
<TABLE>
<CAPTION>
At or for the Year
Ended December 31,
------------------------------------------
1997 1996 1995
------------- ------------ -----------
<S> <C> <C> <C>
(Dollars in Thousands)
FHLB advances:
Average balance outstanding............................................. $ 8,284 $ 4,259 $3,112
Maximum amount outstanding at any month-end during the period........... 17,800 13,900 7,600
Balance outstanding at end of period.................................... 9,000 -- --
Weighted average interest rate during the period........................ 5.82% 5.93% 6.55%
Debentures:
Average balance outstanding............................................. $ 7,997 -- --
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........................ 14.09% -- --
Lines of credit:
Average balance outstanding............................................. $ 48,765 -- --
Maximum amount outstanding at any month-end during the period........... 226,846 -- --
Balance outstanding at end of period.................................... 100,170 -- --
Weighted average interest rate during the period........................ 6.53% -- --
Total borrowings:
Average balance outstanding............................................. $ 65,046 $ 4,259 $3,112
Maximum amount outstanding at any month-end during the period........... 254,646 13,900 7,600
Balance outstanding at end of period.................................... 119,170 -- --
Weighted average interest rate during the period........................ 7.37% 5.93% 6.55%
</TABLE>
Asset Securitizations. The Company has completed four asset securitizations,
one during the fourth quarter of 1996, one during the first quarter of 1997, one
during the third quarter of 1997, and one during the fourth quarter of 1997. Net
cash proceeds to the Company from these asset securitizations aggregated $411.3
million. As the Company anticipates that it will conduct regular asset
securitizations in the future, it is expected that gain on sale of loans
securitized will constitute a substantial source of cash flow for the Company's
future loan originations, although there can be no assurance in this regard.
COMPETITION
As a purchaser and originator of mortgage loans, the Company faces intense
competition, primarily from mortgage banking companies, commercial banks, credit
unions, thrift institutions, credit card issuers and finance companies. Many of
these competitors in the financial services business are substantially larger
and have more capital and other resources than the Company. Furthermore, certain
large national finance companies and conforming mortgage originators have
announced their intention to adapt their conforming origination programs and
allocate resources to the origination of non-conforming loans. In addition,
certain of these larger mortgage companies and commercial banks have begun to
offer products similar to those offered by the Company targeting
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customers similar to those of the Company. The entrance of these competitors
into the Company's market could have a material adverse effect on the Company's
results of operations and financial condition.
Competition can take many forms, including convenience in obtaining a loan,
service, marketing and distribution channels and interest rates. Furthermore,
the current level of gains realized by the Company and its competitors on the
sale of the type of loans purchased and originated is attracting additional
competitors, including at least one quasi-governmental agency, into this market
with the effect of lowering the gains that may be realized by the Company on
future loan sales. Competition may be affected by fluctuations in interest rates
and general economic conditions. During periods of rising rates, competitors
which have "locked in" low borrowing costs may have a competitive advantage.
During periods of declining rates, competitors may solicit the Company's
borrowers to refinance their loans. During economic slowdowns or recessions, the
Company's borrowers may have new financial difficulties and may be receptive to
offers by the Company's competitors.
The Company depends largely on Originators for its purchases and originations
of new loans. The Company's competitors also seek to establish relationships
with the Company's Originators. The Company's future results may become more
exposed to fluctuations in the volume and cost of its wholesale loans resulting
from competition from other purchasers of such loans, market conditions and
other factors.
In addition, the Company faces increasing competition for deposits and other
financial products from non-bank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds and annuities. In order to compete
with these other institutions with respect to deposits and fee services, the
Company relies principally upon local promotional activities, personal
relationships established by officers, directors and employees of the Company
and specialized services tailored to meet the individual needs of the Company's
customers.
Subsidiaries
As of December 31, 1997, the Company had two subsidiaries: the Bank and Life
Investment Holdings, Inc. Life Investment Holdings, Inc. was incorporated in
Delaware in 1997 as a bankruptcy-remote entity for use in the Company's asset
securitization activities. The Bank had no subsidiaries at December 31, 1997.
Personnel
As of December 31, 1997, the Company had 268 full-time employees and 7 part-
time employees. The employees are not represented by a collective bargaining
unit and the Company considers its relationship with its employees to be good.
Year 2000 Compliance
As the year 2000 approaches, a critical business issue has emerged regarding
how existing application software programs and operating systems can accommodate
this date value. In brief, many existing application software products were
designed to only accommodate a two digit position which represents the year
(e.g., 95 is stored on the systems and represents the year 1995). The Company
has implemented a program designed to ensure that all software used in
connection with the Company's business will manage and manipulate data involving
the transition from 1999 to 2000 without functional or data abnormality and
without inaccurate results related to such data. The Company will utilize
internal resources to monitor and test for year 2000 compliance. However, there
can be no assurances that such program will be effective. To the extent the
Company's systems are not fully year 2000 compliant, there can be no assurance
that potential systems interruptions or the cost necessary to update software
would not have a material adverse effect on the Company's business, financial
condition, results of operations and
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<PAGE>
business prospects. In addition, the Company has limited information concerning
the compliance status of its suppliers and customers. In the event that any of
the Company's significant suppliers do not successfully and timely achieve year
2000 compliance, the Company's business or operations could be adversely
affected. The costs associated with compliance efforts are not expected to have
a significant impact on the Company's ongoing results of operations.
REGULATION
General
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the
activities of savings institutions, such as the Bank, are governed by the HOLA
and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its primary federal regulator, and the FDIC, as the deposit insurer.
The Bank is a member of the Federal Home Loan Bank ("FHLB") System and its
deposit accounts are insured up to applicable limits by the SAIF managed by the
FDIC. The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory approvals
prior to entering into certain transactions such as mergers with, or
acquisitions of, other savings institutions. The OTS and/or the FDIC conduct
periodic examinations to test the Bank's safety and soundness and compliance
with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the OTS, the FDIC or the Congress, could have a material
adverse impact on the Company, the Bank and their operations. Certain of the
regulatory requirements applicable to the Bank and to the Company are referred
to below or elsewhere herein. The description of statutory provisions and
regulations applicable to savings institutions and their holding companies set
forth in this Form 10-K/A does not purport to be a complete description of such
statutes and regulations and their effects on the Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company
within the meaning of the HOLA. As a unitary savings and loan holding company,
the Company generally is not restricted under existing laws as to the types of
business activities in which it may engage, provided that the Bank continues to
be a qualified thrift lender ("QTL"). See "Federal Savings Institution
Regulation--QTL Test." Upon any non-supervisory acquisition by the Company of
another savings institution or savings bank that meets the QTL test and is
deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive limitations on the
types of business activities in which it could engage. The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under Section 4(c)(8) of the Bank Holding Company Act ("BHC Act"),
subject to the prior approval of the OTS, and certain activities authorized by
OTS regulation, and no multiple savings and loan holding company may acquire
more than 5% the voting stock of a company engaged in impermissible activities.
The HOLA prohibits a savings and loan holding company, directly or indirectly,
or through one or more subsidiaries, from acquiring more than 5% of the voting
stock of another savings institution or holding company
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<PAGE>
thereof, without prior written approval of the OTS or acquiring or retaining
control of a depository institution that is not insured by the FDIC. In
evaluating applications by holding companies to acquire savings institutions,
the OTS must consider the financial and managerial resources and future
prospects of the company and institution involved, the effect of the acquisition
on the risk to the insurance funds, the convenience and needs of the community
and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, subject to two exceptions: (i) the approval of interstate
supervisory acquisitions by savings and loan holding companies and (ii) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions. The
states vary in the extent to which they permit interstate savings and loan
holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions as described below. The Bank must notify the OTS 30 days
before declaring any dividend to the Company. In addition, the financial impact
of a holding company on its subsidiary institution is a matter that is evaluated
by the OTS and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings institutions
to meet three minimum capital standards: a 1.5% tangible capital ratio, a 3%
leverage (core) capital ratio and an 8% risk-based capital ratio. In addition,
the prompt corrective action standards discussed below also establish, in
effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
ratio (3% for institutions receiving the highest rating on the CAMELS financial
institution rating system), and, together with the risk-based capital standard
itself, a 4% Tier I risk-based capital standard. Core capital is defined as
common stockholders' equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
mortgage servicing rights and credit card relationships. The OTS regulations
also require that, in meeting the tangible, leverage (core) and risk-based
capital standards, institutions must generally deduct investments in and loans
to subsidiaries engaged in activities as principal that are not permissible for
a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, as assigned by the OTS capital regulation based on the
risks OTS believes are inherent in the type of asset. The components of Tier I
(core) capital are equivalent to those discussed earlier. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock and the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100% of
core capital.
The OTS regulatory capital requirements also incorporate an interest rate risk
component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash flows
from assets, liabilities and off-balance sheet contracts) that would result from
a hypothetical 200 basis point increase or decrease in market interest rates
divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure
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<PAGE>
exceeds 2% must deduct an amount equal to one-half of the difference between the
institution's measured interest rate risk and 2%, multiplied by the estimated
economic value of the institution's assets. The Director of the OTS may waive or
defer a savings institution's interest rate risk component on a case-by-case
basis. A savings institution with assets of less than $300 million and risk-
based capital ratios in excess of 12% is not subject to the interest rate risk
component, unless the OTS determines otherwise. For the present time, the OTS
has deferred implementation of the interest rate risk component. At December 31,
1997, the Bank met each of its capital requirements and it is anticipated that
the Bank will not be subject to the interest rate risk component.
The following table presents the Bank's capital position at December 31, 1997.
<TABLE>
<CAPTION>
Capital Ratios
------------------------
Actual Required Excess Actual Required
--------- ------------ --------- ---------- -----------
<S> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Tangible.............. $21,545 $ 6,008 $15,537 5.38% 1.50%
Core (Leverage)....... 21,545 12,016 9,529 5.38 3.00
Risk-based............ 33,947 25,813 8,134 10.52 8.00
</TABLE>
Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
regulations, the OTS is required to take certain supervisory actions against
undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution is
considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the OTS to meet a specific
capital level. A savings institution generally is considered "adequately
capitalized" if its ratio of total capital to risk-weighted assets is at least
8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%,
and its ratio of core capital to total assets is at least 4% (3% if the
institution receives the highest CAMELS rating). A savings institution that has
a ratio of total capital to risk weighted assets of less than 8%, a ratio of
Tier I (core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized" and a savings institution
that has a tangible capital to assets ratio equal to or less than 2% 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 a savings institution receives notice that it is
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Compliance with the plan must be guaranteed by any parent
holding company. In addition, numerous mandatory supervisory actions become
immediately applicable to an undercapitalized institution, including, but not
limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion. The OTS could also take any one of a number
of discretionary supervisory actions, including the issuance of a capital
directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Bank are presently insured by
the SAIF. 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. The SAIF was undercapitalized due primarily to a
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. 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 was generally tax deductible. The SAIF Special
Assessment recorded by the Bank amounted to $448,000 on a pre-tax basis and
$261,000 on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds
across all SAIF and Bank Insurance Fund ("BIF") members. The BIF is the fund
which primarily insures commercial bank deposits. Beginning on
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<PAGE>
January 1, 1997, BIF deposits were assessed for a FICO payment of approximately
1.3 basis points, while SAIF deposits pay approximately 6.4 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 effectively lower SAIF
assessments to 0 to 27 basis points as of January 1, 1997, a range comparable to
that of BIF members. SAIF members will also continue to make the FICO payments
described above. 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 fiscal 1997 ranged from 9.3 to 9.5 basis points
and the premium paid for this period was $102,000. 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. Various proposals to eliminate the federal thrift charter, create a
uniform financial institutions charter and abolish the OTS have been introduced
in Congress. Some bills would require federal savings institutions to convert to
a national bank or some type of state charter by a specified date under some
bills, or they would automatically become national banks. Under some proposals,
converted federal thrifts would generally be required to conform their
activities to those permitted for the charter selected and divestiture of
nonconforming assets would be required over a two year period, subject to two
possible one year extensions. State chartered thrifts would become subject to
the same federal regulation as applies to state commercial banks. A more recent
bill passed by the House Banking Committee would allow savings institutions to
continue to exercise activities being conducted when they convert to a bank
regardless of whether a national bank could engage in the activity. Holding
companies for savings institutions would become subject to the same regulation
as holding companies that control commercial banks, with some limited
grandfathering, including savings and loan holding company activities. The
grandfathering would be lost under certain circumstances such as a change in
control of the Company. The Bank is unable to predict whether such legislation
would be enacted or the extent to which the legislation would restrict or
disrupt its operations.
Loans to One Borrower. Under the HOLA, savings institutions are generally
subject to the limits on loans to one borrower applicable to national banks.
Generally, savings institutions may not make a loan or extend credit to a single
or related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if such loan is secured by readily-marketable collateral, which is
defined to include certain financial instruments and bullion. At December 31,
1997, the Bank's limit on loans to one borrower was $3.6 million. At December
31, 1997, the Bank's largest aggregate outstanding balance of loans to one
borrower was $1.2 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test. Under the
QTL test, a savings and loan association is either must qualify as a "domestic
building and loan association" as defined in the Internal Revenue Code or
required to maintain at least 65% of its "portfolio assets" (total assets
less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles,
including goodwill; and (iii) the value of property used to conduct business) in
certain "qualified thrift investments" (primarily residential mortgages and
related investments, including certain mortgage-backed securities) in at least 9
months out of each 12 month period.
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<PAGE>
A savings institution that fails the QTL test is subject to certain operating
restrictions and may be required to convert to a bank charter. As of December
31, 1997, the Bank maintained 99.9% of its portfolio assets in qualified thrift
investments and, therefore, met the QTL test. Recent legislation has expanded
the extent to which education loans, credit card loans and small business loans
may be considered "qualified thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations upon
all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in capital requirements before and after a proposed capital
distribution ("Tier 1 Bank") and has not been advised by the OTS that it is in
need of more than normal supervision, could, after prior notice but without
obtaining approval of the OTS, make capital distributions during a calendar year
equal to the greater of (i) 100% of its net earnings to date during the calendar
year plus the amount that would reduce by one-half its "surplus capital ratio"
(the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year or (ii) 75% of its net income for the previous
four quarters. Any additional capital distributions would require prior
regulatory approval. In the event the Bank's capital fell below its regulatory
requirements or the OTS notified it that it was in need of more than normal
supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any institution, which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice. In December 1994, the OTS proposed amendments to its capital
distribution regulation that would generally authorize the payment of capital
distributions without OTS approval provided that the payment does not cause the
institution to be undercapitalized within the meaning of the prompt corrective
action regulation. However, institutions in a holding company structure would
still have a prior notice requirement. At December 31, 1997, the Bank was a Tier
1 Bank.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage of its net withdrawable deposit accounts plus short-term borrowings.
This liquidity requirement was 5% for fiscal 1997, but is subject to change from
time to time by the OTS to any amount within the range of 4% to 10% depending
upon economic conditions and the savings flows of member institutions. In 1997,
OTS regulations also required each savings institution to maintain an average
daily balance of short-term liquid assets of at least 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 OTS has recently lowered the liquidity requirement from 5% to
4% and eliminated the 1% short term liquid asset requirement. The Bank's
liquidity ratio for the month of December, 1997 was 6.04%, which exceeded the
applicable requirements. The Bank has never been subject to monetary penalties
for failure to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the OTS
to fund the agency's operations. The general assessments, paid on a semi-annual
basis, are computed upon the savings institution's total assets, including
consolidated subsidiaries, as reported in the Bank's latest quarterly thrift
financial report. The assessments paid by the Bank for the fiscal year ended
December 31, 1997 totaled $102,000.
Branching. OTS regulations permit nationwide branching by federally chartered
savings institutions to the extent allowed by federal statute. This permits
federal savings institutions to establish interstate networks and to
geographically diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
savings institutions.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (e.g., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and 23B
of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of
covered transactions with any individual affiliate to 10% of the capital and
surplus of the savings institution. The aggregate amount of covered transactions
with all affiliates is limited to
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<PAGE>
20% of the savings institution's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in Section 23A and the purchase of low quality assets from affiliates
is generally prohibited. Section 23B generally provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings institutions are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings institution may purchase the securities of any
affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and 10%
shareholders ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Recent legislation created an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Regulation O also places individual and aggregate
limits on the amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility
over savings institutions and has the authority to bring actions against the
institution and all institution-affiliated parties, including stockholders, and
any attorneys, appraisers and accountants who knowingly or recklessly
participate in wrongful action likely to have an adverse effect on an insured
institution. Formal enforcement action may range from the issuance of a capital
directive or cease and desist order to removal of officers and/or directors to
institution of receivership, conservatorship or termination of deposit
insurance. Civil penalties cover a wide range of violations and can amount to
$25,000 per day, or even $1 million per day in especially egregious cases. Under
the FDI Act, the FDIC has the authority to recommend to the Director of the OTS
enforcement action to be taken with respect to a particular savings institution.
If action is not taken by the Director, the FDIC has authority to take such
action under certain circumstances. Federal law also establishes criminal
penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have adopted
Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. 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
standards set forth in 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 rule establishes deadlines for the submission and review of such
safety and soundness compliance plans when such plans are required.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to maintain
non-interest earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). The Federal Reserve Board regulations generally
required for most of 1997 that reserves be maintained against aggregate
transaction accounts as follows: for accounts aggregating $49.3 million or less
(subject to adjustment by the Federal Reserve Board) the reserve requirement was
3%; and for accounts aggregating greater than $49.3 million, the reserve
requirement was $1.48 million plus 10% (subject to adjustment by the Federal
Reserve Board between 8% and 14%) against that portion of total transaction
accounts in excess of $49.3 million. The first $4.4 million of otherwise
reservable balances (subject to adjustments by the Federal Reserve Board) were
exempted from the reserve requirements. The
-44-
<PAGE>
Bank maintained compliance with the foregoing requirements. For 1998, the
Federal Reserve Board has decreased from $49.3 to $47.8 million the amount of
transaction accounts subject to the 3% reserve requirement and to increase the
amount of exempt reservable balances from $4.4 million to $4.7 million. The
balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements imposed by the OTS.
