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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 1996.
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934.
For the transition period from_________ to _________
Commission file number 0-28706
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FIRST ALLIANCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 33-0721183
- ------------------------------ -----------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
17305 Von Karman Avenue, Irvine, California 92614
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(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code (714) 224-8500
Securities registered pursuant to Section 12(b) of the Act: None
Title of each class Name of each exchange on which registered
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Class A Common Stock, NASDAQ National Market System
par value $0.01
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment of this Form 10-K. [ ]
As of February 28, 1997, the aggregate market value of voting stock held
by nonaffiliates of registrant was approximately $109 million.
As of February 28, 1997, the shares outstanding of the issuer's classes
of common stock were as follows:
Class A Common Stock: 4,043,067 shares; Class B Common Stock: 10,750,000
shares.
DOCUMENTS INCORPORATED BY REFERENCE:
The information required by Part III, Items 10, 11, 12 and 13 is
incorporated by reference to First Alliance Corporation's proxy statement
which will be filed with the Commission not more than 120 days after
December 31, 1996.
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PART I
Item 1. Business.
General
First Alliance Corporation ("FACO"), together with its subsidiaries
(the "Company"), is a financial services organization principally engaged in
mortgage loan origination, purchases, sales and servicing. Loans originated
by the Company primarily consist of fixed and adjustable rate loans secured
by first mortgages on single family residences. The majority of the
Company's loans are made to owners of single family residences who use the
loan proceeds for such purposes as debt consolidation and financing of home
improvements. Typically, the Company's borrowers are individuals who do not
qualify for conventional loans because of impaired or unsubstantiated credit
characteristics and/or unverifiable income, and whose borrowing needs are
not met by conventional lending institutions. Other borrowers include
individuals who may qualify for a conventional loan but find the Company's
loans attractive due to the Company's personalized service and fast funding
capability. The Company sells loans to wholesale purchasers or securitizes
them in the form of a Real Estate Mortgage Investment Conduit (REMIC) trust.
A significant portion of the mortgages are securitized with the Company
retaining the right to service the loans. The Company is currently licensed
as a consumer finance lender in thirteen states and in the United Kingdom.
To identify potential customers, the Company utilizes a proprietary
marketing methodology developed over its 25 years of existence. This
methodology focuses on a distinct segment of the home equity lending market
by narrowly targeting homeowners believed by management, based on historic
customer profiles, to be pre-disposed to using the Company's products and
services, and who otherwise satisfy its underwriting guidelines. Using
information obtained from a variety of outside sources for new and existing
markets, the Company develops a list of homeowners with characteristics that
make them likely customers. The Company then focuses its telemarketing and
mailing efforts on these identified homeowners.
Prior to 1994, all of the Company's operations were conducted from
retail branch offices located in California. Since 1994, the business
strategy of the Company has been to expand its retail branch office
operations to states other than California to maximize opportunities that
exist in new markets. Currently, the Company has 24 retail branch offices
in 13 states and the United Kingdom and has identified locations in six
other states and additional areas in the United Kingdom in which it may open
new retail branch offices in the future.
The Company is primarily a retail originator of loans, with 90% of its
loan volume in 1996 coming from its retail branch office and portfolio
refinancing operations. Besides a strong emphasis placed on its marketing
and sales efforts, the Company provides a high degree of personalized
service and timely response to loan applications. Historically, the
Company's customers have been willing to pay the Company's loan origination
fees and interest rates, which are typically higher than those charged by
conventional lending institutions.
The Company has maintained conservative underwriting guidelines when
originating and purchasing loans. The Company has originated loans with
higher levels of credit risk to earn origination fees, however, it
generally sells such loans on a servicing released basis. In conjunction
with the Company's aggressive collection and foreclosure procedures, this
approach has allowed the Company to historically maintain low delinquency
and loan losses relative to others in the industry.
Marketing and Sales
Marketing
The Company's marketing efforts are designed to identify, locate and
focus on individuals who, based on the Company's historic customer profiles,
display a statistical likelihood for becoming a consumer of the Company's
products and services and, at the same time, satisfying the Company's
underwriting guidelines. The Company believes its focused marketing
approach makes a more efficient use of its marketing resources and leads to
a higher marketing success rate than a broad indiscriminate marketing
approach aimed at a wide range of homeowners.
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The Company utilizes a proprietary marketing methodology to
subjectively analyze the Company's historical customer base to identify
characteristics common to its customers. These common characteristics are
integrated with information obtained from a number of outside sources
related to the homeowner pool in new or existing markets. The
characteristics of individual homeowners and their properties in the
homeowner pool are compared with characteristics common to the Company's
historical customer base to identify and locate homeowners ("Targeted
Homeowners") with characteristics that make them likely to become customers
for the Company's products and services and to satisfy its underwriting
guidelines.
In general, the factors analyzed by the Company in identifying Targeted
Homeowners include prior consumer finance borrowing, home value, the amount
of equity in the home and the length of time a homeowner has owned the home.
Credit problems, a lack of a significant credit history and prior borrowings
from consumer finance companies indicate a homeowner is unlikely to be able
to obtain loans from conventional lending institutions, and thus is a more
likely candidate for the Company's products and services. Similarly, the
Company's experience indicates that a longer ownership period usually
results in significant equity in the home, creating an opportunity for a
loan that will satisfy the Company's conservative loan-to-value
requirements. Management continually refines the Company's proprietary
marketing methodology. The Company monitors the performance of its
marketing campaigns in evaluating the effectiveness of its methodology in
identifying Target Homeowners in each market.
While the Company has utilized mass marketing in the past, the
Company's experience has proven that focusing its marketing efforts on
Targeted Homeowners produces a greater yield for its marketing expenditures
and leads to more opportunities for loan originations. The majority of
Targeted Homeowners who become customers of the Company generally use the
proceeds of their loans to lower their monthly payments by consolidating
outstanding mortgage and consumer debt or to make home improvements.
Targeted Marketing
By focusing its marketing efforts on Targeted Homeowners who are likely
to satisfy the Company's underwriting guidelines, the Company expends fewer
resources on homeowners and properties that would not satisfy such
guidelines. The Company's marketing personnel, including telemarketing
staff, appraisers, loan officers, branch managers and headquarters
personnel, are trained to be aware of the Company's underwriting guidelines
and, as described below, review each loan lead to focus on Targeted
Homeowners whose overall qualifications and properties satisfy such
guidelines.
Mailing Campaigns and Telemarketing
The Company's mailing and telemarketing campaigns focus on Targeted
Homeowners in the communities surrounding its 24 retail branch offices by
utilizing many different mailing campaigns focusing on the multiple benefits
of the Company's services and loan products. The Company distributes over
1.5 million pieces of mail monthly. All of the Company's mailing campaigns
originate from its mail processing center in Orange, California. The
Company's mailing campaigns result in over 4,000 inbound loan inquiry calls
from Targeted Homeowners monthly. The Company continually monitors the
effectiveness of each of its mailing campaigns and continues, modifies or
discontinues a particular mailing campaign based on the results of such
monitoring.
The Company's telemarketing department handles both inbound and
outbound calls from and to Targeted Homeowners and existing customers.
Substantially all of the inbound calls are from Targeted Homeowners
responding to the Company's mailing campaigns. The Company monitors the
effectiveness of each mailing campaign by tracking which campaign is the
source of each inbound call. The outbound telemarketing department uses
computerized predictive dialers to continually solicit the Targeted
Homeowners and the Company's current borrowers. Telemarketing
representatives also place follow-up calls to prospective borrowers who have
previously set and later canceled appointments to have a Company appraiser
visit and inspect the subject property and obtain information about the
applicant (an "Appraisal Appointment"), failed to show up for an appointment
with a loan officer in a retail branch office to prepare loan documents (a
"Sales Appointment") or declined a loan program offered to them by the
Company.