-45-
<PAGE>
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank report their income on a consolidated basis
and the accrual method of accounting, and are subject to federal income taxation
in the same manner as other corporations with some exceptions, including
particularly the Bank's reserve for bad debts discussed below. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Bank or the
Company. The Bank has not been audited by the IRS . For its 1997 taxable year,
the Bank is subject to a maximum federal income tax rate of 35.0%.
Bad Debt Reserves. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans (generally secured
by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture (i.e.,
take into income) certain portions of their accumulated bad debt reserves. The
1996 Act repeals the reserve method of accounting for bad debts effective for
tax years beginning after 1995. Thrift institutions that would be treated as
small banks are allowed to utilize the Experience Method applicable to such
institutions, while thrift institutions that are treated as large banks (those
generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
To the extent the allowable bad debt reserve balance using the thrift's
historical computation method exceeds the allowable bad debt reserve method
under the newly enacted provisions, such excess is required to be recaptured
into income under the provisions of Code Section 481(a). Any Section 481(a)
adjustment required to be taken into income with respect to such change
generally will be taken into income ratably over a six-taxable year period,
beginning with the first taxable year beginning after 1995, subject to the
residential loan requirement.
Under the residential loan requirement provision, the recapture required by
the 1996 Act will be suspended for each of two successive taxable years,
beginning with the Bank's current taxable year, in which the Bank originates a
minimum of certain residential loans based upon the average of the principal
amounts of such loans made by the Bank during its six taxable years preceding
its current taxable year.
Under the 1996 Act, the Bank is permitted to use the Experience Method to
compute its allowable addition to its reserve for bad debts for the current
year. The Bank's bad debt reserve as of December 31, 1995 was computed using the
permitted Experience Method computation and was therefore not subject to the
recapture of any portion of its bad debt reserve as discussed above.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
-46-
<PAGE>
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if the Bank makes a non-dividend distribution
to the Company, approximately one and one-half times the amount of such
distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee on
every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
Additional Item. EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth certain information regarding the executive
officers of the Company and the Bank who are not also directors.
<TABLE>
<CAPTION>
Age at Position with the Company and Bank
Name 12/31/97 and Past Five Years Experience
- ----------------------- -------------- -----------------------------------------------------------------
<S> <C> <C>
L. Bruce Mills, Jr..... 40 Executive Vice President, Secretary and Treasurer
Mary E. Darter......... 37 Executive Vice President. Joined the Bank in 1994. Previously in
charge of warehouse line of credit division and bulk acquisitions
at Imperial Credit Industries/Southern Pacific Thrift and Loan
Joseph R.L. Passerino.. 43 Senior Vice President. Joined the Bank in February 1994.
Previously in charge of loan production for St. Thomas Capital
Corporation.
</TABLE>
-47-
<PAGE>
ITEM 2. PROPERTIES
As of December 31, 1997, the Company conducted its business through thirteen
offices.
<TABLE>
<CAPTION>
Net Book Value
Original of Property or
Year Leasehold
Leased Leased Date of Improvements at
or or Lease December 31,
Location Owned Acquired Expiration 1997
- ----------------------------------- ----- -------- ---------- --------------
<S> <C> <C> <C> <C>
Corporate Headquarters and
Regional Lending Center:(1)
10540 Magnolia Avenue, Suites B & C
Riverside, CA Leased 1997 2002 $1,202,000
Regional Lending Center:
2600 South Parker Road, Suite 6-300
Aurora, CO Leased 1997 2000 71,000
Regional Lending Center:
8031 Philips Highway
Jacksonville, FL Leased 1997 2002 --
Branch Office:
1598 E. Highland Avenue
San Bernardino, CA Leased 1986 2001 218,000
Branch Office:
10530 Magnolia Avenue, Suite A
Riverside, CA Leased 1997 2002 9,000
National Servicing Center:
4110 Tigris Way
Riverside, CA Owned 1996 -- 464,000
Retail Lending Office:
1518 Huntington Drive
S. Pasadena, CA Leased 1997 2000 3,000
Retail Lending Office:
424/426 S. Citrus Ave.
Covina, CA Leased 1997 2000 5,000
Retail Lending Office:
259 E. Campbell Avenue, Suite 3
Campbell, CA Leased 1997 (1) --
Retail Lending Office:
11339 183rd Street
Cerritios, CA Leased 1997 2001 --
</TABLE>
-48-
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
Retail Lending Office:
Sierra Vista Plaza
Placentia, CA Leased 1997 2000 --
Capital Markets Office:
10777 Main Street
Bellevue, WA Leased 1997 1999 --
</TABLE>
- --------------
(1) Lease is month to month
The Company opened five low-cost retail lending offices during the year ended
December 31, 1997. Subsequent to that date, the Company has opened three
additional retail lending offices, and intends to enter into leases for an
additional seven retail lending offices by the end of 1998, all located in
Southern California.
ITEM 3. LEGAL PROCEEDINGS
The Company and the Bank are not involved in any pending legal proceedings
other than legal proceedings occurring in the ordinary course of business.
Management believes that none of these legal proceedings, individually or in the
aggregate, will have a material adverse impact on the results of operations or
financial condition of the Company or the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-49-
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company has been quoted on the Nasdaq National Market
under the symbol "LFCO" since the Company's IPO on June 30, 1997. As of March
13, 1998, there were approximately 327 holders of record of the Common Stock.
The following table summarizes the range of the high and low closing sale prices
per share of Common Stock as quoted by Nasdaq for the periods indicated.
High Low
-------- --------
Quarter Ended
June 30, 1997.......... $13.50 $13.38
September 30, 1997..... 19.25 13.63
December 31, 1997...... 21.87 11.75
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------------------
1997 (9) 1996 (9) 1995 1994 1993
-------------- -------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
(In Thousands, Except Per Share and Share Data)
Selected Balance Sheet Data:
Total assets........................... $ 397,071 $ 101,763 $ 74,136 $ 71,402 $ 78,256
Securities held-to-maturity and FHLB
stock................................. 6,079 8,837 2,700 2,860 3,883
Loans held for sale.................... 289,268 31,018 21,688 17,070 2,348
Loans held for investment.............. 31,649 38,520 42,870 47,939 64,820
Allowance for estimated loan losses.... 2,573 1,625 1,177 832 436
Residual assets at fair value.......... 45,352 4,691
Mortgage servicing rights.............. 8,526 2,645 683
Deposit accounts....................... 211,765 85,711 67,535 65,689 72,008
Borrowings............................. 119,170 3,278 1,250 1,200
Stockholders' equity................... 50,886 7,716 4,268 3,748 4,419
Book value per share(1)................ $ 7.77 $ 2.40 $ 2.29 $ 2.01 $ 2.37
Shares outstanding(1).................. 6,546,716 3,211,716 1,866,216 1,866,216 1,866,216
</TABLE>
(Continued on the next page)
-50-
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------------------------------------------
1997 (9) 1996 (9) 1995 1994 1993
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
(In Thousands, Except Per Share and Share Data)
SELECTED OPERATING DATA:
Interest income.............................................. $ 21,146 $ 6,928 $ 5,825 $ 4,824 $ 5,445
Interest expense............................................. 12,830 3,766 3,448 2,721 3,045
---------- ---------- ---------- ---------- ----------
Net interest income......................................... 8,316 3,162 2,377 2,103 2,400
Provision for estimated loan losses.......................... 1,850 963 1,194 1,306 404
---------- ---------- ---------- ---------- ----------
Net interest income after provision for estimated loan
losses..................................................... 6,466 2,199 1,183 797 1,996
Net gains from mortgage financing operations................. 25,730 5,708 3,575 1,428 1,144
Other non-interest income.................................... 1,500 760 445 260 253
Non-interest expense:
Compensation and benefits................................... 9,210 5,233 2,544 1,575 1,403
Net loss on foreclosed real estate.......................... 126 158 53 280 228
SAIF special assessment..................................... 448
Other expense............................................... 6,654 2,842 1,792 1,601 1,562
---------- ---------- ---------- ---------- ----------
Total non-interest expense.................................. 15,990 8,681 4,389 3,456 3,193
---------- ---------- ---------- ---------- ----------
Income (loss) before income tax provision (benefit).......... 17,706 (14) 814 (971) 200
Income tax provision (benefit)............................... 7,382 38 294 (300) 107
---------- ---------- ---------- ---------- ----------
Net income (loss)............................................ $ 10,324 $ (52) $ 520 $ (671) $ 93
========== ========== ========== ========== ==========
Basic earnings (loss) per share(2)........................... $ 2.11 $ (0.02) $ 0.28 $ (0.36) $ 0.05
========== ========== ========== ========== ==========
Diluted earnings (loss) per share(2)......................... $ 2.02 $ (0.02) $ 0.28 $ (0.36) $ 0.05
========== ========== ========== ========== ==========
Basic weighted average shares outstanding(2)................. 4,884,993 2,370,779 1,866,216 1,866,216 1,823,765
========== ========== ========== ========== ==========
Diluted weighted average shares outstanding(2)............... 5,107,951 2,370,779 1,866,216 1,866,216 1,823,765
========== ========== ========== ========== ==========
At or for the Year Ended December 31,
------------------------------------------------------------------
1997 (9) 1996 (9) 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
SELECTED FINANCIAL RATIOS AND OTHER DATA(3):
PERFORMANCE RATIOS:
Return on average assets................................... 4.19% (0.06)% 0.69% (0.89)% 0.12%
Return on average equity................................... 40.45 (0.90) 13.64 (17.01) 2.11
Average equity to average assets........................... 10.35 6.77 5.04 5.22 5.51
Equity to total assets at end of period.................... 12.82 7.58 5.76 5.25 5.65
Average interest rate spread(4)............................ 3.30 3.78 3.09 2.79 3.02
Net interest margin(5)..................................... 3.68 3.95 3.25 2.88 3.14
Average interest-earning assets to
average interest-bearing liabilities..................... 106.65 103.64 103.50 102.27 103.08
Efficiency Ratio(6)........................................ 44.63 88.50 67.78 83.78 78.09
LOAN ORIGINATIONS AND PURCHASES.............................. $ 773,107 $ 222,553 $ 134,772 $ 72,815 $ 82,015
BANK REGULATORY CAPITAL RATIOS(7):
Tangible capital........................................... 5.38% 7.57% 5.68% 5.25% 5.65%
Core capital............................................... 5.38 7.57 5.68 5.25 5.65
Risk-based capital......................................... 10.52 8.09 10.17 10.00 10.87
ASSET QUALITY RATIOS:
Non-performing assets as a percent of total
assets(8)................................................ 1.65% 2.93% 3.00% 3.42% 5.05%
Allowance for estimated loan losses as a percent of
non-performing loans..................................... 50.20 67.26 84.25 44.04 20.02
</TABLE>
(footnotes on next page)
-51-
<PAGE>
(1) Book value per share is based upon the shares outstanding at the end of each
period, adjusted for a 100% stock dividend which occurred during 1996. Book
value per share is then adjusted for the exchange of three shares of Company
Common Stock for one share of Bank common stock in the Reorganization.
(2) Earnings per share is based upon the weighted average shares outstanding
during the period, adjusted for a 100% stock dividend which occurred during
1996. Earnings per share is then adjusted for the exchange of three shares
of Company Common Stock for one share of Bank common stock in the
Reorganization.
(3) Asset Quality Ratios and Regulatory Capital Ratios are end of period ratios.
With the exception of end of period ratios, all ratios are based on average
daily or average month-end balances during the indicated periods.
(4) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities.
(5) The net interest margin represents net interest income as a percent of
average interest-earning assets.
(6) The efficiency ratio represents noninterest expense less (gain) loss on
foreclosed real estate divided by noninterest income plus net interest
income before provision for estimated loan losses.
(7) For definitions and further information relating to the Bank's regulatory
capital requirements, see "Item 1--Business--Regulation."
(8) Non-performing assets consist of non-performing loans and REO.
(9) As restated, see Note 21 of Notes to Consolidated Financial Statements
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Restatement of Financial Statements
Subsequent to the issuance of the Company's 1997 financial statements, the
Company's management determined that residual assets retained in certain of the
Company's 1997 and 1996 securitization transactions had not been determined
using the cash-out method, as required by the Financial Accounting Standards
Board's (FASB) Special Report, "A Guide to Implementation of Statement 125 on
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, Second Edition", dated December 1998, and related guidance set
forth in statements made by the staff of the Securities and Exchange Commission
(SEC) on December 8, 1998.
From December 1996 through June 1997, the Company completed two
securitizations, which total $155 million of original loan balance securitized,
that are effected by this restatement. The Company's other securitization
transactions have been properly measured and accounted for using the cash-out
method. Initial deposits to restricted cash accounts and subsequent cash flows
received by securitization trusts sponsored by the Company accumulate as credit
enhancement assets until certain targeted levels are achieved, after which cash
is distributed to the Company on an unrestricted basis. Under the method
previously used by the Company, (i) the assumed discount period for measuring
the present value of credit enhancement assets ended when cash flows were
received by the securitization trusts and (ii) interest-bearing initial deposits
to restricted cash accounts were recorded at face value. Under the cash-out
method required by the FASB and SEC, the assumed discount period for measuring
the fair value of credit enhancement assets ends when cash, including return of
the initial deposits, is distributed to the Company on an unrestricted basis.
As a result, the 1997 and 1996 financial statements have been restated from
amounts previously reported to properly reflect the pretax fair values of the
residual assets, including restricted cash, and the resulting pretax gains and
income tax provision, as of and for the years ended December 31, 1997 and 1996,
as computed on the cash-out
-52-
<PAGE>
basis. The effects of this restatement are summarized in Note 21 of Notes to
Consolidated Financial Statements and are reflected herein.
Summary
The Company originates, purchases, sell, securitizes and services primarily
non-conventional mortgage loans principally secured by first and second
mortgages on one- to four-family residences. The Company makes Liberator Series
loans, which are for the purchase or refinance of residential real property by
sub-prime borrowers and Portfolio Series loans, which are debt consolidation
loans for Agency-Qualified Borrowers, generally with loan-to-value ratios of up
to 125%. While the Company is currently emphasizing the origination of Portfolio
Series loans, it intends to market both products as demand permits. In addition,
to a much lesser extent, the Company originates multi-family residential and
commercial loans. The Company purchases and originates mortgage loans and other
real estate secured loans through a network of Originators throughout the
country. The Company funds substantially all of the loans which it originates or
purchases through deposits, other borrowings, internally generated funds and
FHLB advances. In the immediate and foreseeable future, the Company will also
fund loans from the cash proceeds, if any, received from securitizations.
Deposit flows and cost of funds are influenced by prevailing market rates of
interest primarily on competing investments, account maturities and the levels
of savings in the Company's market area. The Company's ability to purchase or
sell loans is influenced by the general level of product available from its
correspondent relationships and the willingness of investors to purchase the
loans at an acceptable price to the Company. Due to substantial activity in the
purchase and sale of loans in recent years, the net gains from mortgage
financing operations have been significant. The Company's results of operations
are also affected by the Company's provision for loan losses and the level of
operating expenses. The Company's operating expenses primarily consist of
employee compensation and benefits, premises and occupancy expenses, and other
general expenses. The Company's results of operations are also affected by
prevailing economic conditions, competition, government policies and actions of
regulatory agencies. See "Item 1--Business--Regulation."
-53-
<PAGE>
Average Balance Sheets
The following tables set forth certain information relating to the Company at
December 31, 1997 and for the years ended December 31, 1997, 1996 and 1995. 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>
Year Ended December 31, 1997
--------------------------------------------------
Average
Yield/ Average Yield/
Balance Cost Balance Interest Cost
-------- ------ -------- ------- -------
<S> <C> <C> <C> <C> <C>
(dollars in Thousands)
ASSETS
----------------------------------------------
Interest-earning assets:
Interest-earning deposits and short-term investments.............. $ 2,651 5.31% $ 9,709 $ 635 6.54%
Investment securities(1).......................................... 6,070 5.88 8,685 495 5.70
Loans receivable, net(2).......................................... 318,344 10.33 191,140 17,746 9.28
Mortgage-backed securities(1)..................................... 9 7.50 9 1 11.11
Residual assets................................................... 45,352 13.50 16,549 2,269 13.71
-------- -------- -------
Total interest-earning assets..................................... 372,426 10.40 226,092 21,146 9.35
-------
Non-interest-earning assets(3).................................... 24,645 20,471
-------- --------
Total assets(3)................................................... $397,071 $246,563
======== ========
LIABILITIES AND EQUITY
----------------------------------------------
Interest-bearing liabilities:
Passbook accounts................................................. $ 3,838 2.10 $ 4,003 84 2.10
Money market accounts............................................. 2,729 2.98 2,971 88 2.96
Checking accounts................................................. 11,353 2.99 11,756 279 2.37
Certificate accounts.............................................. 193,845 5.94 128,213 7,587 5.92
-------- -------- -------
Total deposit accounts............................................ 211,765 5.68 146,943 8,038 5.47
Borrowings(4)..................................................... 119,170 7.71 65,046 4,792 7.37
-------- -------- -------
Total interest-bearing liabilities................................ 330,935 6.41 211,989 12,830 6.05
Non-interest-bearing liabilities(3)............................... 15,250 9,052
-------- --------
Total liabilities(3).............................................. 346,185 221,041
Equity(3)......................................................... 50,886 25,522
-------- --------
Total liabilities and equity(3)................................... $397,071 $246,563
======== ========
Net interest income before provision for estimated loan losses.... $ 8,316
=======
Net interest rate spread(5)....................................... 3.99 3.30
Net interest margin(6)............................................ 3.68
Ratio of interest-earning assets to interest-bearing liabilities.. 112.54 106.65
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------
1996 1995
----------------------------- ----------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------- -------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
ASSETS
----------------------------------------------
Interest-earning assets:
Interest-earning deposits and short-term investments.............. $ 5,358 $ 286 5.34% $ 4,225 $ 203 4.80%
Investment securities(1).......................................... 1,912 100 5.23 3,458 188 5.44
Loans receivable, net(2).......................................... 72,650 6,513 8.96 65,521 5,433 8.29
Mortgage-backed securities(1)..................................... 11 1 9.09 12 1 8.33
Residual assets................................................... 166 28 16.87 -- -- --
------- ------ ------- ------
Total interest-earning assets..................................... 80,097 6,928 8.65 73,216 5,825 7.96
------ ------
Non-interest-earning assets(3).................................... 5,123 2,465
------- -------
Total assets(3)................................................... $85,220 $75,681
======= =======
LIABILITIES AND EQUITY
----------------------------------------------
Interest-bearing liabilities:
Passbook accounts................................................. $ 4,401 92 2.09 $ 5,090 127 2.50
Money market accounts............................................. 4,233 118 2.79 5,493 144 2.62
Checking accounts................................................. 7,048 112 1.59 6,434 92 1.43
Certificate accounts.............................................. 57,333 3,192 5.57 50,608 2,829 5.59
------- ------ ------- ------
Total deposit accounts............................................ 73,015 3,514 4.81 67,625 3,192 4.72
Borrowings(4)..................................................... 4,268 252 5.90 3,112 256 8.23
------- ------ ------- ------
Total interest-bearing liabilities................................ 77,283 3,766 4.87 70,737 3,448 4.87
------ ------
Non-interest-bearing liabilities(3)............................... 2,170 1,131
------- -------
Total liabilities(3).............................................. 79,453 71,868
Equity(3)......................................................... 5,767 3,813
------- -------
Total liabilities and equity(3)................................... $85,220 $75,681
======= =======
Net interest income before provision for estimated loan losses.... $3,162 $2,377
====== ======
Net interest rate spread(5)....................................... 3.78 3.09
Net interest margin(6)............................................ 3.95 3.25
Ratio of interest-earning assets to interest-bearing liabilities.. 103.64 103.50
</TABLE>
(footnotes on next page)
-54-
<PAGE>
(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 year ending December 31, 1995
included the effects of $52,000 in interest expense on swap transactions
with a notional principal balance of $2.0 million in 1995. Without this
added expense, the average yield on borrowings for the years ending
December 31, would have been 6.56%. The yield on total interest-bearing
liabilities for the years ending December 31, 1995 would have been 4.80%.