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The Company understands its practice to be different from that of its
competitors in that the centralized telemarketing department reviews all
prospective customers and produces all initial Appraisal Appointments with
Targeted Homeowners. The centralized telemarketing department, not the
retail branch office personnel, is responsible for converting loan inquiries
into appointments. The Company believes its centralized telemarketing
practice creates greater operating efficiencies by allowing task
specialization and reallocation of telemarketing resources to meet
geographic needs.
The telemarketing representative's responsibility is to sell the
benefits of the Company's products and services, obtain information about
the Targeted Homeowner, the subject property, equity in the subject property
and the purpose of the loan and, assuming this initial information satisfies
the Company's underwriting guidelines, schedule an Appraisal Appointment.
By focusing on the equity in the subject property, the telemarketing phase
concentrates on Targeted Homeowners and properties whose characteristics
satisfy the Company's underwriting guidelines.
Individual telemarketing representatives are rated and compensated
based on the number of Appraisal Appointments set. The Company monitors the
performance of its telemarketing staff on a weekly and monthly basis.
Appraisal
The Company's valuation process occurs throughout the loan application
process. In some cases, the first stage valuation occurs immediately after
a telemarketing representative sets an Appraisal Appointment. Staff at the
Company's headquarters gather publicly available information with respect to
recent sales of comparable properties in the same area as the subject
property. The estimated value of the subject property is verified by the
comparable sales data. Only properties that satisfy this stage of the
initial underwriting process will be verified and forwarded to the
respective retail branch offices for Appraisal Appointments.
The property is appraised typically within two days of the initial
telemarketing contact. This appraisal, which provides a valuable marketing
opportunity, is the applicant's first face-to-face contact with the
Company's representatives, and the Company stresses to its appraisers the
importance of the marketing aspect of their positions. The appraiser's
responsibilities are to obtain additional information and required
documentation about the applicant, perform a complete technical appraisal of
the subject property and schedule a Sales Appointment. The appraiser
gathers and delivers to the retail branch office the applicant's relevant
documents, including the current mortgage documents, if any, evidence of
ownership of the subject property and information regarding other bills to
be refinanced with the new loan.
Appraisers at the Company's headquarters perform a desk review of the
property appraisal on the following loan applications: (i) all properties
with a market value above $150,000, (ii) all loan applications with a
combined loan-to-value ratio equal to or greater than 55% (62% in
California), (iii) all loan applications prepared by a new retail branch
office for the first 90 days of its existence, (iv) all income properties,
(v) all properties with values less than $100,000 and (vi) approximately 10%
of the loan applications not otherwise reviewed.
Unlike many of its competitors, the Company does not use independent
fee-based appraisers. Instead, the Company recruits, hires and trains its
own field and desk appraisers. In connection with each securitization of
the Company's loans, independent appraisers have conducted appraisals of
samples of the subject properties that are the collateral for the
securitized loans. The appraisals performed by the Company's appraisers
have been within 1.5% of the aggregate appraisal values on securitization
pools to date as calculated by the independent appraisers.
The Company hires certified appraisers in those states which require
such designation. Individual retail branch office appraisers are rated and
compensated based on the number of Sales Appointments set and the ongoing
quality of the appraisals performed. The Company monitors the performance
of its appraisers on a weekly and monthly basis.
Loan Production
The retail branch offices are responsible for the next step in the
sales process that, if successful, converts the Sales Appointments set by
the appraisers into underwritten loan files to be submitted to the Company's
quality control department. Each Sales Appointment allows the sales
personnel to clearly determine the applicant's need for financing, tailor a
loan program to fit the applicant's financial needs, perform preliminary
underwriting and provide to the applicant a choice of loan products and a
detailed explanation thereof.
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The loan officer utilizes a loan origination software system developed
by the Company to preliminarily determine an applicant's qualification for
the various products of the Company and the terms applicable to such
products. The loan origination software system incorporates the Company's
underwriting guidelines with respect to collateral, credit quality,
character, and capacity to repay. For over a decade, the Company has relied
upon a proprietary credit scoring system in its underwriting process. Prior
to each Sales Appointment, the retail branch loan officer or branch manager
will run a credit report for each applicant and determine the applicant's
overall credit score. All accounts on an applicant's credit report,
including mortgage loans, are reviewed and assigned a value derived from the
performance of the account. Based upon credit scores, an applicant is
preliminarily designated as an "A", "B", "C" or "D" risk. This designation
is reviewed by the Company's centralized quality control department before
final underwriting.
The typical retail branch office consists of a branch manager, one or
two loan officers, one or two appraisers and one or two loan processors.
The Company generally recruits and hires its loan officers in the location
of the branch office. The Company focuses on candidates with professional
sales experience for loan officer positions. Loan officer and branch
manager candidates are required to successfully complete four weeks of sales
and technical underwriting training to learn the Company's sales
presentation and lending procedures prior to their placement in a retail
branch office. Existing retail branch office sales personnel return to
corporate headquarters quarterly for continuing sales training.
Loan officers and branch managers are rated and compensated based on
the amount of loans funded. The Company strives to develop its loan
officers and to promote the most qualified loan officers to branch managers.
The Company monitors the performance of its loan officers and branch
managers on a weekly and monthly basis.
Repeat Business and Preservation of Loan Portfolio
A significant number of the Company's borrowers are repeat customers of
the Company. Once a loan is funded, the Company maintains a relationship
with its borrowers to ensure borrower satisfaction and to respond to any
future borrowing needs.
Many competitors in the Company's markets obtain publicly available
information with respect to the Company's borrowers and solicit such
borrowers for additional borrowing or refinancing. The Company's portfolio
refinancing programs have allowed it to retain a significant number of
borrowers who might otherwise have obtained additional borrowings or
refinanced their existing mortgages with the Company's competitors.
Loan Origination and Acquisition Through Brokers and Lenders
The Company has historically augmented its loan production by
purchasing loans from other affiliated, unaffiliated and related party
brokers and lenders. The Company has entered into mortgage loan purchase
agreements with each originator which require specified minimum levels of
experience in origination of non-conventional mortgage loans and provide
representations, warranties and buy-back provisions which are not less
restrictive than representations and warranties required of the Company for
the securitization of its own loan originations.
Underwriting
The Company views its underwriting process as beginning with the
marketing of its products and services. The Company has designed its
marketing programs to screen out those homeowners and subject properties
that do not meet the Company's underwriting guidelines. As an integral part
of its marketing process, the Company trains its telemarketing
representatives, appraisers and loan officers to evaluate each subject
property in light of the Company's underwriting guidelines.
The main underwriting and quality control functions are centralized at
the Company's headquarters. The most significant of the Company's
underwriting functions are performed by senior management. The Company
maintains a quality control department and a loan committee. Each loan
application file is reviewed by the Company's loan committee. The loan
committee works in conjunction with the quality control department to
provide a final review of the underwriting and terms of a potential loan.
The Company strives to process each loan application received from its
retail branch office network as quickly as possible in accordance with the
Company's loan application approval procedures. Accordingly, most loan
applications receive decisions within three days of receipt and are funded
within 15 days of approval.
Each retail branch office submits executed initial applications to the
quality control department. The quality control department reviews, in its
entirety, every loan file forwarded by retail branch offices and wholesale
originators. Loan files are reviewed for completeness, accuracy, and
compliance with the Company's underwriting criteria and applicable
governmental regulations. Based on their initial review, quality control
personnel inform retail branch office personnel of any additional
requirements that must be fulfilled to complete the loan file, such as
additional proof of income.
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After a full review by the quality control department, each initial
loan application file is forwarded to the loan committee for approval.
These documents are again subjected to a full review. Loans that clearly
conform to the Company's underwriting guidelines are approved at the first
level. Other loans which present more complicated underwriting issues are
reviewed by senior underwriting personnel.
The decision of the loan committee to approve a loan is based upon a
number of factors, including the appraised value of the property, the
applicant's creditworthiness and the Company's perceptions of the
applicant's ability to repay the loan. With respect to the value of the
collateral, loans secured by first mortgages are generally limited to a
maximum 75% combined loan-to-value ratio; however, the Company will
originate loans with a combined loan-to-value ratio of up to 85% for loans
expected to be sold on a whole loan basis. Loans secured by second
mortgages are limited to a maximum 70% combined loan-to-value ratio. The
Company has established classifications with respect to the credit profiles
of loans and subject properties based on certain of the applicant's
characteristics. Each loan application is placed into one of the Company's
four ratings ("A" through "D", with subratings within those categories),
depending upon the following three primary factors: (i) an applicant's
credit score under the Company's proprietary credit scoring system which
uses information obtained from national credit bureau reports, (ii) combined
loan-to-value ratios and (iii) debt-to-income ratios. Terms of loans made
by the Company vary depending upon the classification of the application.
Applications with lower classifications generally are subject to higher
interest rates. A loan application must meet the following minimums with
respect to each of the three primary factors to be included in the
applicable ratings shown below:
"A" "B" "C" "D"
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Borrower credit score 100-87 86-64 63-36 35-0
Maximum combined loan-to-value ratio 75% 73% 72% 65%
Maximum debt-to-income ratio 40% 49% 59% 60%
In addition to the above criteria, the Company requires higher interest
rates on loans with certain risk factors. These factors include an
unsubstantiated employment history, a recent foreclosure proceeding, a
number of recent delinquent payments on an existing mortgage, a recent
bankruptcy filing, the presence of a senior mortgage or zoning restrictions
on the subject property or a combined loan-to-value ratio in excess of 71%.
During the past three years, the Company's mix of loans by risk
classification has not changed significantly. The following table reflects
the risk classifications of the Company's loan originations and purchases
for the year ended December 31, 1996:
Initial
Weighted
% of Average
Loan Classification Amount Total Coupon
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(Dollars in thousands)
"A" Risk........................... $167,991 52% 9.0%
"B" Risk........................... 77,753 24 9.6
"C" Risk........................... 52,661 16 10.4
"D" Risk........................... 26,083 8 11.4
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Total.............................. $324,488 100% 9.6
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Loan Originations and Purchases
The following table highlights selected information relating to the
origination and purchase of loans by the Company for the years ended
December 31:
1996 1995 1994
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Type of property securing loan:
Single Family....................... 95.1% 95.0% 92.4%
Multi Family........................ 3.3 2.7 5.4
Planned Unit Development and other.. 1.6 2.3 2.2
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100.0% 100.0% 100.0%
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Type of mortgage securing loan:
First Mortgage........................... 99.3% 94.5% 95.4%
Second Mortgage.......................... 0.7 5.4 4.4
Third Mortgage........................... 0.1 0.2
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100.0% 100.0% 100.0%
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Weighted average interest rate........... 9.6% 10.3% 8.7%
Weighted average initial combined
loan-to-value ratio (1)............. 62.2 59.4 56.2
(1) The combined loan-to-value ratio of a loan secured by a senior
mortgage is determined by dividing the amount of the loan by the appraised
value of the mortgaged property at origination. The combined loan-to-value
ratio of a loan secured by any junior mortgage is determined by taking the
sum of the loan secured by such mortgage and any senior mortgages and
dividing the total by the appraised value of the mortgaged property at
origination.
Loan Sales
Securitization
In a securitization, the Company sells a pool of loans to a REMIC trust
in exchange for a residual interest and regular interests. The Company
retains the residual interest and immediately sells the regular interests.
The proceeds are used to repay borrowings under the warehouse financing
facilities. The holders of the regular interests 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. As holder of
the residual interest, the Company is entitled to receive certain excess
cash flows. These excess cash flows are calculated as the difference
between (a) principal and interest paid by borrowers and (b) the sum of (i)
pass-through principal and interest paid to holders of the regular
interests, (ii) trustee fees, (iii) third party credit enhancement fees,
(iv) servicing fees and (v) loan losses. The Company's right to receive
these excess cash flows begins after certain overcollateralization
requirements, which are specific to each securitization, have been met.
To increase the profitability from the sale of securitized loans, the
Company arranges for credit enhancement to achieve an improved credit rating
on the regular interests issued. This credit enhancement generally takes
the form of an insurance policy, issued by a monoline insurance company,
ensuring the holders of the regular interests of timely payment of the pass-
through and principal interest. In addition, the pooling and servicing
agreements that govern the distribution of cash flows from the loan pool
included in the REMIC trusts typically require overcollateralization as an
additional means of credit enhancement. The purpose of the
overcollateralization is to provide a source of payment in the event of
higher than anticipated loan losses. Overcollateralization requirements may
include an initial deposit, the sale of loans at less than par, or retention
in the REMIC trust of collections from the pool until a specified
overcollateralization amount has been attained. This retention of excess
cash flow creates a faster amortization of the scheduled balance of the
regular interests than the amortization of the principal balance of the
securitized loan pool. Losses resulting from defaults by borrowers on a
payment of principal or interest on the loans in the securitized pool will
reduce the overcollateralization to the extent that funds are available and
may result in a reduction in the value of the residual interests held by the
Company. If payment defaults exceed the amount of overcollateralization and
excess cash flows, the insurance policy will pay any further losses
experienced by holders of the regular interests in the related REMIC trust.
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Generally, the Company sells loans at face value to a REMIC trust,
except for when it sells loans at less than par for overcollateralization
purposes. Loans are sold without recourse except for certain
representations and warranties provided by the Company. Under the terms of
the pooling and servicing agreements the Company may be required either to
repurchase or to replace loans that do not conform to such representations
and warranties. To date, the Company has not been required to substitute or
repurchase any such loans.
The Company retains the right to service loans it securitizes. In
addition to management servicing fees, the Company also receives prepayment
and other ancillary servicing fees on securitized loans.
Whole Loan Sales
Certain loans originated or purchased by the Company are not chosen for
inclusion in a REMIC trust. These loans may include loans with higher
combined loan-to-value ratios and/or loans that have increased credit risk.
The Company will originate these loans to earn the origination fees and will
then sell such loans to wholesale purchasers on a servicing released basis
to avoid credit risks related to such loans. The Company anticipates that
it will continue to sell certain loans on a whole loan basis.
Prior to 1992, the Company sold its loan origination volume to private
investors. Since the Company's utilization of securitizations in 1992, its
use of loan sales to private investors has declined. The Company has
retained the rights to service loans it has sold to private investors.
Interest Rate Risk Management
The Company's profitability is in part determined by the difference, or
"spread", between the effective rate of interest receivable on the loans
originated or purchased by the Company and the pass-through interest rates
payable to regular interests issued in securitizations. After a loan is
originated or purchased and while it is held pending sale or securitization,
the spread can be adversely affected by increases in the interest rate
demanded by purchasers or investors in the Company's securitizations. Whole
loan sales by the Company are generally to other companies with a higher
tolerance for credit risk who purchase loans from the Company to augment
their own securitization volume.
The Company has implemented a hedging program designed to provide a
level of protection against the impact of rapid changes in interest rates on
the value of fixed rate loans from the time the Company commits to fund or
purchase such loans to the date of their securitization or sale. The
Company does not hedge the interest rate risk associated with holding
adjustable rate mortgages pending their securitization or sale due to the
decreased significance of such risk as the pass-through rates for regular
interests related to the Company's adjustable rate mortgage pools are also
adjustable.
The Company's hedging program was initiated in 1994. During 1996, 1995
and 1994, hedging transactions were limited to selling short United States
Treasury securities and prefunding loan originations in its securitizations.