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.
Rate/Volume Analysis. The following table presents the extent to which
changes in interest rates and changes in the volume of interest-earning assets
and interest-bearing liabilities have affected the Company's interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to: (I) changes attributable to changes in volume (changes
in volume multiplied by prior rate); (ii) changes attributable to changes in
rate (changes in rate multiplied by prior volume); and (iii) the net change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1997 December 31, 1996
-------------------------- ----------------------
Compared to Compared to
Year Ended Year Ended
December 31, 1996 December 31, 1995
-------------------------- ----------------------
Increase Increase
(Decrease) (Decrease)
Due to Due to
-------------------------- ----------------------
Volume Rate Net Volume Rate Net
------- ------ ------- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Interest-earning assets:
Interest-earning deposits and short-term
investments................................ $ 274 $ 75 $ 349 $ 93 $ (10) $ 83
Investment securities, net................... 385 10 395 (81) (7) (88)
Loans receivable, net(1)..................... 10,992 241 11,233 580 500 1,080
Residual assets.............................. 2,247 (6) 2,241 28 28
Mortgage-backed securities...................
------- ---- ------- ----- ---- ------
Total interest-earning assets............. 13,898 320 14,218 620 483 1,103
Interest-bearing liabilities:
Money market accounts........................ (37) 7 (30) (35) 9 (26)
Passbook accounts............................ (8) (8) (16) (19) (35)
Checking accounts............................ 96 71 167 9 11 20
Certificate accounts......................... 4,182 213 4,395 374 (11) 363
Borrowings................................... 4,462 78 4,540 80 (84) (4)
------- ---- ------- ----- ---- ------
Total interest-bearing liabilities........ 8,695 369 9,064 412 (94) 318
------- ---- ------- ----- ---- ------
Change in net interest income.................. $ 5,203 $(49) $ 5,154 $ 208 $577 $ 785
======= ==== ======= ===== ==== ======
</TABLE>
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<PAGE>
(1) Includes interest on loans held for sale.
Comparison of Operating Results for the Year Ended December 31, 1997 and
December 31, 1996
General
For the year ended December 31, 1997 the Company recorded net income of
$10.3 million compared to a net loss of $52,000 for the year ended December 31,
1996. The basic and diluted earnings (loss) per share for the year ended
December 31, 1997 were $2.11 and $2.02, respectively, compared to $(0.02) and
$(0.02), respectively, for the year ended December 31, 1996. The increase in net
income was due to the expansion of the mortgage financing operations, the
increase in gains with respect to such operations, increases in net interest
income and the absence of a special SAIF assessment.
Interest Income
Interest income for the year ended December 31, 1997 was $21.1 million,
compared to $6.9 million for the year ended December 31, 1996, due to an
increase in the average balance of interest earning assets, combined with an
increase in the yield on those assets. Average interest earning assets increased
to $226.1 million for the year ended December 31, 1997 compared to $80.1 million
for the year ended December 31, 1996. The yield on interest earning assets
increased to 9.35% for the year ended December 31, 1997 compared to 8.65% for
the year ended December 31, 1996. The largest single component of interest
earning assets was average loans receivable, net, which were $191.1 million with
a yield of 9.28% for the year ended December 31, 1997 compared to $72.7 million
with a yield of 8.96% for the year ended December 31, 1996. The income in the
average balance of loans receivable was attributable to the continued growth of
the Company's mortgage financing operation.
Interest Expense
For the year ended December 31, 1997, interest expense was $12.8 million,
compared to $3.8 million for the year ended December 31, 1996 due to an increase
in the average balance of interest bearing liabilities combined with an increase
in the cost of those liabilities. At the end of the quarter ended March 31,
1997, the Company issued subordinated debentures with an interest rate of 13.5%.
This issuance of debentures, combined with an increased use of borrowed funds as
well as a heavier reliance on certificate accounts, resulted in an increase in
the average cost of interest bearing liabilities to 6.05% for the year ended
December 31, 1997 compared to 4.87% for the year ended December 31, 1996.
Average interest bearing liabilities were $212.0 million for the year ended
December 31, 1997 compared to $77.3 million for the year ended December 31,
1996.
The largest component of average interest bearing liabilities was
certificate accounts, which averaged $128.2 million with an average cost of
5.92% compared to $57.3 million with an average cost of 5.57% for the year ended
December 31, 1996. The second largest component of interest bearing liabilities
is borrowings, which increased to an average balance of $65.0 million with an
average cost of 7.37% for the year ended December 31, 1997 compared to $4.3
million with an average cost of 5.90% for the year ended December 31, 1996.
During 1997, increased borrowings include the issuance of the subordinated
debentures, as well as two warehouse lines of credit in the amount of $250.0
million which are indexed to LIBOR. In addition, the Company entered into a
residual financing line of credit in the amount of $40.0 million, which is also
indexed to LIBOR.
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<PAGE>
Net Interest Income Before Provision for Estimated Loan Losses
Net interest income before provision for estimated loan losses for the year
ended December 31, 1997 was $8.3 million compared to $3.2 million for the year
ended December 31, 1996. This increase was the net effect of an increase in
average interest earning assets and average interest bearing liabilities, as
well as an increase in the ratio of interest earning assets to interest bearing
liabilities. Average interest earning assets increased to $226.1 million for the
year ended December 31, 1997 compared to $80.1 million for the year ended
December 31, 1996. Average interest bearing liabilities increased to $212.0
million with an average cost of 6.05% for the year ended December 31, 1997
compared to $77.3 million with an average cost of 4.87% for the year ended
December 31, 1996. The ratio of interest earning assets to interest bearing
liabilities was 106.65% for the year ended December 31, 1997 compared to 103.64%
for the year ended December 31, 1996.
Provision for Estimated Loan Losses
Provision for estimated loan losses were $1.9 million for the year ended
December 31, 1997 compared to $963,000 for the year ended December 31, 1996. The
increase in provisions was based on an evaluation of the composition of the
Company's loan portfolio and an increase in non-performing consumer loans.
Charge offs net of recoveries for the year ended December 31, 1997 were $902,000
compared to $515,000 for the year ended December 31, 1996. The Company had non-
accrual loans at December 31, 1997 of $5.1 million, compared to $2.4 million at
December 31, 1996. The increase in non-accrual loans was largely due to an
increase in non-performing consumer loans, which were $1.7 million as of
December 31, 1997 compared to $10,000 as of December 31, 1996. The increase in
non-performing consumer loans relates directly to a bulk purchase of $7.4
million in consumer loans during 1997. Management believes that the allowance
for loan losses at December 31, 1997 was adequate to absorb known and inherent
risks in the Company's loan portfolio. No assurance can be given, however, that
economic conditions which may adversely affect the Company's or the Bank's
service areas or other circumstances will not be reflected in increased losses
in the loans portfolio. In addition, regulatory agencies, as an integral part of
their examination process, periodically review the Bank's allowance for loan
losses. Such agencies may require the Bank to recognize additions to the
allowance or to take charge-offs (reductions in the allowance) in anticipation
of losses. See "Item 1--Business--Lending Overview--Delinquencies and
Classified Assets" and "--Lending Overview--Allowance for Loan Losses."
Non-Interest Income
For the year ended December 31, 1997, net gains from mortgage financing
operations totaled $25.7 million compared to $5.7 million for the year ended
December 31, 1996. The net gain includes a pre-tax unrealized loss of $966,000,
due to an adjustment to the valuation of the residual assets related to the
1997-1 securitization, as a result of the higher-than-estimated prepayment
speeds. See "Item 1--Business-loan Sales and Asset Securitizations." The
increase in net gains from mortgage financing operations was attributable to the
increase in the level of mortgage financing operations, with loans sold or
securitized totaling $510.1 million for the year ended December 31, 1997
compared to $206.6 million for the year ended December 31, 1996. Net gains from
mortgage financing operations as a percent of loans sold or securitized was
5.04% for the year ended December 31, 1997 compared to 2.76% for the year ended
December 31, 1996. This increase in percentage reflected the effects of the
securitization of loans compared to whole loan sales. During the year ended
December 31, 1997, loans securitized represented 81.5% of loan sales and
securitizations, while during the year ended December 31, 1996, loans
securitized represented 25.1% of loan sales and securitizations. Loans
originated and purchased totaled $773.1 million for the year ended December 31,
1997 compared to $222.6 million for the year ended December 31, 1996.
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<PAGE>
Non-Interest Expense
For the year ended December 31, 1997, non-interest expense was $16.0
million compared to $8.7 million for the year ended December 31, 1996. The
increase was due primarily to an increase in compensation and benefits and other
operating expenses resulting from the expansion of the mortgage financing
operations. New loans originated and purchased totaled $773.1 million for the
year ended December 31, 1997 compared to $222.6 million for the year ended
December 31, 1996.
For the year ended December 31, 1997, compensation and benefits were $9.2
million compared to $5.2 million for the year ended December 31, 1996. These
costs are directly related to the expansion of the mortgage financing operations
and the corresponding increase in personnel, to an average of 230 for the year
ended December 31, 1997 compared to 97 for the year ended December 31, 1996.
Premises and occupancy expenses were $1.4 million for the year ended
December 31, 1997 compared to $746,000 for the year ended December 31, 1996 due
to the expansion of the mortgage financing operation and the addition of the
regional operating center in the Denver, Colorado metropolitan area, the new
corporate headquarters and regional lending center located in Riverside,
California during 1997, the relocation of the Florida regional office, the
addition of five low cost retail lending offices in California, and the opening
of one new retail Bank branch in Riverside, California. The Company anticipates
that premises and occupancy expense will continue to increase as the Company
adds new retail lending and retail banking offices, as well as additional office
space for expansion of the loan servicing operations.
As a result of the expansion of the mortgage financing operations, other
operating expenses increased as well. Data processing increased to $809,000 for
the year ended December 31, 1997 compared to $390,000 for the year ended
December 31, 1996. The increase in non-interest expense was partially offset by
a reduction in FDIC insurance premiums in the 1997 period. During the quarter
ended September 30, 1996, the Bank paid a one time assessment to the FDIC of
$448,000 for the recapitalization of the SAIF. Marketing, telephone,
professional services and other expenses were $301,000, $650,000, $467,000 and
$3.0 million, respectively, for the year ended December 31, 1997 compared to
$189,000, $246,000, $218,000 and $879,000 for the year ended December 31, 1996.
Other expense for the year ended December 31, 1997 included a write down of the
servicing asset in the amount of $1.3 million. This write down is the result of
an increase in prepayment speeds on adjustable rate mortgage loans which are
being serviced by the Company for other investors. Management performs a
quarterly analysis of the Company's servicing assets and believes that the
servicing assets are properly valued at December 31, 1997.
Income Taxes
The provision for income taxes increased to $7.4 million for the year ended
December 31, 1997 compared to $38,000 for the year ended December 31, 1996.
Income before income tax provision increased to $17.7 million for the year ended
December 31, 1997 compared to a loss of $14,000 for the year ended December 31,
1996. The effective tax rate was 41.7% for the year ended December 31, 1997.
Comparison of Financial Condition at December 31, 1997 and December 31, 1996
Total assets increased to $397.1 million as of December 31, 1997 compared
to $101.8 million as of December 31, 1996 due to the expansion of the mortgage
financing operations. Loans held for sale totaled $289.3 million as of December
31, 1997 compared to $31.0 million as of December 31, 1996. This increase was
partially offset by a decrease in loans held for investment to $29.1 million as
of December 31, 1997 compared to $36.9 million as of December 31, 1996. During
the year ended December 31, 1997, the Company sold or securitized $510.1 million
of loans (including $94.7 million in whole loan sales). The increase in loans
held for sale also resulted in an increase in accrued interest receivable to
$2.6 million as of December 31, 1997 compared to $537,000 as of December 31,
1996.
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<PAGE>
As a result of the Company's loan securitization activities, residual
assets increased to $45.4 million as of December 31, 1997 compared to $4.7
million as of December 31, 1996. Mortgage servicing rights also increased to
$8.5 million as of December 31, 1997 compared to $2.6 million as of December 31,
1996 as a result of the securitization of loans with servicing retained.
Cash and cash equivalents were $3.5 million as of December 31, 1997
compared to $12.6 million as of December 31, 1996. During the year ended
December 31, 1997, the Company invested in leasehold improvements on the new
corporate headquarters as well as adding the Denver, Colorado regional lending
center and five low-cost retail lending offices in California increasing
premises and equipment to $4.8 million as of December 31, 1997 compared to $1.6
million as of December 31, 1996. Real estate owned increased to $1.4 million as
of December 31, 1997 compared to $561,000 as of December 31, 1996 as part of the
Company's continuing effort to resolve problem loans.
During the year ended December 31, 1997 the Company 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
year ended December 31, 1997. In addition, the Company increased its liabilities
by increasing deposit accounts to $211.8 million as of December 31, 1997
compared to $85.7 million as of December 31, 1996. The major component of
deposit accounts is certificates of deposit, which increased to $193.8 million
as of December 31, 1997 compared to $69.4 million as of December 31, 1996. The
additional funds were used to fund loans held for sale during the year ended
December 31, 1997.
The Company also increased its use of FHLB advances and other borrowings to
fund loans held for sale. During 1997, the Company has added two warehouse lines
of credit with a combined credit limit of $250.0 million. In addition, the
Company added a residual financing line of credit with a credit limit of $40.0
million. The availability of such borrowings permits the Company to access
sufficient cash to originate and hold loans pending securitization or sale and
to thereafter repay the lines of credit following securitization or sale of the
loans. Other borrowings increased to $100.2 million as of December 31, 1997
compared to $3.3 million as of December 31, 1996, while FHLB advances were $9.0
million as of December 31, 1997 and were zero as of December 31, 1996. The
Company also issued $10.0 million in subordinated debentures during the year
ended December 31, 1997 with a coupon rate of 13.5%. Interest rates on the
warehouse lines of credit range between LIBOR plus 50 basis points to LIBOR plus
100 basis points, while the residual financing line of credit has an interest
rate of LIBOR plus 235 basis points.
Accounts payable and other liabilities increased to $15.3 million as of
December 31, 1997 compared to $5.1 million as of December 31, 1996 due to an
increase in loans serviced for other investors and the corresponding increase in
amounts due investors between the time the borrowers make payments to the
Company and the time the Company remits payments to the investors.
Stockholders' equity increased to $50.9 million as of December 31, 1997
compared to $7.7 million as of December 31, 1996 due to the issuance of
2,900,000 shares of Company common stock to the public in the Company's initial
public offering, completed on June 30, 1997 and the issuance of an additional
435,000 shares to the public pursuant to the exercise of the underwriter's
overallotment option. The initial offering price to the public was $11.00 per
share, which resulted in $32.8 million in net proceeds after expenses.
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<PAGE>
Comparison of Operating Results for the Years Ended December 31, 1996 and
December 31, 1995
General
Net income decreased by $572,000 from $520,000 for the year ended December
31, 1995 to a net loss of $52,000 for the year ended December 31, 1996. Net loss
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. Net income for the year ended
December 31, 1996 would have been approximately $450,000 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 $5.7 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 $1.4 million.
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.
In addition, during the year ended December 31, 1996, the Bank acquired the
Riverside, California property it has been leasing by exercising its lease
purchase 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 8.65% 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 $80.1 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 $72.7 million for the year 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. The yield on loans receivable increased from
8.29% for the year ended December 31, 1995 to 8.96% for the year ended December
31, 1996.
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<PAGE>
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 3.95% 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 2.93% 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.
Non-Interest Income
Net gains from mortgage financing operations for the year ended December
31, 1995 were $3.6 million compared to $5.7 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.
Net gains from mortgage financing operations as a percent of loans sold and
securitized remained fairly stable at 2.84% for the year ended December 31, 1995
compared to 2.76% for the year ended December 31, 1996.
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<PAGE>
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.
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 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 decreased from $294,000 for the year ended
December 31, 1995 to $38,000 for the year ended December 31, 1996. The decrease
in income taxes is the result of the decrease in income before tax, which
decreased from $814,000 for the year ended December 31, 1995 to a loss of
$14,000 for the year ended December 31, 1996.