United States Treasury securities are utilized by the Company due to the
liquidity of the market for such securities and the high degree of
correlation between such securities and the pass-through interest rates for
regular interests in the Company's fixed rate mortgage pools. Prefunding
allows the Company to fix the relationship between the interest rates
charged on the loans and the pass-through rates for the regular interests by
permitting the Company to deliver loans to a REMIC trust after the date of
its closing.
The Company may utilize various financial instruments in its hedging
activities. The nature and quantity of hedging transactions are determined
by the Company's management based on various factors, including market
conditions and the expected volume of mortgage loan originations and
purchases. To decrease market risk, only highly liquid instruments are
utilized in the Company's hedging activities. By their nature, however, all
such instruments involve risks, and the maximum potential loss may exceed
the value at which such instruments are carried. As is customary for these
types of instruments, the Company does not require collateral or other
security from counterparties to these instruments. The Company manages its
credit exposure to counterparties through credit approvals, credit limits
and other monitoring procedures.
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Servicing
The Company retains the right to service the loans it originates and
purchases (other than loans sold to wholesale purchasers). Loan servicing
includes collecting payments from borrowers, remitting payments to investors
who have purchased loans, investor reporting, accounting for principal and
interest, contacting delinquent borrowers, conducting foreclosure
proceedings and disposing of foreclosed properties. The Company's servicing
portfolio includes 8,895 loans with an outstanding balance of $641.2 million
as of December 31, 1996. The Company receives management servicing fees
ranging from 0.5% to 2.5% per annum for fixed rate loans and 0.5% to 1.0%
per annum for adjustable rate loans, based upon the outstanding balance of
loans in REMIC trusts. The Company currently services only Company
originated or purchased loans.
The Company has installed a sophisticated computer-based loan servicing
system that it believes enables it to provide effective and efficient
processing of loans. The system, which is able to service fixed and
adjustable rate loans, provides the Company with, among other things,
payment-processing, cashiering, collection and reporting functions.
The Company believes its aggressive collection practices contribute to
the relatively low delinquency and loss rates on its servicing portfolio.
The following table illustrates the timeline of the Company's collection
practices, assuming (i) the loan is originated in California and (ii) a ten
day grace period applies by contract or under applicable law:
Time Event
- ------------------------------------- -----------------------------------
1st day of the month................. Borrower loan payment due.
11th day of the month................ Payment not received is late.
12th day of the month................ Notice of past due payment mailed
to borrower.
20th day of the month................ Foreclosure notice mailed to
borrower.
26th day of the month................ Final notice mailed to borrower.
42 days after due date............... File forwarded to foreclosure
department which records notice of
default after the 45th day of
delinquency.
After notice of default or similar
notice is recorded................ Borrower informed of status and the
Company's reinstatement period
dates.
During the reinstatement period...... Pre-foreclosure property valuation
performed.
End of the reinstatement period...... Notice of trustee's sale recorded
and trustee's sale date scheduled.
Property sold to a third party or
acquired on behalf of the Company
or a REMIC trust.
The borrower is contacted by telephone prior to recording the notice of
default to inform the borrower of the situation. If the borrower does not
bring the loan current within the reinstatement period, a notice of sale is
published and a trustee's sale date is scheduled. During this period of
time, the Company performs a pre-foreclosure valuation of the property to
determine whether changes in the value of the property have occurred since
the date of origination. If the loan is not reinstated, the property is
either sold to a third party at the trustee's sale or acquired on behalf of
the Company. The Company forecloses as quickly as state regulations allow.
The Company contracts on a nationwide basis with several independent
foreclosure service companies to facilitate the foreclosure process for
properties located outside California. For delinquent loans originated
within California, the Company performs foreclosure procedures internally.
Properties acquired by the Company are managed with the objective of
immediate sale.
In other states, the Company's collection procedures described above
may occur sooner or later depending upon state specific foreclosure
regulations.
8
<PAGE>
The Company's loan servicing software also allows the Company to track
and maintain hazard insurance information. Periodic expiration reports list
all policies scheduled to expire within 30 days. When policies lapse, a
letter is issued advising the borrower of the lapse and that the Company
will obtain force placed insurance at the borrower's expense. Additionally,
the Company maintains a blanket insurance policy that provides fire
insurance coverage for the Company in the event that the Company fails to
obtain force placed insurance in a timely manner upon expiration of the
homeowner's policy.
Regulation and practices in the United States regarding the liquidation
of properties (i.e. foreclosure) and the rights of the mortgagor in default
vary greatly from state to state. Loans originated 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 costs and expenses incurred in enforcing the obligation
during a statutorily prescribed reinstatement period.
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. 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. In such states, the Company
requires the borrower to waive his or her right of homestead. Such waivers
of homestead rights may not be enforceable in certain states.
Although foreclosure sales are typically public sales, frequently no
third party purchaser bids in excess of the amount of the lender's lien.
Such a lack of bidding is due to several factors, including the difficulty
of determining the status of title to the property, the possible
deterioration of the property during foreclosure proceedings and the
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus, the foreclosing lender often purchases the property from the
trustee and subsequently re-markets the property. Depending upon market
conditions, the proceeds of the subsequent resale by the Company may not be
adequate to cover the investment in the loan.
Current Markets and Expansion Plans
Current Markets
The Company originates loans through 23 retail branch offices in 13
states in the United States and one retail branch office in the United
Kingdom. The Company believes that originating loans through an extensive
retail branch office network represents the most profitable loan origination
strategy due to the significant level of loan origination fees earned by the
Company. Additionally, such a strategy allows the Company to maintain its
underwriting quality standards when compared to competitors using
independent mortgage brokers.
Although the Company is licensed to originate loans in 13 states and
the United Kingdom, its business has historically been concentrated in
California. While this concentration has declined, California remains a
significant part of the Company's business and contributed 37.9% of the
Company's total loan originations and purchases for 1996. Expansion outside
California began in late 1994. The number of retail branch offices within
California has declined from a historical high of 11 in 1992 to seven as of
February 28, 1997.
9
<PAGE>
The following table shows the geographic distribution of the Company's
loan originations and purchases for the years ended December 31:
1996 1995 1994
---------- --------- ----------
United States
California...................... 37.9% 43.0% 94.3%
Illinois........................ 14.2 14.1
Washington...................... 10.9 14.9 3.4
Florida......................... 6.7 8.1 0.1
Oregon.......................... 5.6 5.9 0.2
Colorado........................ 4.2 6.7 0.4
Pennsylvania.................... 3.9
Utah............................ 3.0 2.5
New Jersey...................... 3.0
Others states................... 9.7 4.8 1.6
United Kingdom.................... 0.9
---------- --------- ----------
Total........................... 100.0% 100.0% 100.0%
========== ========== ==========
Nationwide and International Geographic Expansion
The Company intends to continue to expand its existing retail branch
office network in the United States and in the United Kingdom. The Company
currently plans to open at least four new retail branch offices per year.
The Company's expansion strategy involves (i) identifying areas with
demographic statistics comparable to existing markets in which the Company
has been successful in originating loans, (ii) understanding each new
market's regulatory requirements and tailoring the Company's loan programs
and practices to comply with such requirements and (iii) identifying and
training branch managers and loan officers for each new retail branch
office.
The Company believes that its products and services are best suited for
those housing markets with home values near the nation's averages. After
identifying a potential new market, the Company contracts with regional or
national companies to gather publicly available information with respect to
that market and to integrate such information with the Company's proprietary
marketing methodology. The Company produces a list of Targeted Homeowners
that the Company believes, based on its historic customer profile, are
likely to utilize the Company's products and services and satisfy the
Company's underwriting guidelines than the average homeowner. The Company
then focuses its marketing efforts in the new market on the Targeted
Homeowners.
The Company has generally entered into short term leases for its retail
branch offices. Additionally, the Company generally recruits and hires the
personnel required to staff retail branch offices from the area near the new
market. Branch managers of new retail branch offices are generally branch
managers of existing retail branch offices or loan officers promoted from
existing retail branch offices.
Competition
As a consumer finance company, the Company continues to face intense
competition. Traditional competitors in the financial services business
include other mortgage banking companies, mortgage brokers, commercial
banks, credit unions, thrift institutions, credit card issuers and finance
companies. Many of these competitors in the consumer finance business are
substantially larger and have considerably greater financial, technical and
marketing resources than the Company. Competition can take many forms
including convenience in obtaining a loan, customer service, marketing and
distribution channels, amount of the loan, loan origination fees and
interest rates. In addition, the current level of gains realized by the
Company and its existing competitors on the sale of loans could attract
additional competitors into this market with the possible effect of lowering
gains on future loan sales owing to increased competition.
The Company believes that it is able to compete on the basis of
providing prompt and responsive service, consistent underwriting and
competitive loan programs to borrowers whose needs are not met by
conventional lending institutions.
10
<PAGE>
Regulation
The Company's business is subject to extensive regulation at both the
Federal and state level. Regulated matters include loan origination, credit
activities, maximum interest rates and finance and other charges, disclosure
to customers, terms of secured transactions, the collection, repossession
and claims handling procedures utilized by the Company, multiple
qualification and licensing requirements for doing business in various
jurisdictions and other trade practices.
Truth in Lending. The Truth in Lending Act ("TILA") and Regulation Z
promulgated thereunder contain certain disclosure requirements designed to
provide consumers with uniform, understandable information with respect to
the terms and conditions of loans and credit transactions in order to give
them the ability to compare credit terms. TILA also guarantees consumers a
three day right to cancel certain credit transactions including loans of the
type originated by the Company. Management of the Company believes that it
is in compliance with TILA in all material respects. If the Company were
found not to be in compliance with TILA, aggrieved borrowers could have the
right to rescind their loans and to demand, among other things, the return
of finance charges and fees paid to the Company.
In September 1994, the Riegle Act was enacted. Among other things, the
Riegle Act makes certain amendments to TILA (the "TILA Amendments"). The
TILA Amendments generally apply to mortgage loans (other than mortgage loans
to finance the acquisition or initial construction of a dwelling), with (i)
total loan origination fees and other fees upon origination in excess of the
greater of eight percent of the total loan amount or a certain dollar amount
(currently $400) or (ii) an annual percentage rate of more than ten
percentage points higher than comparably maturing U.S. Treasury securities
("Covered Loans"). The Company estimates that substantially all of the
loans currently originated or purchased by the Company are Covered Loans.
The TILA Amendments impose additional disclosure requirements on
lenders originating Covered Loans and prohibits lenders from engaging in a
pattern or practice of originating Covered Loans that are underwritten
solely on the basis of the borrower's home equity without regard to the
borrower's ability to repay the loan. The Company will, consistent with its
practices with respect to all loans, apply to all Covered Loans underwriting
criteria that take into consideration the borrower's ability to repay.
The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Covered Loans to borrowers with a monthly debt-to-income ratio in
excess of 50% or Covered Loans used to refinance existing loans originated
by the same lender or an affiliate of such lender. The Company reported
$4.0 million, $3.2 million and $3.1 million in prepayment fee revenue in
fiscal year 1996, 1995 and 1994, respectively. The Company will continue to
collect prepayment fees on loans originated prior to the October 1995
effectiveness of the TILA Amendments and on non-Covered Loans as well as on
Covered Loans in permitted circumstances. Compliance with the TILA
Amendments may cause the level of prepayment fee revenue to decline in
future years. The TILA Amendments impose other restrictions on Covered
Loans, including restrictions on balloon payments and negative amortization
features, which the Company does not believe will have a material impact on
its operations.
Other Lending Laws. The Company is also required to comply with the
Equal Credit Opportunity Act of 1974, as amended ("ECOA"), which prohibits
creditors from discriminating against applicants on certain prohibited
bases, including race, color, religion, national origin, sex, age or marital
status. Regulation B promulgated under ECOA restricts creditors from
obtaining certain types of information from loan applicants. Among other
things, it also requires certain disclosures by the lender regarding
consumer rights and requires lenders to advise applicants of the reasons for
any credit denial. In instances where the applicant is denied credit or the
rate or charge for loans increases as a result of information obtained from
a consumer credit agency, another statute, the Fair Credit Reporting Act of
1970, as amended, requires lenders to supply the applicant with the name and
address of the reporting agency. In addition, the Company is subject to the
Fair Housing Act and regulations thereunder, which broadly prohibit certain
discriminatory practices in connection with the Company's business. The
Company is also subject to the Real Estate Settlement Procedures Act of
1974, as amended.
In addition, the Company is subject to various other Federal and state
laws, rules and regulations governing among other things, the licensing of,
and procedures that must be followed by, mortgage lenders and servicers, and
disclosures that must be made to consumer borrowers. Failure to comply with
such laws, as well as with the laws described above, may result in civil and
criminal liability.
11
<PAGE>
Insurance Regulatory Laws. As a condition to funding its loans, the
Company requires each borrower to obtain and maintain a policy of insurance
providing coverage, at an amount equal to the greater of the replacement
cost or loan amount, for improvements on any real property securing the
borrower's loan. If the borrower fails to provide such coverage prior to
closing of the borrower's loan or if the borrower's coverage is subsequently
canceled or not renewed at any time during the loan period and the borrower
fails to obtain new coverage, the Company will provide coverage on the
borrower's behalf under policies insuring the Company's interest in the
collateral. Such practice is commonly referred to as "forced placement" of
insurance. The Company receives a fee in connection with its placement of
such insurance in California, which activity is not required to be licensed.
Insurance which is force placed is subject to regulation under TILA,
the National Flood Insurance Act, and state insurance regulatory and lender
statutes. Such laws and regulations generally impose disclosure and notice
requirements which must be satisfied prior to forced placement of coverage,
limitations on the amount of coverage that a lender may obtain to protect
its interest in the collateral, and restrictions on fees and charges that
the Company may assess in connection with such insurance.
In addition, in California only, the Company provides insurance agency
services with respect to credit life insurance and credit disability
insurance. The Company's sale of these insurance products in California is
subject to statutes and regulations applicable to insurance producers.
Failure to comply with any of the foregoing federal and state laws and
regulations could result in the imposition of civil penalties on the
Company, class action lawsuits and administrative enforcement actions.
United Kingdom Regulations. The Company's mortgage business in the
United Kingdom is subject to regulations promulgated under the United
Kingdom Consumer Credit Act of 1974 (the "CCA") with respect to loans made
to individuals or partnerships with principal balances of 15,000 UK pounds or
less. Loans with principal balances in excess of 15,000 UK pounds are not
currently regulated within the United Kingdom. The CCA and regulations
promulgated thereunder, among other things, impose licensing obligations on
the Company's United Kingdom subsidiaries, set down certain requirements
relating to the form, content, legibility, execution and delivery of loan
documents, restrict communication with the borrower prior to completion of a
transaction, require information and notice of enforcement to be given to
the borrower, require rebates to the borrower on early settlement and create
a cause of action for "extortionate credit bargains". A license is required
to service loans in the United Kingdom irrespective of the size of the loan.
Failure to comply with the requirements of these rules and regulations can
result in the revocation or suspension of the license to do business and
render the mortgage unenforceable in the absence of a court order.
The Company's operations in the United Kingdom involve loans with
principal balances in excess of 15,000 UK pounds and are therefore largely
unregulated.
Environmental Matters
To date, the Company has not been required to perform any investigation
or clean up activities, nor has it been subject to any environmental claims.
There can be no assurance, however, that this will remain the case in the
future.