Management of Interest Rate Risk
The principal objective of the Company's interest rate risk management
function is to evaluate the interest rate risk included in certain balance sheet
accounts, determine the level of appropriate risk given the Company's business
focus, operating environment, capital and liquidity requirements and performance
objectives and manage the risk consistent with Board approved guidelines through
the establishment of prudent asset concentration guidelines. Through such
management, management of the Company seeks to reduce the vulnerability of the
Company's operations to changes in interest rates. Management of the Company
monitors its interest rate risk as such risk relates to its operational
strategies. The Company's Board of Directors reviews on a quarterly basis the
Company's asset/liability position, including simulations of the effect on the
Company's capital of various interest
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<PAGE>
rate scenarios. The extent of the movement of interest rates, higher or lower,
is an uncertainty that could have a negative impact on the earnings of the
Company.
Between the time the Company originates loans and purchase commitments are
issued, the Company is exposed to both upward and downward movements in interest
rates which may have a material adverse effect on the Company. The Board of
Directors of the Company recently implemented a hedge management policy
primarily for the purpose of hedging the risks associated with loans held for
sale in the Company's mortgage pipeline. In a flat or rising interest rate
environment, this policy enables management to utilize mandatory forward
commitments to sell fixed rate assets as the primary hedging vehicles to shorten
the maturity of such assets. In a declining interest rate environment, the
policy enables management to utilize put options. The hedge management policy
also permits management to extend the maturity of its liabilities through the
use of short financial futures positions, purchase of put options, interest rate
caps or collars, and entering into "long" interest rate swap agreements. Since
this policy was implemented after March 31, 1997, the Company has engaged in
only a limited amount of hedging activities. Management is continuing to
evaluate and refine its hedging policies. No hedging positions were outstanding
at December 31, 1997.
Net Portfolio Value. The Bank's interest rate sensitivity is monitored by
management through the use of a model which estimates the change in net
portfolio value ("NPV") over a range of interest rate scenarios. NPV is the
present value of expected cash flows from assets, liabilities and off-balance
sheet contracts. An NPV Ratio, in any interest rate scenario, is defined as the
NPV in that scenario divided by the market value of assets in the same scenario.
The sensitivity measure is the decline in the NPV Ratio, in basis points, caused
by a 2% increase or decrease in rates, whichever produces a larger decline (the
"Sensitivity Measure"). The higher an institution's Sensitivity Measure is,
the greater its exposure to interest rate risk is considered to be. The Bank
utilizes a market value model prepared by the OTS (the "OTS NPV model"), which
is prepared quarterly, based on the Bank's quarterly Thrift Financial Reports
filed with the OTS. The OTS NPV model measures the Bank's interest rate risk by
estimating the Bank's NPV, which is the net present value of expected cash flows
from assets, liabilities and any off-balance sheet contracts, under various
market interest rate scenarios which range from a 400 basis point increase to a
400 basis point decrease in market interest rates. The interest rate risk policy
of the Bank provides that the maximum permissible change in NPV for a 400 basis
point increase or decrease in market interest rates is a 45% change in the net
portfolio value. The OTS has incorporated an interest rate risk component into
its regulatory capital rule. Under the rule, an institution whose Sensitivity
Measure in the event of a 200 basis point increase or decrease in interest rates
exceeds 2% would be required to deduct an interest rate risk component in
calculating its total capital for purpose of the risk-based capital requirement.
See "Item 1--Business--Regulation--Federal Savings Institution Regulation." As
of December 31, 1997, the most recent date for which the relevant data is
available, the Bank's Sensitivity Measure, as measured by the OTS, resulting
from a 200 basis point increase in interest rates was 89 basis points and would
result in a $3.9 million reduction in the NPV of the Bank. As of December 31,
1997, 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 indefinitely the date the component will first be deducted
from an institution's total capital. See "Item 1--Business--Federal Savings
Institution Regulation."
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in NPV requires the making of
certain assumptions that may tend to oversimplify the manner in which actual
yields and costs respond to changes in market interest rates. First, the models
assume that the composition of the Bank's interest sensitive assets and
liabilities existing at the beginning of a period remains constant over the
period being measured. Second, the models assume that a particular change in
interest rates is reflected uniformly across the yield curve regardless of the
duration to maturity or repricing of specific assets and liabilities. Third, the
model does not take into account the impact of the Bank's business or strategic
plans on the structure of interest-earning assets and interest-bearing
liabilities. In particular, the Bank's core products 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
-63-
<PAGE>
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, 1997 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)
NPV as % of Portfolio
Value of Assets
Net Portfolio Value % Change
-------------------- ---------------------
Change in Rates $ Amount $ Change % Change NPV Ratio (BP)
- --------------- -------- --------- -------- --------- -------
(Dollars in Thousands)
+ 400 bp $ 21,106 $(15,411) (42)% 5.95% (383)
+ 300 bp 27,557 (8,961) (25) 7.63 (216)
+ 200 bp 32,663 (3,854) (11) 8.90 (89)
+ 100 bp 35,850 (668) (2) 9.66 (13)
Static 36,517 -- -- 9.79 --
- 100 bp 37,173 656 2 9.91 12
- 200 bp 39,974 3,456 9 10.55 76
- 300 bp 43,957 7,440 20 11.44 165
- 400 bp 48,919 12,401 34 12.53 274
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, FHLB advances, other
borrowings, principal and interest payments on loans, cash proceeds from the
sale of loans and securitizations, and to a lesser extent, interest payments on
investment securities and proceeds from the maturation of investment securities.
While maturities and scheduled amortization of loans are a predictable source of
funds, deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition. However, the Bank has
continued to maintain the required minimum levels of liquid assets as defined by
OTS regulations. This requirement, which may be varied at the direction of the
OTS depending upon economic conditions and deposit flows, is based upon a
percentage of deposits and short-term borrowings. The required ratio is
currently 4%. The Bank's average liquidity ratios were 10.4%, 8.5%, and 9.4% for
the years ended December 31, 1997, 1996 and 1995, respectively. Management
currently attempts to maintain a minimum liquidity ratio of 5.0%.
The Company's cash flows are comprised of three primary classifications:
cash flows from operating activities, investing activities and financing
activities. Cash flows used in operating activities were $315.9 million, $19.4
million and $5.3 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Such cash flows primarily consisted of loans originated and
purchased for sale (net of loan fees) of $796.8 million, $227.2 million and
$135.6 million, net of proceeds from the sale and securitization of loans held
for sale of $489.5 million, $210.6 million and $130.1 million for the years
ended December 31, 1997, 1996 and 1995, respectively. Net cash provided by
investing activities were $32.3 million, $3.0 million and $7.1 million for the
years ended December 31, 1997, 1996, and 1995 respectively, and consisted
primarily of principal collections on loans and proceeds from maturation of
investments, offset by investment purchases. Proceeds from the maturation of
investment securities were $5.0 million, $2.0 million and $9.2 million for the
years ended December 31, 1997, 1996 and 1995, respectively. Net cash provided by
financing activities consisted primarily of net activity in deposit accounts and
borrowings. The net
-64-
<PAGE>
increase in deposits and borrowings was $241.6 million, $21.5 million and
$596,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The
Company received net proceeds from the IPO of the Company's Common Stock of
$32.8 million during the year ended December 31, 1997. The Bank also received
proceeds from the issuance of common stock in the Private Placement of $3.5
million in August 1996.
At December 31, 1997, the Bank exceeded all of its regulatory capital
requirements with a tangible capital level of $21.5 million, or 5.4% of total
adjusted assets, which is above the required level of $6.0 million, or 1.50%;
core capital of $21.5 million, or 5.4% of total adjusted assets, which is above
the required level of $12.0 million, or 3.0%, and risk-based capital of $33.9
million, or 10.5% of risk-weighted assets, which is above the required level of
$25.8 million, or 8.0%. See "Item 1--Regulation--Federal Savings Institution
Regulation--Capital Requirements."
The Company's most liquid assets are cash and short-term investments. The
levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At December 31, 1997,
cash and short-term investments totalled $3.5 million. The Company has other
sources of liquidity if a need for additional funds arises, including the
utilization of FHLB advances. At December 31, 1997, the Bank had $9.0 million in
advances outstanding from the FHLB. Other sources of liquidity include
investment securities maturing within one year. The Bank also has two warehouse
lines of credit available in the amount of $250.0 million of which $84.6 million
had been drawn upon at December 31, 1997. The Bank is in the process of
negotiating a third warehouse line of credit in the amount of $250.0 million to
fund loan originations. The Company has a residual financing line of credit in
the amount of $40.0 million, of which $15.5 million has been drawn upon at
December 31, 1997.
The Company had no material contractual obligations or commitments for
capital expenditures at December 31, 1997. At December 31, 1997 the Company had
outstanding commitments to originate or purchase mortgage loans of $29.2 million
compared to $9.2 million at December 31, 1996. The Company anticipates that it
will have sufficient funds available to meet its current and anticipated loan
origination commitments. Certificates of deposit which are scheduled to mature
in one year or less from December 31, 1997, totalled $187.5 million. The Company
expects that a substantial portion of the maturing certificates of deposit will
be retained by the Company at maturity.
On March 11, 1998, the Company entered into an Agreement and Plan of Merger
("Merger Agreement") with FIRSTPLUS Financial Group, Inc. ("FIRSTPLUS"),
pursuant to which the Company will be acquired by and become a wholly-owned
subsidiary of FIRSTPLUS. The Merger Agreement is subject to the receipt of
regulatory approval and the approval of shareholders of the Company. Under the
Merger Agreement, at the effective date of the merger, each outstanding share of
common stock of the Company will be converted into the right to receive between
0.500 and 0.667 shares of FIRSTPLUS common stock, as calculated pursuant to the
Exchange Ratio outlined in the Merger Agreement. Management believes that the
merger will enhance return to the Company's shareholders through greater
efficiencies in securitization as well as greater marketing capabilities through
a combined marketing strategy.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with Generally Accepted Accounting Principles
("GAAP"), which require the measurement of financial position and operating
results in terms of historical dollar amounts without considering the changes in
the relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations. Unlike
industrial companies, nearly all of the assets and liabilities of the Company
are monetary in nature. As a result, interest rates have a greater impact on the
Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.
-65-
<PAGE>
Impact of New Accounting Standards
In June 1996 the Financial Accounting Standards Board ("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. This Statement supersedes SFAS No. 122,
"Accounting for Mortgage Servicing Rights." The adoption of SFAS No. 125 as
amended by SFAS No. 127 did not have a material impact on the Company's results
of operations or financial condition.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting
and display of comprehensive income and its components (revenues, expenses,
gains, and losses) in a full set of general purpose financial statements. SFAS
No. 130 requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. SFAS No. 130 requires that an enterprise (a) classify
items of other comprehensive income by their nature in a financial statement and
(b) display the accumulated balance of other comprehensive income separately
from net worth and additional paid-in capital in the equity section of a
statement of financial position. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997. Reclassification of financial statements for
earlier periods provided for comparative purposes is required. The Company does
not anticipate that the adoption of SFAS No. 130 will have a material impact on
its financial reporting.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information." SFAS No. 131 requires disclosures for
each segment that are similar to those required under current standards with the
addition of quarterly disclosure requirements and a finer partitioning of
geographic disclosures. It requires limited segment data on a quarterly basis.
It also requires geographic data by country, as opposed to broader geographic
regions as permitted under current standards. SFAS No. 131 is effective for
fiscal year beginning after December 15, 1997 with earlier application
permitted. The Company does not anticipate that the adoption of SFAS No. 131
will have a material impact on its financial reporting.
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<PAGE>
Quantitative and Qualitative Disclosures About Market Risk
The following table provides information regarding the Company's primary
categories of assets and liabilities which are sensitive to changes in interest
rates. The information presented reflects the expected cash flows of the primary
categories by year including the related weighted average interest rate. The
cash flows for loans and mortgage-backed securities are based on maturity date
and are adjusted for expected prepayments which are based on historical and
current market information. The loans and mortgage-backed securities which have
adjustable rate features are presented in accordance with their next interest-
repricing date. Cash flow information on interest-bearing liabilities such as
passbooks, NOW accounts and money market accounts also is adjusted for expected
decay rates which are based on historical information. Also, for purposes of
cash flow presentation, premiums or discounts on purchased assets, mark-to-
market adjustments and loans on non-accrual are excluded from the amounts
presented. Investment securities are presented as to maturity date as are all
certificates of deposit and borrowings.
<TABLE>
<CAPTION>
Year 1 Year 2 Year 3 Year 4 Year 5 Thereafter
--------- -------- -------- -------- -------- -----------
(Dollars in Thousands)
Selected Assets:
<S> <C> <C> <C> <C> <C> <C>
Investments and Fed Funds............. $ 4,071 $ 1,999 $ -- $ -- $ -- $ --
Average interest rate................. 5.75% 6.12% 0.00% 0.00% 0.00% 0.00%
Mortgage-backed securities--
adjustable rate..................... $ 9 $ -- $ -- $ -- $ -- $ --
Average interest rate................. 7.50% 0.00% 0.00% 0.00% 0.00% 0.00%
Loans--fixed rate..................... $ 685 $ 495 $ 662 $ 1,449 $ 4,351 $122,528
Average interest rate................. 13.02% 9.37% 13.36% 15.82% 12.27% 12.00%
Loans--adjustable rate................ $125,892 $45,892 $10,495 $ 75 $ -- $ --
Average interest rate................. 9.05% 9.95% 9.74% 10.13% 0.00% 0.00%
Residual Assets....................... $ 2,954 $ 4,066 $11,656 $10,449 $10,793 $ 5,434
Average Interest Rate................. 13.50% 13.50% 13.50% 13.50% 13.50% 13.50%
Mortgage Servicing Rights............. $ 3,576 $ 2,892 $ 2,058 $ -- $ -- $ --
Average Interest Rate................. 16.00% 16.00% 16.00% 0.00% 0.00% 0.00%
Selected Liabilities:
Interest-bearing NOW passbook
and MMDA's.......................... $ 3,585 $ 2,867 $ 2,293 $ 1,835 $ 1,468 $ 5,872
Average interest rate................. 2.80% 2.80% 2.80% 2.80% 2.80% 2.80%
Certificates of deposit................. $187,501 $ 3,631 $ 1,179 $ 589 $ 421 $ 524
Average interest rate................... 5.93% 6.07% 6.56% 6.40% 6.02% 6.83%
FHLB Advances......................... $ 9,000
Average interest rate................. 7.07% 0.00% 0.00% 0.00% 0.00% 0.00%
Warehousing lines of credit and
subordinated debentures............. $100,170 $ -- $ -- $ -- $ -- $ 10,000
Average interest rate................. 7.19% 0.00% 0.00% 0.00% 0.00% 13.50%
</TABLE>
The Company does not have any foreign exchange exposure nor any commodity
exposure and therefore does not have any market risk exposure for these issues.
-67-
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
LIFE Financial Corporation
Riverside, California
We have audited the accompanying consolidated statements of financial
condition of LIFE Financial Corporation and subsidiaries (the Company) as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such 1997 and 1996 consolidated financial statements
present fairly, in all material respects, the financial position of LIFE
Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
As discussed in Note 21, the accompanying 1997 and 1996 consolidated
financial statements have been restated.
Deloitte & Touche LLP
Costa Mesa, California
February 27, 1998 (March 11, 1998, as to Note 20, and March 26, 1999
as to Note 21)
-68-
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
LIFE Financial Corporation
We have audited the accompanying statements of operations, stockholders'
equity and cash flows of LIFE Financial Corporation (formerly Life Savings Bank,
Federal Savings Bank) for the year ended December 31, 1995. 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 financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of LIFE
Financial Corporation for the year ended December 31, 1995, 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.
GRANT THORNTON LLP
Irvine, California
February 8, 1996 (except for the "Earnings Per Share" paragraph of Note 1,
as to which the date is June 30, 1997)
-69-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF DECEMBER 31, 1997 AND 1996
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
------------ ------------
As restated, As restated,
ASSETS See Note 21 See Note 21
-------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents................................................................ $ 3,467 $ 12,575
Securities held to maturity, estimated fair value of $5,030 (1997) and $7,981 (1996)..... 5,012 8,023
Residual assets, at fair value........................................................... 45,352 4,691
Loans held for sale...................................................................... 289,268 31,018
Loans held for investment, net of allowance for estimated loan losses of $2,573 (1997)
and $1,625 (1996)....................................................................... 29,076 36,895
Mortgage servicing rights................................................................ 8,526 2,645
Accrued interest receivable.............................................................. 2,638 537
Foreclosed real estate, net.............................................................. 1,440 561
Premises and equipment, net.............................................................. 4,764 1,579
Federal Home Loan Bank stock............................................................. 1,067 814
Other assets............................................................................. 6,461 2,425
-------- --------
TOTAL ASSETS............................................................................. $397,071 $101,763
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
-------------------------------------------------------------------------
LIABILITIES:
Deposit accounts....................................................................... $211,765 $ 85,711
Federal Home Loan Bank advances........................................................ 9,000
Other borrowings....................................................................... 100,170 3,278
Subordinated debentures................................................................ 10,000
Accounts payable and other liabilities................................................. 15,250 5,058
-------- --------
Total liabilities.................................................................... 346,185 94,047
COMMITMENTS AND CONTINGENCIES (Note 12)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 5,000,000 shares authorized; no shares outstanding
Common stock, $.01 par value; 25,000,000 shares authorized; 6,546,716 (1997)
and 3,211,716 (1996) shares issued and outstanding.................................... 65 32
Additional paid-in capital............................................................. 42,171 9,358
Retained earnings (deficit), partially restricted...................................... 8,650 (1,674)
-------- --------
Total stockholders' equity........................................................... 50,886 7,716
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................................... $397,071 $101,763
======== ========
</TABLE>
See notes to consolidated financial statements.