In the course of its business, the Company, generally on behalf of the
REMIC trusts, has acquired and may acquire in the future properties securing
loans that are in default. Although the Company primarily lends to owners
of residential properties, there is a risk that the Company could be
required to investigate and clean up hazardous or toxic substances or
chemical releases at such properties after acquisition by the Company, and
may be held liable to a governmental entity or to third parties for property
damage, personal injury and investigation and cleanup costs incurred by such
parties in connection with the contamination. In addition, the owner or
former owners of a contaminated site may be subject to common law claims by
third parties based on damages and costs resulting from environmental
contamination emanating from such property.
12
<PAGE>
Employees
As of February 28, 1997, the Company had a total of 404 employees. The
Company has 235 employees working at its corporate headquarters. None of
the Company employees is covered by a collective bargaining agreement. The
Company considers its relations with its employees to be good.
Item 2. Properties.
The Company leases its corporate headquarters, which are located at
17305 Von Karman Avenue, Irvine, California, 92614-6203, from a partnership
beneficially owned by its principal stockholder. The Company also leases
space for all of its retail branch offices, its mail processing center in
Orange, California and a telemarketing office in Placentia, California. The
Company believes its facilities are both suitable and adequate for the
current business activities conducted at its corporate headquarters and at
its existing retail branch offices.
Item 3. Legal Proceedings.
The Company is a party to various routine legal proceedings arising out
of the ordinary course of its business. Management believes that none of
these actions, individually or in the aggregate, will have a material
adverse effect on the consolidated financial condition or results of
operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1996.
13
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
In July 1996, the Company's Class A Common Stock began trading under
the symbol FACO on the NASDAQ National Market. The following table sets
forth the range of high and low closing sale prices of the Company's Class A
Common Stock for the periods indicated:
High Low
---------- ----------
1996
Third Quarter $ 25.25 $ 18.63
Fourth Quarter $ 30.50 $ 22.00
No dividends were declared during the period covered by the above
table. The Company does not anticipate declaring dividends in the near
future. However, the Board of Directors of the Company reviews the
Company's dividend policy at least annually in light of earnings, cash
position and capital needs of the Company, general business conditions and
other relevant factors.
On February 28, 1997, the Company had approximately 7 stockholders of
record of its Class A Common Stock. The Company believes its Class A Common
Stock is beneficially held by more than 2,200 stockholders.
14
<PAGE>
<TABLE>
Item 6. Selected Financial Data
FIRST ALLIANCE CORPORATION
SELECTED CONSOLIDATED FINANCIAL DATA
<CAPTION>
1996 (5) 1995 1994 (3) 1993 (3) 1992
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Statement of Income Data:
Gain (loss) on sale of loans....... $ 10,965 $ 8,982 $ (1,547) $ 2,056 $ 1,731
Origination fees and other......... 37,206 26,484 29,449 20,433 18,275
Servicing and other fees revenue... 8,854 8,614 9,106 8,989 7,145
Interest revenue................... 13,562 14,624 8,650 4,452 2,285
Total revenue...................... 70,871 58,880 45,802 35,950 29,468
Interest expense................... 2,655 4,167 3,744 2,106 871
Noninterest expense (4)............ 29,977 23,693 26,824 22,881 17,934
Income before income tax provision. 38,239 31,020 15,234 10,963 10,663
Net income......................... 32,139 30,542 14,871 10,741 10,395
Net income per share............... 2.59 2.87 1.40 1.01 0.98
Pro forma net income (1)........... 22,561 18,302 8,988 6,468 6,291
Pro forma net income per share (1). 1.53 1.24 0.61 0.44 0.43
Income before income tax provision
as a % of revenue................ 54.0% 52.7% 33.3% 30.5% 36.2%
Dividends declared (2)............. $ 60,080 $ 12,205 $ 7,341 $ 5,853 $ 3,987
Balance Sheet Data:
Cash and cash equivalents.......... $ 27,414 $ 4,019 $ 5,298 $ 4,387 $ 1,111
Loans held for sale................ 11,023 24,744 18,676 74,196 10,080
Residual interests................. 29,253 19,705 11,645 6,879 2,792
Total assets....................... 87,457 66,911 48,266 99,855 24,517
Total borrowings................... 131 19,356 14,839 68,773 966
Stockholders' equity............... 77,978 42,321 23,984 26,454 21,566
Other Data:
Loan originations and purchases
Retail branch originations....... $ 274,813 $ 200,371 $ 151,338 $ 148,718 $ 93,596
Portfolio refinancing originations 16,994 16,195 70,501 47,189
Wholesale purchases.............. 32,681 24,078 91,826 84,034 13,622
---------- ---------- ---------- ---------- ----------
Total.......................... $ 324,488 $ 240,644 $ 313,665 $ 279,941 $ 107,218
========== ========== ========== ========== ==========
Average retail branch origination
loan size........................ $ 82 $ 69 $ 66 $ 54 $ 36
Number of retail branches.......... 23 17 13 11 11
Weighted average interest rate
on loan originations and purchases 9.6% 10.3% 8.7% 9.5% 13.6%
Weighted average initial combined
loan-to-value ratio:
Retail branch and portfolio
refinancing originations..... 61.7% 58.6% 54.4% 52.4% 46.6%
Wholesale purchases............ 67.3% 66.5% 60.5% 61.6% 61.4%
Weighted average loan originations
and processing fees as a % of gross
retail branch loan originations. 14.8% 15.3% 15.6% 17.8% 22.2%
Loan sales
Securitizations.................. $ 267,661 $ 167,974 $ 350,331 $ 141,795 $ 39,024
Whole loan sales................. 71,864 65,251 22,857 70,554 69,298
---------- ---------- ---------- ---------- ----------
Total.......................... $ 339,525 $ 233,225 $ 373,188 $ 212,349 $ 108,322
========== ========== ========== ========== ==========
Servicing portfolio................ $ 641,191 $ 613,791 $ 555,685 $ 385,570 $ 240,221
Total delinquencies as a % of the
servicing portfolio.............. 5.5% 5.8% 4.3% 4.0% 5.0%
Real estate owned as a % of the
servicing portfolio.............. 0.6% 1.3% 0.6% 0.9% 0.6%
Losses on real estate owned as a
% of the average servicing portfolio
during the period................ 0.35% 0.03% 0.01% 0.02% 0.02%
(1) Pro forma amounts reflect adjustments for Federal and state income taxes as if the Company had
been taxed as a C corporation rather than as an S corporation. Pro forma net income per share
assumes that the total number of shares outstanding upon completion of the Company's initial public
offering were outstanding in all prior periods.
(2) Included in dividends in 1996 is $45.0 million of S distribution dividends made in anticipation
of the Company's initial public offering. Historical dividends include dividends used by the
stockholder to pay income taxes on the Company's S corporation earnings and are not necessarily
indicative of dividends expected to be declared in the future.
(3) The Company typically securitizes or sells most of its loan origination and purchases within
each year. At the end of 1993, the Company had $74 million of loans held for sale resulting in
increased assets and increased borrowings on the Company's warehouse financing facility. These loans
were sold in 1994 resulting in an increase in the ratio of loan sales to loan originations and
purchases in 1994 as compared to other years.
(4) During 1994 and 1993, the Company incurred legal expenses and settlement costs of $7 million and
$2 million, respectively, related to litigation initiated in December of 1989.
(5) During 1996, the Company completed an initial public offering whereby 4,025,000 shares of Class
A Common Stock were issued and the Company changed its tax status from that of an S corporation to a
C corporation. The Company received $63.1 million of net proceeds from the initial public offering,
of which $45.0 million was used to pay off the S distribution notes.
</TABLE>
15
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation.