-70-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ -------
INTEREST INCOME: As restated, As restated,
See Note 21 See Note 21
<S> <C> <C> <C>
Loans............................................................. $17,746 $6,513 $5,433
Residual assets................................................... 2,269 28
Securities held to maturity....................................... 435 56 159
Other interest-earning assets..................................... 696 331 233
------- ------ ------
Total interest income.......................................... 21,146 6,928 5,825
------- ------ ------
INTEREST EXPENSE:
Deposit accounts.................................................. 8,038 3,514 3,192
Federal Home Loan Bank advances and other borrowings.............. 3,665 252 256
Subordinated debentures........................................... 1,127
------- ------ ------
Total interest expense......................................... 12,830 3,766 3,448
------- ------ ------
NET INTEREST INCOME BEFORE PROVISION FOR ESTIMATED LOAN
LOSSES............................................................. 8,316 3,162 2,377
PROVISION FOR ESTIMATED LOAN LOSSES................................. 1,850 963 1,194
------- ------ ------
NET INTEREST INCOME AFTER PROVISION FOR ESTIMATED LOAN
LOSSES............................................................. 6,466 2,199 1,183
NONINTEREST INCOME:
Loan servicing and other fees..................................... 959 496 231
Service charges on deposit accounts............................... 130 128 111
Net gains from mortgage financing operations...................... 25,730 5,708 3,575
Other income...................................................... 411 136 103
------- ------ ------
Total noninterest income....................................... 27,230 6,468 4,020
</TABLE>
See notes to consolidated financial statements.
-71-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ----------
NONINTEREST EXPENSE: As restated, As restated,
See Note 21 See Note 21
<S> <C> <C> <C>
Compensation and benefits.................... $ 9,210 $ 5,233 $ 2,544
Premises and occupancy....................... 1,360 746 471
Data processing.............................. 809 390 208
Net loss on foreclosed real estate........... 126 158 53
FDIC insurance premiums...................... 102 174 184
SAIF special assessment...................... 448
Marketing.................................... 301 189 65
Telephone.................................... 650 246 143
Professional services........................ 467 218 92
Other expense................................ 2,965 879 629
---------- ---------- ----------
Total noninterest expense................... 15,990 8,681 4,389
---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAX PROVISION..... 17,706 (14) 814
INCOME TAX PROVISION.......................... 7,382 38 294
---------- ---------- ----------
NET INCOME (LOSS)............................. $ 10,324 $ (52) $ 520
========== ========== ==========
EARNINGS (LOSS) PER SHARE:
Basic earnings (loss) per share.............. $ 2.11 $ (0.02) $ 0.28
========== ========== ==========
Diluted earnings (loss) per share............ $ 2.02 $ (0.02) $ 0.28
========== ========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic earnings (loss) per share.............. 4,884,993 2,370,779 1,866,216
========== ========== ==========
Diluted earnings (loss) per share............ 5,107,951 2,370,779 1,866,216
========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
-72-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Additional Retained Total
Common Stock Paid-in Earnings Stockholders'
------------------- --------- --------- ------------
Shares Amounts Capital (Deficit) Equity
--------- ------- --------- --------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE, January 1, 1995........................ 933,108 $ 9 $ 3,393 $ 346 $ 3,748
Net income...................................... -- -- -- 520 520
--------- ------ ------- ------- ------------
BALANCE, December 31, 1995...................... 933,108 9 3,393 866 4,268
Stock split effected in the form of a dividend.. 933,108 9 2,479 (2,488)
Net proceeds from issuance of common stock...... 1,345,500 14 3,486 3,500
Net loss (as restated, see Note 21)............. -- -- -- (52) (52)
--------- ------ ------- ------- ------------
BALANCE, December 31, 1996 (as restated, see
Note 21)....................................... 3,211,716 32 9,358 (1,674) 7,716
Net proceeds from issuance of common stock...... 3,335,000 33 32,813 32,846
Net income (as restated, see Note 21)........... -- -- -- 10,324 10,324
--------- ------ ------- ------- ------------
BALANCE, December 31, 1997 (as restated, see
Note 21)....................................... 6,546,716 $ 65 $42,171 $ 8,650 $ 50,886
========= ====== ======= ======= ===========
</TABLE>
See notes to consolidated financial statements.
-73-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES: As restated, As restated,
See Note 21 See Note 21
<S> <C> <C> <C>
Net income (loss)........................................................ $ 10,324 $ (52) $ 520
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization......................................... 683 301 166
Provision for estimated loan losses................................... 1,850 963 1,194
Accretion of deferred fees............................................ (26) (41) (11)
Provision for estimated losses on foreclosed real estate.............. 108 145 104
Gain on sale of foreclosed real estate, net........................... (74) (41) (137)
Gain on sale and securitization of loans held for sale................ (24,210) (5,385) (3,549)
Gain on bulk sale of mortgage servicing rights........................ (26)
Net unrealized gain on residual assets................................ (1,520) (323)
Net accretion of residual assets...................................... (2,269) (28)
Change in valuation allowance on mortgage servicing rights............ (12) 13
Direct writedown of mortgage servicing rights......................... 1,281
Amortization of mortgage servicing rights............................. 958 320 268
Purchase and origination of loans held for sale, net of loan fees..... (796,829) (227,156) (135,552)
Proceeds from sales and securitization of loans held for sale......... 489,540 210,590 130,086
Increase in accrued interest receivable............................... (2,101) (30) (76)
Deferred income taxes................................................. 8,125 (1,347) (81)
Decrease in income taxes receivable................................... 479
Increase in accounts payable and other liabilities.................... 9,423 2,725 1,618
Federal Home Loan Bank stock dividend................................. (58) (34) (30)
(Increase) decrease in other assets................................... (11,082) 52 (315)
--------- --------- ---------
Net cash used in operating activities.............................. (315,877) (19,353) (5,329)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in loans.................................................... 32,308 8,578 6,428
Proceeds from sale of foreclosed real estate............................. 1,034 1,471 1,097
Purchase of securities held to maturity.................................. (2,000) (8,013) (8,969)
Proceeds from maturities of securities held to maturity.................. 5,000 1,975 9,241
Purchase of mortgage servicing rights.................................... (706)
Proceeds from bulk sales of servicing rights............................. 632
Additions to premises and equipment, net................................. (3,814) (904) (523)
Purchase of Federal Home Loan Bank stock................................. (195) (65) (82)
--------- --------- ---------
Net cash provided by investing activities.......................... 32,333 3,042 7,118
</TABLE>
See notes to consolidated financial statements.
-74-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES: As restated, As restated,
See Note 21 See Note 21
<S> <C> <C> <C>
Net increase in deposit accounts........................................... $126,054 $18,176 $ 1,846
Increase (decrease) in Federal Home Loan Bank advances..................... 9,000 -- (1,250)
Net proceeds from other borrowings......................................... 96,892 3,278 --
Net proceeds from issuance of common stock................................. 32,846 3,500 --
Net proceeds from issuance of subordinated debentures...................... 9,644 -- --
-------- ------- -------
Net cash provided by financing activities.............................. 274,436 24,954 596
-------- ------- -------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........................ (9,108) 8,643 2,385
CASH AND CASH EQUIVALENTS, beginning of year................................ 12,575 3,932 1,547
-------- ------- -------
CASH AND CASH EQUIVALENTS, end of year...................................... $ 3,467 $12,575 $ 3,932
======== ======= =======
SUPPLEMENTAL CASH FLOW DISCLOSURES--
Cash paid during the year for:
Interest.................................................................. $ 11,298 $ 3,773 $ 3,418
======== ======= =======
Income taxes.............................................................. $ 3,616 $ 267 $ 191
======== ======= =======
NONCASH INVESTING ACTIVITIES DURING THE YEAR:
Transfers from loans held for sale to loans held for investment............ $ -- $ 856 $ --
======== ======= =======
Transfers from loans to foreclosed real estate............................. $ 2,234 $ 2,070 $ 1,983
======== ======= =======
Loans to facilitate sales of foreclosed real estate........................ $ 287 $ 761 $ 647
======== ======= =======
NONCASH FINANCING ACTIVITIES DURING THE YEAR--
Stock dividends paid....................................................... $ -- $ 2,488 $ --
======== ======= =======
</TABLE>
See notes to consolidated financial statements.
-75-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
1. Description of Business and Summary of Significant Accounting Policies
Basis of Presentation and Description of Business--The consolidated
financial statements include the accounts of LIFE Financial Corporation (LIFE)
and its wholly-owned subsidiaries, Life Bank (formerly Life Savings Bank,
Federal Savings Bank) (the Bank) and Life Investment Holdings, Inc. (Life
Investment) (collectively, the Company). All significant intercompany accounts
and transactions have been eliminated in consolidation.
LIFE is a savings and loan holding company, incorporated in the State of
Delaware, that was initially organized for the purpose of acquiring all of the
capital stock of the Bank through the holding company reorganization (the
Reorganization) of the Bank, which was consummated on June 27, 1997. Pursuant to
the Reorganization, LIFE issued 3,211,716 shares of common stock in exchange for
the 1,070,572 shares of the Bank's outstanding common stock and, accordingly,
the Bank became a wholly-owned subsidiary of LIFE. Such business combination was
accounted for at historical cost in a manner similar to a pooling of interests.
On June 30, 1997, the Company completed its sale of 2,900,000 additional shares
of its common stock through an initial public offering. On July 2, 1997, the
Company issued 435,000 shares of common stock to the public through the exercise
of the underwriter's overallotment option. The consolidated financial condition
and results of operations of the Company for periods prior to the date of the
Reorganization consist of those of the Bank.
The Company originates, purchases, sells and services nonconventional
mortgage loans principally secured by first and second mortgages on one- to
four- family residences. The Company focuses on loans for the purchase or
refinance of residential real property by borrowers who, because of prior credit
problems or the absence of a credit history, are considered "subprime
borrowers." The Company also originates debt consolidation loans generally up to
125% of the loan-to-value ratio of such loans for borrowers whose credit history
qualifies for loans under federal agency programs. The Company purchases and
originates mortgage loans and other real estate secured loans through a network
of approved correspondents and mortgage brokers on a nationwide basis, as well
as through the Company's retail lending division. Except for a limited number of
loans specifically originated for retention in the Company'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 Company generally retains the majority of the servicing
rights to the loans sold or securitized and may sell servicing rights at a later
date, depending on market opportunities. In addition, the Company purchases and
originates for resale in the secondary market, smaller commercial real estate
and multi-family loans. The Company funds substantially all of the loans which
it purchases or originates through deposits from customers concentrated in the
communities surrounding the Bank's home office in San Bernardino County,
internally generated funds, advances from the Federal Home Loan Bank and other
borrowings.
The Company has 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 Company has targeted borrowers seeking loans secured by
multi-family properties or properties used for commercial business purposes such
as small office buildings or light industrial or retail facilities. Such loans
are generally originated for sale.
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,
-76-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
using the interest method over the period to maturity. The Company designates
securities as held to maturity upon acquisition.
Loans--The Company's real estate loan portfolio consists primarily of long-
term loans secured by first and second trust deeds on single-family residences.
The Company primarily originates mortgage loans for sale in the secondary
market. At origination or purchase, mortgage loans are designated as held for
sale or held for investment. Loans held for sale are carried at the lower of
cost or estimated market value determined on an aggregate basis by outstanding
investor commitments or current investor requirements and include related loan
origination costs and fees, as well as premiums or discounts for purchased
loans. Net unrealized losses, if any, are recognized in a valuation allowance by
charges to operations. Any transfers of loans held for sale to the investment
portfolio are recorded at the lower of cost or estimated market value on the
transfer date. At December 31, 1997 and 1996, the principal balance of loans
held for sale consists of $255,137,000 and $25,414,000, respectively, in single-
family residential mortgage loans; $8,634,000 and $2,628,000, respectively, in
multi-family residential mortgage loans; $10,749,000 and $2,412,000,
respectively, in commercial mortgage loans; and $6,339,000 and $0, respectively,
in other loans.
Loans held for investment are carried at amortized cost and net of deferred
loan origination fees and costs and allowance for estimated loan losses. Net
deferred loan origination fees and costs on loans are amortized or accreted
using the interest method over the expected lives of the loans. Amortization of
deferred loan fees is discontinued for nonperforming loans. Loans held for
investment are not adjusted to the lower of cost or estimated market value
because it is management's intention, and the Company has the ability, to hold
these loans to maturity.
Interest on loans is credited to income as earned. Interest receivable is
accrued only if deemed collectible. Generally, allowances are established for
uncollected interest on loans on which payments are more than 90 days past due.
On January 1, 1995, the Company 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, financial position or cash flows of the Company, taken as a
whole.
The Company considers a loan impaired when it is probable that the Company
will be unable to collect all contractual principal and interest payments under
the terms of the original loan agreement. Loans are evaluated for impairment as
part of the Company's normal internal asset review process. However, in
determining when a loan is impaired, management also considers the loan
documentation, current loan to value ratios and the borrower's current financial
position. Included as impaired loans are all loans delinquent 90 days or more
and all loans that have a specific loss allowance applied to adjust the loan to
fair value. The accrual of interest on impaired loans is 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
-77-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
reversed. Interest income is subsequently recognized only to the extent cash
payments are received. Where impairment is considered other than temporary, a
charge-off is recorded; where impairment is considered temporary, an allowance
is established. Impaired loans which are performing under the contractual terms
are reported as performing loans, and cash payments are allocated to principal
and interest in accordance with the terms of the loans. The Company uses the
fair value of collateral method for measuring impaired loans. The Company
applies such measurement provision to all loans in its portfolio except for one-
to four-family residential mortgage loans and unsecured consumer loans, which
are collectively evaluated for impairment.
Allowances for Estimated Loan and Real Estate Losses--It is the policy of
the Company to maintain separate allowances for estimated loan and real estate
losses at levels deemed appropriate by management to provide for known or
inherent risks in the portfolio. Specific loss allowances are established for
loans if the fair value of the loan or the collateral is estimated to be less
than the gross carrying value of the loan. In estimating losses, management
considers the estimated sales price, cost of refurbishment, payment of
delinquent taxes, cost of holding the property (if an extended period is
anticipated) and cost of disposal. Additionally, general valuation allowances
for loan and real estate losses have been established. Management's
determination of the adequacy of the loan and real estate loss allowances is
based on an evaluation of the composition of the portfolio, actual loss
experience, current and prospective economic conditions, industry trends and
other relevant factors, in the area in which the Company's lending and real
estate activities are based, which may affect the borrowers' ability to pay and
the value of the underlying collateral. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses. Such agencies may require the Bank to
recognize additions to the allowance based on judgments different from those of
management.
Although management uses the best information available to make these
estimates, future adjustments to the allowances may be necessary due to
economic, operating, regulatory and other conditions that may be beyond the
Company's control.
Mortgage Financing Operations--The Company sells and securitizes the
majority of loans held for sale with servicing retained. Under the servicing
agreements, the investor is paid its share of the principal collections together
with interest at an agreed-upon rate, which generally differs from the loans'
contractual interest rate.
Effective July 1, 1995, the Company adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights", which amended SFAS No. 65, "Accounting for Certain
Mortgage Banking Activities". SFAS No. 122 required 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 $.23 for the year ended December 31, 1995.
Effective January 1, 1997, the Company adopted SFAS No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities", which was amended by SFAS No. 127. This statement provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities based on consistent application of a
financial-components approach that focuses on control. It distinguished
transfers of financial assets that are sales from transfers that are secured
borrowings. Under the financial-components approach, after a transfer of
financial assets, an entity recognizes all financial and servicing assets it
controls and liabilities its has incurred and derecognizes financial assets it
no longer controls and liabilities that have been extinguished. The financial-
components approach focuses on the assets that exist after the transfer. Many of
-78-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
these assets and liabilities are components of financial assets that existed
prior to the transfer. If a transfer does not meet criteria for a sale, the
transfer is accounted for as a secured borrowing with pledge of collateral. The
statement is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996. SFAS No. 125
superseded SFAS No. 122
The Company evaluates its capitalized mortgage servicing rights (MSRs) for
impairment based on the fair value of those rights. The Company's periodic
evaluation is performed on a disaggregated basis whereby MSRs are stratified
based on type of interest rate (variable or fixed), loan type and original loan
term. Impairment is recognized in a valuation allowance for each pool in the
period of impairment. The Company determines fair value based on the present
value of estimated net future cash flows related to servicing income. In
estimating fair values at December 31, 1997 and 1996, the Company utilized a
weighted average prepayment assumption of 21.1% and 23.0%, respectively, and a
weighted average discount rate of 16.0% and 16.5%, respectively. The cost
allocated to servicing rights is amortized in proportion to, and over the period
of, estimated net future servicing fee income.
In 1995, gains on bulk sales of mortgage loan servicing rights were
recognized when title and all risks and rewards irrevocably passed to the buyer
and there were no significant unresolved contingencies.
Residual Assets--In 1997 and 1996, the Company completed the securitization
and sale of approximately $415,350,000 and $51,900,000, respectively, in loans
in the form of mortgage pass-through certificates and recognized gains of
approximately $22,500,000 and $1,400,000, respectively. These certificates are
held in a trust independent of the Company. The Company will act as servicer for
the trust and receive a stated servicing fee. The Company has also retained a
beneficial interest in the form of an interest-only strip which represents the
subordinated right to receive cash flows from the pool of securitized loans
after payment of the required amounts to the holders of the securities and the
costs associated with the securitization. This interest-only strip receivable is
classified as a trading security and recorded at fair value with any unrealized
gains or losses recorded in the results of operations in the period of the
change in fair value. For the years ended December 31, 1997 and 1996, net
unrealized gains of $1,520,000 and $323,000, respectively, resulted from changes
in fair value and are included in results of operations.
Valuations at origination and at each reporting period are based on
discounted cash flow analyses. The cash flows are estimated as the excess of the
weighted average coupon on each pool of loans sold over the sum of the pass-
through interest rate, a servicing fee, a trustee fee, an insurance fee and an
estimate of annual future credit losses related to the prepayment, default, loss
and interest rate assumptions that market participants would use for similar
financial instruments subject to prepayment, credit and interest rate risk and
are discounted using an interest rate that a purchaser unrelated to the seller
of such a financial instrument would demand. At origination, the Company
utilized prepayment assumptions ranging from 12% to 25%, an estimated loss
factor assumption ranging from 0.5% to 2.5% and a weighted average discount rate
of 13.5% to value residual assets. At December 31, 1997 and 1996, the Company
utilized prepayment assumptions ranging from 12% to 60%, an estimated loss
factor assumption ranging from 0.5% to 2.5% and a weighted average discount rate
of 13.5% to value residual assets. The valuation includes consideration of
characteristics of the loans including loan type and size, interest rate,
origination date, term and geographic location. The Company also uses other
available information such as externally prepared reports on prepayment rates,
collateral value, economic forecasts, and historical default and prepayment
rates of the portfolio under review. To the Company's knowledge, there is no
active market for the sale of residual assets. The range of values attributable
to the factors used in determining fair value is broad. Accordingly, the
Company's estimate of fair value is subjective.
-79-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
In connection with the first two of its securitization transactions, the
Company initially deposited cash with a trustee and will subsequently deposit a
portion of the servicing spread collected on the related loans. Such amounts
serve as credit enhancement for the related trust. The amounts set aside are
available for distribution to investors in the event of certain shortfalls in
amounts due to investors. These amounts are subject to increase up to a reserve
level as specified in the related securitization documents. Cash amounts on
deposit are invested in certain instruments as permitted by the related
securitization documents. To the extent amounts on deposit exceed specified
levels, distributions are made to the Company; and, at the termination of the
related trust, any remaining amounts on deposit are distributed to the Company.
The gross amount on deposit at December 31, 1997 and 1996 is $12.3 million and
$1.6 million, respectively, and included in residual assets in the accompanying
consolidated statements of financial condition at its fair value.
Foreclosed Real Estate--Real estate properties acquired through, or in lieu
of, loan foreclosure are initially recorded at fair value at the date of
foreclosure through a charge to the allowance for estimated loan losses. After
foreclosure, valuations are periodically performed by management and an
allowance for losses is established by a charge to operations if the carrying
value of a property exceeds its fair value less estimated cost to sell. Revenue
and expenses from operations and changes in the valuation allowance are included
in net loss on foreclosed real estate in the consolidated statement of
operations.
Premises and Equipment--Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
computed using both the straight-line and accelerated methods over the estimated
useful lives of the assets, which range from 31 years for buildings, 15 years
for leasehold improvements, 7 years for furniture, fixtures and equipment, and 3
years for computer equipment.
The Company accounts for impairment under SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of".
The statement established accounting standards for the impairment of long-lived
assets that either will be held and used in operations or that will be disposed
of. Accordingly, the Company periodically evaluates the recoverability of long-
lived assets, such as premises and equipment, to ensure the carrying value has
not been impaired.
Income Taxes--The Company 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 Company's financial statements or tax returns.
In estimating future tax consequences, all expected future events other than
enactments of changes in the tax law or rates are considered. If necessary, a
valuation allowance is established based on management's determination of the
likelihood of realization of deferred tax assets.
Derivative Financial Instruments--The Company 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 December 31, 1997 and 1996 (Note 14).
In the ordinary course of business, the Company 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.
-80-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Earnings Per Share--The Company adopted SFAS No. 128, "Earnings per Share",
effective as of December 31, 1997. The statement establishes standards for
computing and presenting earnings per share (EPS) and applies to entities with
publicly-held common stock or potential common stock. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a reconciliation
of the numerator and denominator of the basic EPS computation to the numerator
and denominator of the diluted EPS computation. The adoption of SFAS No. 128 did
not have a significant impact on the Company's earnings per share.
Earnings per share has been adjusted retroactively to reflect the three-
for-one stock exchange effected pursuant to the Reorganization and the stock
split effected in the form of a dividend during 1996. The per share amounts and
weighted average shares outstanding included in the accompanying consolidated
financial statements have been restated to reflect the Reorganization and stock
split.
Presentation of Cash Flows--For purposes of reporting cash flows, cash and
cash equivalents include cash and federal funds sold. Generally, federal funds
are sold for one-day periods. At December 31, 1997 and 1996, federal funds sold
approximated $550,000 and $10,350,000, respectively.
Use of Estimates--The preparation of the consolidated financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Stock-Based Compensation--SFAS No. 123, "Accounting for Stock-Based
Compensation", issued in 1995, encourages companies to account for stock
compensation awards based on their fair value at the date the awards are
granted. SFAS No. 123 does not require the application of the fair value method
and allows for the continuance of current accounting methods, which require
accounting for stock compensation awards based on their intrinsic value as of
the grant date. However, SFAS No. 123 requires pro forma disclosure of net
income and, if presented, earnings per share, as if the fair value based method
of accounting defined in this statement had been applied. The Company did not
adopt the fair value accounting method in SFAS No. 123 with respect to its stock
option plans and continues to account for such plans in accordance with
Accounting Principles Board (APB) Opinion No. 25.
Recent Accounting Developments--In February 1997, the Financial Accounting
Standards Board (FASB) issued SFAS No. 129, "Disclosure of Information About
Capital Structure". The statement establishes standards for disclosing
information about an entity's capital structure. The disclosure requirements of
SFAS No. 129 are effective for periods ending after December 15, 1997. The
adoption of SFAS No. 129 did not have a significant impact on the Company's
consolidated financial statements.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information". SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general-
purpose financial statements. SFAS No. 131 establishes standards of reporting by
publicly-held business enterprises and disclosure of information about operating
segments in annual financial statements and, to a lesser extent, in interim
financial reports issued to shareholders. SFAS Nos. 130 and 131 are effective
for fiscal years beginning after December 15, 1997. As both SFAS Nos. 130 and
131 deal with financial statement disclosure, the Company does not anticipate
-81-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
the adoption of these new standards will have a material impact on its financial
position, results of operations or cash flows.
Reclassifications--Certain reclassifications have been made to the 1996 and
1995 consolidated financial statements to conform to the 1997 presentation.
2. Regulatory Capital Requirements and Other Regulatory Matters
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below). The Bank's primary regulatory agency, the Office of Thrift Supervision
(OTS), requires that the Bank maintain minimum ratios of tangible capital (as
defined in the regulations) of 1.5%, core capital (as defined) of 3%, and total
risk-based capital (as defined) of 8%. The Bank is also subject to prompt
corrective action capital requirement regulations set forth by the Federal
Deposit Insurance Corporation (FDIC). The FDIC requires the Bank to maintain
minimum of total and Tier I capital (as defined in the regulations) to risk-
weighted assets (as defined) and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1997 and 1996, that
the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1997 and 1996, the most recent notification from the OTS
categorized the Bank as well-capitalized and adequately-capitalized,
respectively, 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 December 31,
1997 that management believes have changed the Bank's category.
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<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The Bank's actual capital amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
To be Well-
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------- ------ -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
As of December 31, 1997:
Total Capital (to Risk-Weighted Assets).......... $33,947 10.52% $25,813 8.00% $32,265 10.00%
Core Capital (to Adjusted Tangible Assets)....... 21,545 5.38% 16,022 4.00% 20,028 5.00%
Tangible Capital (to Tangible Assets)............ 21,545 5.38% 6,008 1.50% N/A N/A
Tier I Capital (to Risk-Weighted Assets)......... 21,545 6.68% N/A N/A 19,359 6.00%
As of December 31, 1996:
Total Capital (to Risk-Weighted Assets).......... 8,889 8.09% 8,792 8.00% 10,990 10.00%
Core Capital (to Adjusted Tangible Assets)....... 7,716 7.57% 4,079 4.00% 5,099 5.00%
Tangible Capital (to Tangible Assets)............ 7,716 7.57% 1,530 1.50% N/A N/A
Tier I Capital (to Risk-Weighted Assets)......... 7,716 7.02% N/A N/A 6,594 6.00%
</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 December 31, 1996 did not
allow the Bank to accept brokered deposits without prior approval from the
regulators. The Bank had approximately $2,200,000 of brokered deposits at
December 31, 1996. This is not expected to materially impact the Bank as it has
other sources of funds. The Bank's capital levels at December 31, 1997 allow the
Bank to accept brokered deposits without prior approval from the regulators.
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 coming year. However, events
beyond the control of the Bank, such as changing interest rates or a downturn in
the economy in the areas where the Bank has most of its loans, could adversely
affect future earnings and, consequently, the ability of the Bank to meet its
future minimum capital requirements.
At periodic intervals, both the OTS and the 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.
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<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The OTS concluded an examination of the Bank in November 1997. 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 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, imposed a special
one-time assessment on Savings Association Insurance Fund (SAIF) member
institutions, including the Bank, to recapitalize the SAIF. As required by the
Funds Act, the FDIC 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 are 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 lowered 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.
OTS regulations impose limitations upon all capital distributions by
savings institutions, such as cash dividends, payments to repurchase or
otherwise acquire its shares, payments to stockholders of another institution in
a cash-out merger and other distributions charged against capital. The rule
establishes three tiers of institutions, which are based primarily on an
institution's capital level. An institution that exceeds all fully phased-in
regulatory capital requirements before and after a proposed capital distribution
and has not been advised by the OTS that it is in need of more than normal
supervision, could, after prior notice to, but without the approval of the OTS,
make capital distributions during a calendar year equal to the greater of: (I)
100% of its net earnings to date during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" (the excess capital over
its fully phased in capital requirements) at the beginning of the calendar year;
or (ii) 75% of its net earnings for the previous four quarters. Any additional
capital distributions would require prior OTS approval. In the event the Bank's
capital fell below its capital requirements or the OTS notified it that it was
in need of more than normal supervision, the Bank's ability to make capital
distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice.
-84-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
3. Securities Held to Maturity
The amortized cost and estimated fair value of securities held to maturity
were as follows at December 31 (in thousands):
<TABLE>
<CAPTION>
1997
----------------------------------------------
Amortized Estimated
Cost Gross Unrealized Fair Value
--------- ----------------- ----------
Gains Losses
------- ------
<S> <C> <C> <C> <C>
U.S. Treasury and other agency securities...... $5,003 $18 $ -- $5,021
Mortgage-backed securities..................... 9 -- -- 9
------ --- ----- ------
$5,012 $18 -- $5,030
====== === ===== ======
1996
----------------------------------------------
Amortized Estimated
Cost Gross Unrealized Fair Value
--------- ----------------- ----------
Gains Losses
------- ------
<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>
The maturity distribution of securities held to maturity at December 31,
1997 is as follows (in thousands):
Amortized Estimated
Cost Fair Value
--------- ----------
Due in one year or less.......... $3,004 $3,008
Due from one to five years....... 1,999 2,013
Mortgage-backed securities....... 9 9
------ ------
$5,012 $5,030
====== ======
The weighted average yield on securities held to maturity was 5.88% and
5.47% at December 31, 1997 and 1996, respectively.
-85-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
4. Loans Held for Investment
Loans held for investment consisted of the following at December 31 (in
thousands):
1997 1996
------- -------
Mortgage loans:
Residential:
One- to four-family.............................. $23,068 $28,861
Multi-family..................................... 2,019 2,124
Commercial and land................................ 6,014 7,247
------- -------
31,101 38,232
Other loans:
Loans secured by deposit accounts.................. 165 177
Unsecured commercial loans......................... 63 67
Unsecured consumer loans........................... 336 65
------- -------
564 309
------- -------
31,665 38,541
Less:
Deferred loan origination fees..................... 16 21
Allowance for estimated loan losses................ 2,573 1,625
------- -------
2,589 1,646
------- -------
$29,076 $36,895
======= =======
Weighted average interest rate at end of period..... 8.06% 8.06%
======= =======
The Company grants residential and commercial loans held for investment to
customers located primarily in Southern California. Consequently, a borrower's
ability to repay may be impacted by economic factors in the region.
At December 31, 1997, included in loans held for investment and loans held
for sale are adjustable rate loans with principal balances of $169,063,000.
Adjustable rate loans are indexed primarily to LIBOR.
The following summarizes activity in the allowance for estimated loan
losses for the years ended December 31 (in thousands):
1997 1996 1995
------ ------ ------
Balance, beginning of year............... $1,625 $1,177 $ 832
Provision for estimated loan losses...... 1,850 963 1,194
Recoveries............................... 7 219 65
Charge-offs.............................. (909) (734) (914)
------ ------ ------
Balance, end of year..................... $2,573 $1,625 $1,177
====== ====== ======
The Company had nonaccrual loans at December 31, 1997, 1996 and 1995 of
$5,126,000, $2,416,000 and $1,397,000, respectively. If nonaccrual loans had
been performing in accordance with their original terms, the Company would have
recorded interest income of $18,170,000, $6,692,000 and $5,500,000,
respectively, instead of interest income actually recognized of $17,746,000,
$6,513,000 and $5,433,000, respectively, for the years ended December 31, 1997,
1996 and 1995.
-86-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
At December 31, 1997 and 1996, the Company had impaired loans totaling
$5,518,000 and $2,878,000, respectively, with related reserves of $1,017,000 and
$452,000, respectively, recognized in conformity with SFAS No. 114, as amended
by SFAS No. 118. During the years ended December 31, 1997, 1996 and 1995, the
average recorded investment in impaired loans was $3,413,000, $2,300,000 and
$1,980,000, respectively. Total cash collected on impaired loans during the
years ended December 31, 1997, 1996 and 1995 was $1,498,000, $1,339,000 and
$1,079,000, respectively, of which $1,329,000, $1,249,000 and $960,000,
respectively, was credited to principal. Interest income of $169,000, $90,000
and $119,000 on impaired loans was recognized for cash payments received during
the years ended December 31, 1997, 1996 and 1995, respectively.
At December 31, 1997 and 1996, troubled debt restructured loans amounted to
$131,000. There were no troubled debt restructurings effected during the years
ended December 31, 1997 and 1996.
The Company is not committed to lend additional funds to debtors whose
loans have been modified.
The Bank is subject to numerous lending-related regulations. Under FIRREA,
the Bank may not make real estate loans to one borrower in excess of 15% of its
unimpaired capital and surplus except for loans not to exceed $500,000. This 15%
limitation results in a dollar limitation of approximately $3,592,000 at
December 31, 1997.
Activity in loans to directors and executive officers during the year ended
December 31 are as follows (in thousands):
1997 1996 1995
----- ----- -----
Balance, beginning of year......... $ -- $ -- $ --
Originations....................... 778 154
Loans sold servicing released...... (365) (154) --
----- ----- -----
Balance, end of year............... $ 413 $ -- $ --
===== ===== =====
5. Mortgage Financing Operations
Loans serviced for others at December 31, 1997, 1996 and 1995 totaled
$536,726,000, $168,963,000 and $189,451,000, respectively.
In connection with mortgage servicing activities, the Company held funds in
trust for others totaling approximately $8,068,000 and $957,000 at December 31,
1997 and 1996, respectively. At December 31, 1997 and 1996, $32,000 and
$266,000, respectively, of these funds are maintained in deposit accounts of the
Bank (subject to FDIC insurance limits) and are included in the assets and
liabilities of the Company.
For the years ended December 31, 1997 and 1996, respectively, 22.7% and
34.0% of the properties securing loans funded by the Company were located in
California, 4.8% and 11.9% were located in Utah, 3.0% and 7.6% were located in
Colorado, 5.2% and 6.8% were located in Florida, 5.9% and 3.2% were located in
Virginia, 5.4% and 3.9% were located in Maryland, 5.1% and 2.4% were located in
North Carolina, and the remainder were dispersed throughout the country. At
December 31, 1997 and 1996, respectively, 35.0% and 40.0% of the loan servicing
portfolio was collateralized by real estate properties located in California. At
December 31, 1997, no other state accounted for more than 6.0%.
-87-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Although the Company sells without recourse substantially all of the
mortgage loans it originates or purchases, the Company retains some degree of
risk on substantially all of the loans it sells. In addition, during the period
of time that the loans are held for sale, the Company is subject to various
business risks associated with the lending business, including borrower default,
foreclosure and the risk that a rapid increase in interest rates would result in
a decline of the value of loans held for sale to potential purchasers.
In connection with its securitizations, the Company is required to
repurchase or substitute loans in the event of a breach of a representation or
warranty made by the Company. While the Company may have recourse to the sellers
of loans it purchased, there can be no assurance of the sellers' abilities to
honor their respective obligations to the Company. Likewise, in connection with
its whole loan sales, the Company enters agreements which generally require the
Company to repurchase or substitute loans in the event of a breach of a
representation or warranty made by the Company to the loan purchaser, any
misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or early default on such mortgage loans. The remedies
available to a purchaser of mortgage loans from the Company are generally
broader than those available to the Company against the sellers of such loans,
and if a loan purchaser enforces its remedies against the Company, the Company
may not be able to enforce whatever remedies the Company may have against such
sellers. If the loans were originated directly by the Company, the Company will
be solely responsible for any breaches of representations or warranties.
In addition, borrowers, loan purchasers, monoline insurance carriers and
trustees in the Company's securitizations may make claims against the Company
arising from alleged breaches of fiduciary obligations; misrepresentations,
errors and omissions of employees, officers and agents of the Company, including
appraisers; incomplete documentation; and failure by the Company to comply with
various laws and regulations applicable to its business. Any claims asserted in
the future may result in liabilities or legal expenses that could have a
material adverse effect on the Company's results of operations, financial
condition, cash flows and business prospects.