General
The Company is a financial services organization principally engaged in
mortgage loan origination, purchases, sales and servicing. Loans originated
by the Company primarily consist of fixed and adjustable rate loans secured
by first mortgages on single family residences. The Company originates
loans through its retail branch network which is currently comprised of one
office in the United Kingdom and 23 offices in the United States, seven of
which are located in California, two of which are located in each of
Florida, Illinois, New York and New Jersey and one of which is located in
each of Oregon, Washington, Colorado, Utah, Arizona, Ohio, Georgia and
Pennsylvania. In addition, the Company purchases loans from qualified
mortgage originators. The Company sells loans to wholesale purchasers or
securitizes them in the form of REMIC trusts. A significant portion of the
Company's loan production is securitized with the Company retaining the
right to service the loans.
In July and August of 1996, FACO completed an initial public offering
(the "Offering") whereby 4,025,000 shares of its Class A Common Stock were
sold to the public. Concurrently, 10,750,000 shares of the Class B Common
Stock of FACO were issued in exchange for all of the issued and outstanding
shares of First Alliance Mortgage Company ("FAMCO") as part of a
reorganization whereby FAMCO became a wholly owned subsidiary of FACO. The
consolidated financial condition and results of operations of the Company
for periods prior to the date of the reorganization substantially consist of
those of FAMCO.
Prior to 1992, the Company sold its loans to private investors on a
servicing retained basis. Since that time, the Company has sold the
majority of its loans in the secondary market primarily through
securitization and recently, to a lesser extent, through whole loan sales in
which the Company does not retain servicing rights. The Company's
underwriting guidelines require threshold credit criteria and combined loan-
to-value limits for loans sold through securitizations. Accordingly, the
Company sells on a servicing released basis those loans which do not meet
its risk criteria for securitization. The Company retains the right to
service loans which it has securitized.
The Company's strategy of originating, as compared to purchasing, the
majority of its loan volume results in the generation of a significant
amount of loan origination fees. This income has allowed the Company to
generate positive operating cash flow. There can be no assurance, however,
that the Company's operating cash flow will continue to be positive in the
future.
Certain Accounting Considerations
As a fundamental part of its business and financing strategy, the
Company securitizes the majority of its loans in the form of REMIC trusts
whereby the loans are exchanged for regular and residual interests in the
REMIC trusts. A significant portion of the Company's income is associated
with securitization activity.
Gains on servicing released whole loan sales equal the difference
between the net proceeds to the Company from such sales and the loans'
acquisition cost (for purchased loans) or net carrying value (for originated
loans). The net carrying value of originated loans is equal to their
principal balance less net deferred origination fees.
Gains on servicing retained sales of loans through securitization
represent the difference between the net proceeds to the Company in the
securitization and the allocated cost of loans securitized. The allocated
cost of the loans securitized is determined by allocating their acquisition
cost (for purchased loans) or net carrying value (for originated loans)
between the loans securitized and the mortgage servicing rights retained
with respect thereto based upon their relative fair values.
16
<PAGE>
The net proceeds of a securitization consist of the regular and
residual interests received by the Company net of transaction costs. The
regular interests are immediately sold for cash by the Company. As the
holder of the residual interests, the Company is entitled to receive certain
excess cash flows. These excess cash flows are calculated as the difference
between (a) principal and interest paid by borrowers and (b) the sum of (i)
pass-through principal and interest to be paid to holders of the regular
interests, (ii) trustee fees, (iii) third-party credit enhancement fees,
(iv) servicing fees and (v) loan losses. The Company's right to receive
these excess cash flows begins after certain overcollaterization
requirements, which are specific to each securitization and are used as a
means of credit enhancement, have been met.
The Company carries residual interests at fair value. As such, the
carrying value of these securities is impacted by changes in market interest
rates and prepayment and loss experiences of these and similar securities.
The Company determines the fair value of the residual interests utilizing
prepayment, credit loss and other assumptions appropriate for each
particular securitization consistent with those an unrelated third party
would utilize to value such securities. To the Company's knowledge, there
is no active market for the sale of these residual interests. 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.
Prepayments are expressed through a market convention known as an annual
constant prepayment rate ("CPR"). In its past securitizations, the Company
has experienced a CPR on the securitized loans ranging from 9.6% to 48.4%.
Non-conventional mortgage loans, and the Company's loans, historically
prepay at a faster rate than conventional mortgage loans. At origination,
the Company utilized prepayment assumptions ranging from 25.0% to 40.0%,
estimated loss factor assumptions of 0.5% and weighted average discount
rates of 18.0%, 18.0% and 23.6% for the years ended December 31, 1996, 1995,
and 1994, respectively, to value residual interests. Based upon the
historical performance of its loans, the Company expects its securitized
pools to have average lives of three to five years. As of December 31,
1996, the Company's investments in residual interests totaled $29.3 million.
To determine the fair value of mortgage servicing rights, the Company
computes the present value of projected net cash flows expected to be
received over the life of the loans. Such projections incorporate
assumptions, including servicing costs, prepayment rates and discount rates,
consistent with those an unrelated third party would utilize to value such
mortgage servicing rights. These assumptions are similar to those used by
the Company to value residual interests. The Company periodically evaluates
capitalized mortgage servicing rights for impairment, which is measured as
the excess of unamortized cost over fair value. This review is performed on
a disaggregated basis based on loan type. The Company, which generally
makes loans to credit impaired borrowers, has found that credit impaired
borrowers are payment sensitive rather than interest rate sensitive.
Therefore, the Company does not consider interest rates a predominant risk
characteristic for purposes of evaluating impairment. As of December 31,
1996, mortgage servicing rights totaled $6.0 million.
The three primary components of the Company's revenue are loan
origination and sale, loan servicing and other fees and interest income.
Loan origination and sale revenue consists of gain on sale of loans and
the recognition of net deferred origination fees. A significant portion of
loan origination and sale revenue is the recognition upon sale of net
deferred origination fees, which equaled $36.9 million, or 77% of loan
origination and sale revenue during 1996.
Loan servicing and other fee income represents management servicing
fees and other ancillary fees received for servicing loans. Mortgage
servicing rights are amortized against loan servicing and other fee revenue
over the period of estimated net future servicing fee income.
Interest income is comprised of two primary components: (i) interest on
loans held for sale during the warehousing period and (ii) the effective
yield on residual interests. The Company recognizes interest income from
residual interests on a level yield basis over the expected lives of the
securitized loans. At the end of each quarter, the Company computes an
effective yield based on each residual interest's then-current estimate of
future cash flows. This effective yield is used to accrue interest income
in the subsequent quarter.
17
<PAGE>
Loan Origination and Purchases
For the Year Ended December 31,
--------------------------------
1996 1995 1994
---------- ---------- ----------
(Dollars in thousands)
Loan originations and purchases:
Retail branch originations....... $ 274,813 $ 200,371 $ 151,338
Portfolio refinancing
originations (1)............... 16,994 16,195 70,501
Wholesale purchases.............. 32,681 24,078 91,826
---------- ---------- ----------
Total originations and
purchases.................. $ 324,488 $ 240,644 $ 313,665
========== ========== ==========
Number of retail branches as of
the end of the period:
United States:
California..................... 7 7 11
Other States................... 15 10 2
United Kingdom................... 1
---------- ---------- ----------
Total........................ 23 17 13
========== ========== ==========
Weighted average initial interest rate 9.6% 10.3% 8.7%
Weighted average initial combined
loan-to-value ratio:
Retail branch and portfolio
refinancing originations....... 61.7% 58.6% 54.4%
Wholesale purchases.............. 67.3% 66.5% 60.5%
Average retail branch origination
loan size........................ $ 82 $ 69 $ 66
Weighted average loan origination
and processing fees as a percent
of gross loans originated:
Retail branch originations....... 14.8% 15.3% 15.6%
Portfolio refinancing originations (1) 5.0% 13.0% 7.5%
Combined......................... 14.2% 15.1% 13.0%
(1) Portfolio refinancing originations consist primarily of loans
originated by the Company's centralized marketing and sales efforts. Such
efforts focus on preserving the Company's existing portfolio through
refinancing loans to borrowers who have inquired about prepaying their
existing loans. Loan origination fees on portfolio refinancing originations
are less than fees for retail branch originations as customary fees are
waived or reduced as an incentive to refinance with the Company.