The following is a summary of activity in mortgage servicing rights for the
years ended December 31 (in thousands):
1997 1996 1995
------- ------ ------
Balance, beginning of year....................... $ 2,645 $ 683 $ --
Additions through originations................... 8,120 2,270 864
Additions through purchase of servicing rights... 706
Amortization..................................... (958) (320) (268)
Sales............................................ (606)
Change in valuation allowance.................... 12 (13)
Direct writedowns................................ (1,281) -- --
------- ------ -----
Balance, end of year............................. $ 8,526 $2,645 $ 683
======= ====== =====
The following is a summary of activity in the valuation allowance for
mortgage servicing rights for the years ended December 31 (in thousands):
1997 1996 1995
------ ----- ------
Balance, beginning of year.............................. $ 1 $ 13 $ --
Additions (reductions) charged (credited) to operations. -- (12) 13
---- ----- -----
Balance, end of year.................................... $ 1 $ 1 $ 13
===== ==== =====
-88-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Net gains from mortgage financing operations for the years ended December
31 consisted of the following (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
Gains on sale and securitization of loans held for sale.... $24,210 $5,385 $3,549
Net unrealized gain on residual assets..................... 1,520 323
Gains on bulk sale of mortgage servicing rights............ -- -- 26
------- ------ ------
$25,730 $5,708 $3,575
======= ====== ======
</TABLE>
6. Premises and Equipment
Premises and equipment consisted of the following at December 31 (in
thousands):
1997 1996
--------- ---------
Premises............................................. $ 569 $ 569
Leasehold improvements............................... 1,930 530
Furniture, fixtures and equipment.................... 4,116 1,787
------- -------
6,615 2,886
Less accumulated depreciation and amortization....... (1,851) (1,307)
------- -------
$ 4,764 $ 1,579
======= =======
7. Foreclosed Real Estate
Activity in the allowance for estimated real estate losses is summarized as
follows for the years ended December 31 (in thousands):
1997 1996 1995
------ ------ --------
Balance, beginning of year.................... $ 65 $ 44 $ 29
Provision for estimated real estate losses.... 108 145 104
Recoveries.................................... 2 2
Charge offs................................... (96) (126) (89)
----- ----- -----
Balance, end of year.......................... $ 79 $ 65 $ 44
===== ===== =====
Net loss on foreclosed real estate is summarized as follows for the years
ended December 31 (in thousands):
1997 1996 1995
------ ------ ------
Net gain on sales of foreclosed real estate.... $ (74) $ (41) $(137)
Net real estate operating costs................ 92 54 86
Provision for estimated real estate losses..... 108 145 104
----- ----- -----
Net loss on foreclosed real estate............. $ 126 $ 158 $ 53
===== ===== =====
-89-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
8. Deposit Accounts
Deposit accounts consisted of the following at December 31 (in thousands):
1997 1996
----------------------- ----------------------
Weighted Weighted
Average Average
Balance Interest Rate Balance Interest Rate
-------- ------------- ------- -------------
Checking accounts........... $ 11,353 2.99% $ 8,947 2.22%
Passbook accounts........... 3,838 2.10 4,117 2.10
Money market accounts....... 2,729 2.98 3,217 2.99
Certificate accounts:
Under $100,000............ 141,036 5.93 49,437 5.66
$100,000 and over......... 52,809 5.98 19,993 5.63
-------- -------
$211,765 5.68% $85,711 5.02%
======== =======
The aggregate annual maturities of certificate accounts at December 31 are
approximately as follows (in thousands):
1997 1996
---------- --------
Within one year............................. $187,501 $59,438
One to two years............................ 3,631 6,197
Two to three years.......................... 1,179 1,700
Three to four years......................... 589 925
Four to five years.......................... 421 613
Thereafter.................................. 524 557
-------- -------
$193,845 $69,430
======== =======
Interest expense on deposit accounts for the years ended December 31 is
summarized as follows (in thousands):
1997 1996 1995
-------- -------- --------
Checking accounts............... $ 279 $ 112 $ 92
Passbook accounts............... 84 92 127
Money market accounts........... 88 118 144
Certificate accounts............ 7,587 3,192 2,829
------ ------ ------
$8,038 $3,514 $3,192
====== ====== ======
9. Advances from Federal Home Loan Bank and Other Borrowings
As of December 31, 1997 and 1996, the Company had an available line of
credit with the Federal Home Loan Bank of San Francisco (FHLB) of $17,471,000
and $17,346,000, respectively, use of which is contingent upon continued
compliance with the Advances and Security Agreement and other eligibility
requirements established by the FHLB. Advances and/or the line of credit are
collateralized by pledges of certain real estate loans and securities with an
aggregate principal balance of $21,777,000 and $20,474,000 at December 31, 1997
and 1996, respectively.
-90-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
At December 31, 1997, outstanding FHLB advances totaled $9,000,000 at a weighted
average interest rate of 7.07%. There were no FHLB advances outstanding at
December 31, 1996.
The following summarizes activities in advances from the FHLB for the years
ended December 31 (dollars in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Average balance outstanding........................................... $ 8,284 $ 4,259 $3,112
Maximum amount outstanding at any month-end during the year........... 17,800 13,900 7,600
Weighted average interest rate during the year........................ 5.82% 5.93% 6.55%
</TABLE>
At December 31, 1997, the Company had three warehousing lines of credit
available to it from national investment banking firms. The first line allows
the Company to draw up to $50,000,000 and expires on April 30, 1998. The second
line allows the Company to draw up to $200,000,000 and expires August 20, 1998.
The third line allows the Company to draw up to $40,000,000 and maintains a
revolving maturity date. An aggregate balance of $100,170,000 was drawn on these
lines as of December 31, 1997 at a weighted average interest rate of 7.19%.
These lines of credit, which were obtained during 1997, bear interest at a
variable rate based on LIBOR. Outstanding borrowings under these lines of credit
are collateralized by loans held for sale. These lines of credit contain certain
affirmative, negative and financial covenants, with which the Company was in
compliance at December 31, 1997.
The following summarizes activities in the lines of credit for the year
ended December 31, 1997 (dollars in thousands):
<TABLE>
<S> <C>
Average balance outstanding.................................... $ 48,765
Maximum amount outstanding at any month-end during year........ 226,846
Weighted average interest rate during the year................. 6.53%
</TABLE>
At December 31, 1996, the Company 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. Subordinated Debentures
On March 14, 1997, the Bank issued subordinated debentures (Debentures) in
the aggregate principal amount of $10,000,000 through a private placement and
pursuant to a Debenture Purchase Agreement. The Debentures will mature on March
15, 2004 and bear interest at the rate of 13.5% per annum, payable semi-
annually. The Debentures 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
-91-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Reorganization, the Bank may substitute LIFE 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 LIFE to purchase all or part of the holder's
outstanding Debentures at a price equal to 100% of the principal amount
repurchased plus accrued interest through the repurchase date. If the
Substitution occurs, upon a change in control of LIFE, holders of the Debentures
will have the option to require LIFE 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.
11. Income Taxes
Income taxes for the years ended December 31 consisted of the following (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -----
Current provision (benefit):
<S> <C> <C> <C>
Federal.............................................. $ (317) $ 1,073 $ 374
State................................................ (426) 312 1
------ ------- -----
(743) 1,385 375
------ ------- -----
Deferred (benefit) provision:
Federal.............................................. 5,685 (1,036) (81)
State................................................ 2,440 (311) --
------ ------- -----
8,125 (1,347) (81)
------ ------- -----
Total income tax provision......................... $7,382 $ 38 $ 294
====== ======= =====
A reconciliation from statutory federal income taxes
to the Company's effective income taxes for the
years ended December 31 are as follows:
1997 1996 1995
------ ------- -----
Statutory federal taxes.............................. $6,199 $ (5) $ 285
State taxes, net of federal income tax benefit....... 1,315 1
Other................................................ (132) 42 9
------ ------- -----
$7,382 $ 38 $ 294
====== ======= =====
</TABLE>
-92-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
Deferred tax assets (liabilities) were comprised of the following at December 31
(in thousands):
1997 1996
-------- ------
Deferred tax assets:
Depreciation........................... $ 119 $ -
Accrued bonus.......................... 1,276
Net operating loss..................... 3,423
Allowance for loan losses.............. 910 479
Capital loss carryforward.............. 60 63
Loans held for sale.................... 1,391 115
Gain on sale of loans.................. 1,088
Other.................................. 1,245 301
-------- ------
8,424 2,046
-------- ------
Deferred tax liabilities:
Gain on sale of loans.................. (15,166)
Depreciation........................... (61)
Originated servicing rights............ (818) (358)
Federal Home Loan Bank stock........... (132) (106)
-------- ------
(16,116) (525)
-------- ------
(7,692) 1,521
Less valuation allowance.................. (36) (36)
-------- ------
Net deferred tax (liability) asset........ $ (7,728) $1,485
======== ======
At December 31, 1997 and 1996, the net deferred tax liability and net
deferred tax asset are included in other liabilities and other assets,
respectively, in the accompanying consolidated statements of financial
condition. Also included in other assets at December 31, 1997 are refundable
income taxes of $2,428,000.
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, 1997, 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.
-93-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
12. Commitments, Contingencies and Concentrations of Risk
The Company is involved in various legal proceedings associated with normal
operations. In the opinion of management, based on the advice of legal counsel,
such litigation and claims are expected to be resolved without material effect
on the financial position of the Company.
The Company leases a portion of its facilities from nonaffiliates under
operating leases expiring at various dates through 2002. The following schedule
shows the minimum annual lease payments, excluding property taxes and other
operating expenses, due under these agreements (in thousands):
Year ending December 31:
1998.......................... $ 830
1999.......................... 840
2000.......................... 766
2001.......................... 663
2002.......................... 415
Thereafter.................... 5
------
$3,519
======
Rental expense under all operating leases totaled $424,000, $232,000 and
$124,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company and the Bank have negotiated employment agreements with their
chief executive officer. These agreements provide for the payment of a base
salary, a bonus based upon performance of the Company and the payment of
severance benefits upon termination.
Lending Activities--Loans to 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 Company believes that the underwriting procedures and
appraisal processes it employs enable it to somewhat mitigate the higher risks
inherent in loans made to these borrowers, no assurance can be given that such
procedures or processes will afford adequate protection against such risks.
The debt consolidation loans the Company 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
Company, as holder of a second position on the property, would likely lose a
substantial portion, if not all, of its investment. While the Company believes
that the underwriting procedures it employs enable it to somewhat mitigate the
higher risks inherent in such loans, no assurance can be given that such
procedures will afford adequate protection against such risks. Approximately 88%
and 65%, respectively, of the loans included in the securitization transactions
completed in 1997 and 1996 consisted of this type of loan.
-94-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The Company has been actively involved in the origination, purchase and
sale to institutional investors of real estate secured loans and, more recently,
in asset securitizations. Generally, the profitability of such mortgage
financing operations depends on maintaining a sufficient volume of loans for
sale and the availability of purchasers. Changes in the level of interest rates
and economic factors affect the amount of loans originated or available for
purchase by the Company, and thus the amount of gains on sale of loans and
servicing fee income. Changes in the purchasing policies of institutional
investors or increases in defaults after funding could substantially reduce the
amount of loans sold to such investors or sold through asset securitizations.
Any such changes could have a material adverse effect on the Company's results
of operations, financial condition and cash flows.
The Company's ability to originate, purchase and sell loans through its
mortgage financing operations is also significantly impacted by changes in
interest rates. Increases in interest rates may also reduce the amount of loan
and commitment fees received by the Company. A significant decline in interest
rates could also decrease the size of the Company's servicing portfolio and the
related servicing income by increasing the level of prepayments. The Company
does not currently utilize any specific hedging instruments to minimize exposure
to fluctuations in the market price of loans and interest rates with regard to
loans held for sale in the secondary mortgage market. Therefore, between the
time the Company originates the loans or purchase commitments are issued or
asset securitizations are completed, the Company is exposed to downward
movements in the market price of such loans due to upward movements in interest
rates.
The Company depends largely on mortgage brokers and correspondents for its
purchases and originations of new loans. The Company's competitors also seek to
establish relationships with the Company's mortgage brokers and correspondents.
The Company's future results may become increasingly exposed to fluctuations in
the volume and cost of its wholesale loans resulting from competition from other
purchasers of such loans.
Availability of Funding Sources--The Company funds substantially all of the
loans which it originates or purchases through deposits, internally-generated
funds, FHLB advances or other borrowings. The Company competes for deposits
primarily on the basis of rates, and, as a consequence, the Company could
experience difficulties in attracting deposits to fund its operations if the
Company does not continue to offer deposit rates at levels that are competitive
with other financial institutions. The Company also uses the proceeds generated
by the Company in selling loans in the secondary market or pools of loans in
asset securitizations to fund subsequent originations or purchases. On an
ongoing basis, the Company explores opportunities to access credit lines as an
additional source of funds. To the extent that the Company is not able to
maintain its currently available funding sources or to access new funding
sources, it would have to curtail its loan production activities or sell loans
earlier than is optimal. Any such event could have a material adverse effect on
the Company's results of operations, financial condition and cash flows.
Dependence on Securitizations--Since December 1996, the Company has
completed four loan securitization transactions. The Company derived a
significant portion of its income in 1997 and 1996 by recognizing such gains on
sale. The Company's ability to complete securitizations is affected by several
factors, including conditions in the securities markets generally and in the
asset-backed securities markets specifically, the credit quality of the
Company's loan portfolio, and the Company's ability to obtain credit
enhancements. Although the Company obtained credit enhancements in its
securitizations which facilitated an investment-grade rating for the
securitization interests, there can be no assurance that the Company will be
able to obtain future credit enhancements on acceptable terms or that future
securitizations will be similarly rated. Any substantial reduction in the
ability of the Company to complete asset securitizations could have a material
adverse effect on the Company's results of operations, financial condition and
cash flows.
-95-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
13. Benefit Plans
401(k) Plan--The Company maintains an Employee Savings Plan (the Plan)
which qualifies under section 401(k) of the Internal Revenue Code. Under the
Plan, employees may contribute from 1% to 15% of their compensation. The Company
will match, at its discretion, 25% of the amount contributed by the employee up
to a maximum of 8% of the employee's salary. The amount of contributions made to
the Plan by the Company were not material for the years ended December 31, 1997,
1996 and 1995.
Cash Bonus Plan--The Company adopted a cash bonus plan (the Bonus Plan)
effective February 1996. All employees except for commissioned employees and
employees with employment contracts are eligible to participate. Approximately
$1,480,000 and $100,000 in expense was recorded pursuant to the Bonus Plan
during the years ended December 31, 1997 and 1996, respectively.
Stock Option Plans--On November 21, 1996, the Board of Directors of the
Bank adopted the Life Bank 1996 Stock Option Plan (the 1996 Option Plan). The
1996 Option Plan authorizes the granting of options equal to 321,600 shares of
common stock for issuance to executives, key employees, officers and directors.
The 1996 Option Plan will be in effect for a period of ten years from the
adoption by the Board of Directors. Options granted under the 1996 Option Plan
will be made at an exercise price equal to the fair market value of the stock on
the date of grant. Awards granted to officers and employees may include
incentive stock options, nonstatutory stock options and limited rights which are
exercisable only upon a change in control of the Bank, which change in control
did not include the reorganization of the Bank into the holding company. Awards
granted to nonemployee directors are nonstatutory options. Stock options will
become vested and exercisable in the manner specified by the Board of Directors.
The options granted under the 1996 Option Plan will vest at a rate of 33.3% per
year, beginning on November 21, 1999.
-96-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
The components of the 1996 Option Plan as of December 31, 1997 and 1996,
and changes during the years then ended (as adjusted for the Reorganization),
consist of the following:
<TABLE>
<CAPTION>
1997 1996
------------------- ----------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------- -------- -------- ---------
<S> <C> <C> <C> <C>
Options outstanding at the beginning of the year.............. 321,600 $ 3.33 -- $ --
Granted.................................................... 321,600 3.33
Forfeited.................................................. (5,400) 3.33
------- -------
Options outstanding at the end of the year.................... 316,200 3.33 321,600 3.33
======= =======
Options exercisable at the end of the year.................... 27,540 3.33 --
=======
Weighted average remaining contractual life of options
outstanding at end of year.................................. 9 years 10 years
Weighted average information for options granted during
the year:
Fair value.................................................... N/A $ 1.66
</TABLE>
The fair value of options granted under the 1996 Option Plan during 1996
was estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions used: no dividend yield, no
volatility, risk-free interest rate of 7% and expected lives of 10 years.
Options exercisable as of December 31, 1997 were due to the retirement of
three directors. Upon retirement, their options immediately vested. As of June
27, 1997, the date of the Reorganization, the 1996 Option Plan became the
amended and restated LIFE Financial Corporation 1996 Stock Option Plan. Stock
options with respect to shares of the Bank's common stock granted under the 1996
Option Plan and outstanding prior to completion of the Reorganization
automatically became options to purchase three shares of the Company's common
stock upon identical terms and conditions. The Company assumed all of the Bank's
obligations with respect to the 1996 Option Plan.
The Board of Directors of the Company adopted the LIFE Financial
Corporation 1997 Stock Option Plan (the 1997 Option Plan), which became
effective upon the Reorganization (the 1996 Option Plan and the 1997 Option Plan
will sometimes hereinafter be referred to as the Option Plans). The Board of
Directors of the Company has reserved shares equal to 10% of the issued and
outstanding shares of the Company giving effect to the Reorganization and the
public offering, including Company options that were exchanged for Bank options
pursuant to the 1996 Option Plan for issuance under the Option Plans.
-97-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
After the Reorganization, the Option Plans became available to directors,
officers and employees of the Company, and to directors, officers and employees
of its direct or indirect subsidiaries. The options granted pursuant to the 1997
Option Plan will vest at a rate of 33.3% per year, beginning on June 30, 2000.
The following is a summary of activity in the 1997 Option Plan during 1997:
Weighted
Average
Exercise
Shares Price
-------- ---------
Options granted................................. 194,000 $11.14
Options forfeited............................... (1,000) $11.00
-------
Options outstanding at December 31, 1997........ 193,000 $11.14
=======
Options exercisable at December 31, 1997........ 17,500
=======
Options exercisable as of December 31, 1997 were due to the retirement of
one director. Upon retirement, the options immediately vested.
The estimated fair value of the options granted under the 1997 Option Plan
during 1997 was $8.37 per share.
The fair value of options granted under the 1997 Option Plan during 1997
was estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions used: no dividend yield,
volatility rate of 55.92%, risk-free interest rate of 6.45% and expected lives
of 10 years.
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its Option Plans. Accordingly, no compensation cost has been
recognized for its Option Plans. Had compensation cost for the Option Plans been
determined based on the fair value at the grant date for awards under the Plans
based on the fair value method of SFAS No. 123, "Accounting for Stock-Based
Compensation", the Company's net income (loss) and earnings (loss) per share for
the years ended December 31, 1997 and 1996 would have been reduced to the pro
forma amounts indicated below (dollars in thousands, except per share data):
1997 1996
------- ------
Net income(loss) to common stockholders:
As reported.............................. $10,324 $ (52)
Pro forma................................ $ 9,778 $ (68)
Basic earnings(loss) per share:
As reported.............................. $ 2.11 $(0.02)
Pro forma................................ $ 2.00 $(0.03)
Diluted earnings(loss) per share:
As reported.............................. $ 2.02 $(0.02)
Pro forma................................ $ 1.91 $(0.03)
-98-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
14. Financial Instruments with Off Balance Sheet Risk
The Company is a party to financial instruments with off balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit in the form of
originating loans or providing funds under existing lines of credit. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the accompanying consolidated
statements of financial condition.
During 1988, the Company 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 January 1, 1995 was $2,000,000, all of which matured in
1995. 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 years ended
December 31, 1997, 1996 and 1995.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual or notional amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates and may require payment of a
fee. Since many commitments are expected to expire, the total commitment amounts
do not necessarily represent future cash requirements. The Company evaluates
each customer's credit worthiness on a case-by-case basis. The Company's
commitments to extend credit at December 31, 1997 and 1996 totaled $29,173,000
and $9,217,000, respectively.
The Company regularly enters into commitments to sell certain dollar
amounts of loans to third parties under specific, negotiated terms. The terms
include the minimum maturity of the loans, yield to purchaser, servicing spread
to the Company, and the maximum principal amount of the individual loans. The
Company typically satisfies these commitments from its current production of
loans. These commitments have fixed expiration dates and may require a fee. At
December 31, 1997 and 1996, the Company had outstanding commitments to sell
loans of $62,649,000 and $3,072,000, respectively.
15. Fair Value of Financial Instruments
The following disclosures of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments". The estimated fair
value amounts have been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
-99-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
1997
----------------------
Carrying Estimated
Amount Fair Value
--------- ----------
(In Thousands)
Assets:
Cash and cash equivalents........................ $ 3,467 $ 3,467
Securities held to maturity...................... 5,012 5,030
Residual assets.................................. 45,352 45,352
Loans held for sale.............................. 289,268 295,346
Loans held for investment, net................... 29,076 28,493
Mortgage servicing rights........................ 8,526 9,816
FHLB stock....................................... 1,067 1,067
Liabilities:
Deposit accounts................................. 211,765 211,877
FHLB advances.................................... 9,000 9,000
Other borrowings................................. 100,170 100,170
Subordinated debentures.......................... 10,000 10,000
Off-balance sheet unrealized gain on commitments... -- 2,702
1996
----------------------
Carrying Estimated
Amount Fair Value
--------- ----------
(In Thousands)
Assets:
Cash and cash equivalents......................... $12,575 $12,575
Securities held to maturity....................... 8,023 7,981
Residual asset.................................... 4,691 4,691
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
Off-balance sheet unrealized gain on commitments.... -- --
The Company utilized the following methods and assumptions to estimate the
fair value of each class of financial instruments for which it is practicable to
estimate that value:
Cash and Cash Equivalents--The carrying amount approximates fair value.
Securities Held to Maturity--Fair values are based on quoted market prices.
-100-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
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.
FHLB Advances, Other Borrowings and Subordinated Debentures-- The carrying
amount approximates fair value as the interest rate currently approximates
market.
Financial Instruments with Off-Balance Sheet Risk--As of December 31, 1997,
fair values are based on quoted market prices or dealer quotes. As of December
31, 1996, no fair value is ascribed to the Company's outstanding commitments
to fund loans since commitment fees are not significant and predominantly all
such commitments are variable rate commitments.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1997 and 1996. 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.
-101-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
16. Segment Information
The Company's operations within the financial services industry principally
focus on banking and mortgage financing activities. Information about these
segments as of or for the years ended December 31, 1997, 1996 and 1995 is as
follows (dollars in thousands):
<TABLE>
<CAPTION>
1997
-----------------------------------
Mortgage
Banking Financing Total
---------- --------- ----------
<S> <C> <C> <C>
Revenue for the year........................................ $ 4,897 $ 43,479 $ 48,376
Income (loss) before income tax provision for the year...... (730) 18,436 17,706
Assets employed at year-end................................. 50,547 354,560 405,107
Depreciation and amortization for the year.................. 92 537 629
Capital expenditures for the year........................... 936 2,878 3,814
1996
-----------------------------------
Mortgage
Banking Financing Total
---------- --------- ----------
Revenue for the year........................................ $ 3,898 $ 9,498 $ 13,396
Income (loss) before income tax provision for the year...... (2,325) 2,311 (14)
Assets employed at year-end................................. 59,943 42,510 102,453
Depreciation and amortization for the year.................. 120 501 621
Capital expenditures for the year........................... 276 628 904
1995
-----------------------------------
Mortgage
Banking Financing Total
---------- --------- ----------
Revenue for the year........................................ $ 4,207 $ 5,638 $ 9,845
Income (loss) before income tax provision 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>
17. Earnings Per Share
In December 1997, the Company adopted SFAS No. 128, "Earnings Per Share",
which supersedes APB Opinion No. 15, "Earnings Per Share". All prior periods
presented have been restated to reflect the computation of earnings per share
under SFAS No. 128.
SFAS No. 128 requires computation of EPS using basic and diluted
methodologies. Basic EPS excludes any dilution and is computed by dividing
income available to common stockholders by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the dilutive effect of
potential common shares.
-102-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
A reconciliation of the numerators and denominators used in basic and
diluted EPS computations is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Year ended December 31, 1997:
<S> <C> <C> <C>
Net earnings applicable to earnings per share................... $10,324
-------
Basic earnings per share--
Earnings available to common stockholders....................... 10,324 4,885 $ 2.11
======
Effect of dilutive securities--
Stock option plans.............................................. 223
-----
Diluted earnings per share--
Earnings available to common stockholders plus assumed
conversions................................................... $10,324 5,108 $ 2.02
======= ===== ======
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Year ended December 31, 1996:
Net loss applicable to loss per share........................... $ (52)
-------
Basic and diluted loss per share--
Loss available to common stockholders........................... $ (52) 2,371 $(0.02)
======= ===== ======
Year ended December 31, 1995:
Net earnings applicable to earnings per share................... $ 520
-------
Basic and diluted earnings per share--
Earnings available to common stockholders....................... $ 520 1,866 $ 0.28
======= ===== ======
</TABLE>
-103-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
18. Parent Company Financial Information
The following presents the unconsolidated financial statements of the
parent company only, LIFE Financial Corporation (Note 1) as of December 31 (in
thousands):
LIFE FINANCIAL CORPORATION (PARENT COMPANY ONLY)
1997 1996
------- ------
STATEMENTS OF FINANCIAL CONDITION
ASSETS:
Cash and cash equivalents....................... $ 933 $ --
Residual assets................................. 45,352
Investment in subsidiaries...................... 21,552 7,716
Other assets.................................... 1,938 --
------- ------
TOTAL ASSETS................................. $69,775 $7,716
======= ======
LIABILITIES:
Other borrowings................................ $15,537
Accounts payable and other liabilities.......... 3,352 --
------- ------
TOTAL LIABILITIES............................... 18,889 --
------- ------
TOTAL STOCKHOLDERS' EQUITY...................... 50,886 7,716
------- ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...... $69,775 $7,716
======= ======
LIFE FINANCIAL CORPORATION (Parent company only)
1997 1996 1995
------ ------ ------
STATEMENTS OF OPERATIONS
INTEREST INCOME................................. $ 185 $ -- $ --
INTEREST EXPENSE................................ 80
-------
Net interest income........................... 105
NONINTEREST INCOME.............................. 14,088
NONINTEREST EXPENSE............................. 1,308
EQUITY IN NET EARNINGS(LOSS) OF SUBSIDIARIES.... 2,760 (52) 520
------- ----- -----
EARNINGS (LOSS) BEFORE INCOME TAX EXPENSE...... 15,645 (52) 520
INCOME TAX EXPENSE.............................. 5,321 -- --
------- ----- -----
NET EARNINGS (LOSS)............................. $10,324 $ (52) $ 520
======= ===== =====
-104-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
LIFE FINANCIAL CORPORATION (PARENT COMPANY ONLY)
SUMMARY STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
1997 1996 1995
--------- ------ -----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net earnings (loss)............................................................. $ 10,324 $ (52) $ 520
Adjustments to reconcile net earnings (loss) to cash used in operating
activities:
Gain on sale and securitization of loans held for sale........................ (13,631)
Purchase of loans held for sale, net of loan fees............................. (324,795)
Proceeds from sales and securitization of loans held for sale................. 319,941
Net accretion of residual assets.............................................. (1,622)
Net unrealized loss on residual assets........................................ (448)
Increase in accounts payable and other liabilities............................ 3,352
Increase in other assets...................................................... (3,493)
Equity in net (earnings) loss of subsidiaries................................. (2,760) 52 (520)
--------- ----- -----
Net cash used in operating activities...................................... (13,132)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of residual assets from the Bank....................................... (23,243)
Capital contributions to subsidiaries........................................... (11,075) -- --
--------- ----- -----
Net cash used in investing activities...................................... (34,318)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from other borrowings.............................................. 15,537
Net proceeds from issuance of common stock...................................... 32,846 -- --
--------- ----- -----
Net cash provided by financing activities.................................. 48,383 -- --
--------- ----- -----
NET INCREASE IN CASH AND CASH EQUIVALENTS....................................... 933
CASH AND CASH EQUIVALENTS, beginning of year.................................... -- -- --
--------- ----- -----
CASH AND CASH EQUIVALENTS, end of year.......................................... $ 933 $ -- $ --
========= ===== =====
</TABLE>
-105-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
19. Quarterly Results of Operations (Unaudited)
The following is a summary of quarterly results for the years ended
December 31:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
---------- -------- -------- ---------
(In Thousands, Except Per Share Data)
1997(1):
<S> <C> <C> <C> <C>
Interest income.......................... $2,282 $4,159 $5,663 $ 9,042
Interest expense......................... 1,561 2,460 3,080 5,729
Provision for estimated loan losses...... 500 400 950
Noninterest income....................... 1,975 2,363 8,651 14,241
Net earnings (loss)...................... (190) 917 3,880 5,717
Earnings (loss) per share:
Basic................................. (.06) .28 .59 .87
Diluted............................... (.06) .28 .57 .83
1996(1):
Interest income.......................... $1,662 $1,691 $1,569 $ 2,006
Interest expense......................... 929 926 844 1,067
Provision for estimated loan losses...... 68 40 251 604
Noninterest income....................... 1,040 1,432 1,791 2,205
Net earnings (loss)...................... 105 61 2 (220)
Earnings (loss) per share:
Basic................................. .06 .03 .00 (.07)
Diluted............................... .06 .03 .00 (.07)
</TABLE>
(1) As restated, see Note 21. The effects of the restatement on the quarterly
periods ended March 31, 1997, June 30, 1997 and September 30, 1997 are
presented in the condensed financial statements included in the Company's
Quarterly Reports on Form 10-Q/A for the quarterly periods ended March 31,
1998, June 30, 1998 and September 30, 1998. The effects of the restatement
on the quarterly period ended December 31, 1997 resulted in an increase in
net earnings and earnings per share (diluted) from $5,005,000 and $0.73 to
$5,717,000 and $0.83, respectively. The effects of the restatement on the
quarterly period ended December 31, 1996 resulted in a decrease in net
earnings and earnings per share (diluted) from $1,337,000 and $0.42 to a
net loss and loss per share of $220,000 and $0.07, respectively.
20. Subsequent Event
On March 11, 1998, the Company entered into an agreement and plan of merger
(Merger Agreement) with FIRSTPLUS Financial Group, Inc. (FIRSTPLUS). The Merger
Agreement provides for the merger of the Company with and into FIRSTPLUS, with
FIRSTPLUS as the surviving corporation. The Merger Agreement is subject to the
receipt of regulatory approval and the approval of the shareholders of the
Company. Under the Merger Agreement, at the effective date of the merger, each
outstanding share of Company common stock will be converted into the right to
receive between 0.500 and 0.667 share of FIRSTPLUS common stock.
21. Restatement of Financial Statements
Subsequent to the issuance of the Company's 1997 financial statements, the
Company's management determined that residual assets retained in certain of the
Company's 1997 and 1996 securitization transactions had not been determined
using the cash-out method, as required by the Financial Accounting Standards
Board's (FASB) Special Report, "A Guide to Implementation of Statement 125 on
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, Second Edition", dated December 1998, and related guidance set
forth in statements made by the staff of the Securities and Exchange Commission
(SEC) on December 8, 1998.
-106-
<PAGE>
LIFE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997
From December 1996 through June 1997, the Company completed two
securitizations, which total $155 million of original loan balance securitized,
that are effected by this restatement. The Company's other securitization
transactions have been properly measured and accounted for using the cash-out
method. Initial deposits to restricted cash accounts and subsequent cash flows
received by securitization trusts sponsored by the Company accumulate as credit
enhancement assets until certain targeted levels are achieved, after which cash
is distributed to the Company on an unrestricted basis. Under the method
previously used by the Company, (i) the assumed discount period for measuring
the present value of credit enhancement assets ended when cash flows were
received by the securitization trusts and (ii) interest-bearing initial deposits
to restricted cash accounts were recorded at face value. Under the cash-out
method required by the FASB and SEC, the assumed discount period for measuring
the fair value of credit enhancement assets ends when cash, including return of
the initial deposits, is distributed to the Company on an unrestricted basis.
As a result, the 1997 and 1996 financial statements have been restated from
amounts previously reported to properly reflect the pretax fair values of the
residual assets, including restricted cash, and the resulting pretax gains and
income tax provision, as of and for the years ended December 31, 1997 and 1996,
as computed on the cash-out basis. The tax impact of the restatement is
reflected as an increase in deferred tax assets, included within other assets,
of $1.1 million as of December 31, 1996, and a reduction in deferred tax
liabilities, included within accounts payable and other liabilities, of $2.7
million as of December 31, 1997.
A summary of the significant effects of the restatement is as follows:
<TABLE>
<CAPTION>
1997 1996
As As
Previously As Previously As
Reported Restated Reported Restated
<S> <C> <C> <C> <C>
At December 31,
Restricted cash $12,339 $ -- $1,636 $ --
Residual assets, at fair value 40,746 45,352 5,700 4,691
Retained earnings (deficit), partially restricted 12,583 8,650 (117) (1,674)
For the Year Ended December 31,
Total interest income 21,127 21,146 6,929 6,928
Net gains from mortgage financing operations 29,785 25,730 8,352 5,708
Income (loss) before income tax provision 21,742 17,706 2,631 (14)
Income tax provision 9,042 7,382 1,126 38
Net income (loss) 12,700 10,324 1,505 (52)
Net earnings (loss) per share - Basic $ 2.60 $ 2.11 $ 0.63 $ (0.02)
Net earnings (loss) per share - Diluted $ 2.49 $ 2.02 $ 0.63 $ (0.02)
</TABLE>
-107-
<PAGE>
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 28, 1998,
which will be filed with the Securities and Exchange Commission within 120 days
after the end of the Registrant's fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation and directors'
compensation is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 28, 1998,
excluding the Stock Performance Graph and Compensation Report. The Proxy
Statement will be filed within 120 days after the end of the Registrant's fiscal
year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial owners
and management is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 28, 1998,
which will be filed within 120 days after the end of the Registrant's fiscal
year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related transactions
is incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 28, 1998, which will be filed
within 120 days after the end of the Registrant's fiscal year.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Company are included
herein at Item 8.
(2) All schedules are omitted because they are not required or
applicable, or the required information is shown in the consolidated
financial statements or the notes thereto.
(3) Exhibits
-108-
<PAGE>
(a) The following exhibits are filed as part of this report:
3.1 Certificate of Incorporation of LIFE Financial Corporation*
3.2 Bylaws of LIFE Financial Corporation*
4.0 Stock Certificate of LIFE Financial Corporation*
21.0 Subsidiary information is incorporated herein by reference to
"Part I--Subsidiaries"
23.1 Consent of Deloitte & Touche LLP
23.2 Consent of Grant Thornton LLP
27.0 Financial Data Schedule
(b) Reports on Form 8-K
None.
- ---------------
* Incorporated herein by reference into this document from the Exhibits to Form
S-4 Registration Statement, filed on January 27, 1997 and any amendments
thereto, Registration No. 333-20497.
-109-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
LIFE FINANCIAL CORPORATION
By: /s/ DANIEL L. PERL
-----------------------------
Daniel L. Perl
President and Chief Executive Officer
DATED: APRIL 15, 1999
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this Report has been signed by the following persons in the capacities and on
the dates indicated.
SIGNATURE TITLE DATE
- --------------------------- -------------------------------- ---------------
/s/ DANIEL L. PERL President and Chief Executive APRIL 15, 1999
- --------------------------- Officer (principal executive
Daniel L. Perl officer)
/s/ JEFFREY L. BLAKE Vice President and APRIL 15, 1999
- --------------------------- Chief Financial Officer
Jeffrey L. Blake (principal financial and
accounting officer)
/s/ RONALD G. SKIPPER Chairman of the Board APRIL 15, 1999
- ---------------------------
Ronald G. Skipper
/s/ JOHN D. GODDARD Director APRIL 15, 1999
- ---------------------------
John D. Goddard
/s/ MILTON E. JOHNSON Director APRIL 15, 1999
- ---------------------------
Milton E. Johnson
/s/ ROBERT K. RILEY Director APRIL 15, 1999
- ---------------------------
Robert K. Riley
-110-
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-44307 of LIFE Financial Corporation on Form S-8 of our report dated February
27, 1998 (March 11, 1998, as to Note 20, and March 26, 1999, as to Note 21)
(which expresses an unqualified opinion and includes an explanatory paragraph
relating to the restatement described in Note 21), appearing in the Annual
Report on Form 10-K/A of LIFE Financial Corporation for the year ended December
31, 1997.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
April 15, 1999
<PAGE>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We have issued our report dated February 8, 1996 (except for the "Earning per
share" paragraph of Note 1, as to which the date is June 30, 1997) accompanying
the financial statements of LIFE Financial Corporation (formerly Life Savings
Bank, Federal Savings Bank) appearing in Life Financial Corporation's Annual
Report on Form 10-K/A for the year ended December 31, 1997. We hereby consent
to the incorporation by reference of said report in the Registration Statement
on Form S-8 (File #333-44307) of the Life Financial Corporation 401(k) Savings
Plan.
/s/ GRANT THORNTON LLP
Irvine, California
April 15, 1999
<TABLE> <S> <C>
<PAGE>
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<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
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