Originations and purchases increased 35% in 1996 to $324 million from
$241 million in 1995, which in turn was a decrease of 23% from $314 million
in 1994. Retail branch originations increased 37% and 32% in 1996 and 1995,
respectively, as compared to the corresponding prior year amounts. The
increase in retail branch originations is primarily the result of new retail
branch offices opened in 1996 and 1995. The decrease in originations and
purchases in 1995 was due to decreases in portfolio refinancing
originations, resulting from changes in the Company's portfolio refinancing
programs, and decreases in wholesale purchases, resulting from the
curtailment of certain loan purchase programs.
18
<PAGE>
Loan Sales
For the Year Ended December 31,
--------------------------------
1996 1995 1994
---------- ---------- ----------
(Dollars in thousands)
Securitizations.................... $ 267,661 $ 167,974 $ 350,331
Whole loan sales................... 71,864 65,251 22,857
---------- ---------- ----------
Total........................... $ 339,525 $ 233,225 $ 373,188
========== ========== ==========
Loan sales, including securitizations of loans, increased 46% in 1996
to $340 million from $233 million in 1995, which had decreased 38% from $373
million in 1994. The increase in 1996 is due primarily to the increase in
retail branch originations in 1996. The decrease in 1995 was primarily due
to decreased portfolio refinancing originations and wholesale loan purchases
in 1995 as well as the timing of loan sales in 1994 and 1993, offset by the
increase in retail branch originations.
Composition of Revenue and Expense
The following table summarizes certain components of the Company's
consolidated statements of income set forth as a percentage of total revenue
for the years ended December 31:
1996 1995 1994
---------- ---------- ----------
REVENUE:
Loan origination and sale:
Gain (loss) on sale of loans....... 15.5 % 15.3 % (3.4)%
Net loan origination and other fees 52.5 45.0 64.3
Loan servicing and other fees........ 12.5 14.6 19.9
Interest............................. 19.1 24.8 18.9
Other................................ 0.4 0.3 0.3
---------- ---------- ----------
Total revenue.................... 100.0 100.0 100.0
========== ========== ==========
EXPENSE:
Compensation and benefits............ 21.9 17.7 20.9
Professional services................ 1.8 1.3 3.3
Advertising.......................... 5.9 7.4 7.2
Subservicing and other fees.......... 1.0 2.1 2.2
Rent................................. 2.2 2.2 2.1
Supplies............................. 2.2 2.1 1.8
Depreciation and amortization........ 1.2 1.5 1.1
Interest............................. 3.7 7.1 8.2
Legal................................ 1.3 2.5 15.6
Travel, relocation and training...... 1.6 1.3 0.8
Other................................ 3.2 2.1 3.5
---------- ---------- ----------
Total expense.................... 46.0 47.3 66.7
---------- ---------- ----------
Income before income tax provision..... 54.0 52.7 33.3
Income tax provision................... 8.7 0.8 0.8
---------- ---------- ----------
Net income............................. 45.3 % 51.9 % 32.5 %
========== ========== ==========
19
<PAGE>
Results of Operations for the Three Years Ended December 31, 1996
Revenue
The following table sets forth the components of the Company's revenue
for the years ended December 31:
1996 1995 1994
---------- ---------- ----------
(Dollars in thousands)
Loan origination and sale:
Gain (loss) on sale of loans (1)..... $ 10,965 $ 8,982 $ (1,547)
Net loan origination and other fees.. 37,206 26,484 29,449
Loan servicing and other fees.......... 8,854 8,614 9,106
Interest............................... 13,562 14,624 8,650
Other.................................. 284 176 144
---------- ---------- ----------
Total revenue...................... $ 70,871 $ 58,880 $ 45,802
========== ========== ==========
(1) Excluding net loan origination and other fees
The increases in total revenues in 1996 and 1995 of 20% and 29%,
respectively, from the prior year amounts were primarily due to increased
loan origination and sale revenue and, in 1995, increased interest income
from residual interests.
Loan origination and sale revenue increased 36% in 1996 to $48.2
million from $35.5 million in 1995, which increased 27% from $27.9 million
in 1994.
The 22% increase in gain (loss) on sale of loans in 1996 as compared to
1995 was due to the increased volume of loans sold offset by lower premiums
realized on loan sales. The weighted average gain on sales of loans as a
percentage of loan principal balances decreased to 3.2% in 1996 from 3.9% in
1995. This decrease was primarily due to decreased weighted average initial
gross spreads (the difference between the initial weighted average interest
rates for the loans included in the securitizations and the initial weighted
average pass-through interest rates paid to holders of the regular interests
in the securitizations) in residual interests originated in securitizations
which decreased to 2.9% in 1996 from 3.8% in 1995. Gross spreads decreased
due to increasing interest rates during the first half of 1996 as compared
to decreasing interest rates during the first nine months of 1995. These
decreased gross spreads were offset by the results of the Company's hedging
activities which had realized gains of $0.4 million in 1996 as compared to
realized losses of $0.3 million in 1995. Since April 1996, the Company has
continuously hedged fixed rate loans held for sale and commitments to fund
fixed rate loans.
Gain (loss) on sales of loans increased to a gain of $9.0 million in
1995 from a loss of $1.5 million in 1994. This increase was due primarily
to increased premiums on loan sales. The weighted average gain (loss) on
sales of loans as a percentage of loan principal balances increased to a
weighted average gain on sale of loans of 3.9% in 1995 from a weighted
average loss on sale of loans in 1994 of 0.4%. Such increase was primarily
the combined result of (i) gross spreads in residual interests originated in
securitizations which increased to 3.8% in 1995 from 2.4% in 1994 primarily
as a result of decreasing interest rates during 1995 as compared to
increasing interest rates during 1994; (ii) decreased levels of required
initial overcollateralization, which decreased from $2.8 million, or .81% of
the related regular interests balances, in 1994 to $0.1 million, or .04% of
the related regular interests balances, in 1995; and (iii) recognition of
$3.9 million of capitalized mortgage servicing rights originated during 1995
due to the adoption of SFAS No. 122 in 1995 (accordingly no such assets were
recognized in 1994). These increases were offset by the results of the
Company's hedging activities which had realized losses of $0.3 million in
1995 as compared to realized gains of $0.8 million in 1994.
Net loan origination and other fees increased 40% to $37.2 million in
1996 from $26.5 million in 1995 due primarily to increased loan sales. The
10% decrease in net loan origination and other fees in 1995 from $29.4
million in 1994 was primarily due to a corresponding decrease in sales of
loans originated by the Company's retail branch offices.
20
<PAGE>
Loan servicing and other fees as a percentage of the average servicing
portfolio were 1.4%, 1.5% and 1.9% in 1996, 1995 and 1994, respectively.
The decrease in 1995 as compared to 1994 was due primarily to a decrease in
the weighted average servicing rate earned on the Company's servicing
portfolio which decreased to 0.8% in 1995 from 1.1% in 1994 as a result of a
decrease in the proportion of private investor loans to total loans
serviced. The Company earns higher servicing rates on loans sold to private
investors than on loans securitized. Loans sold to private investors as a
percentage of the average servicing portfolio decreased to 13% in 1995 from
25% in 1994, resulting in a decrease in the weighted average servicing rate.
Interest income decreased $1.0 million, or 7%, in 1996 as compared to
1995. Interest income from loans held for sale and loans receivable held for
investment decreased $3.8 million due primarily to a decrease in the average
balance of loans outstanding. This was the result of a decrease in the
average holding period of loans held for sale as the Company completed
securitizations in each quarter of 1996, as compared to two securitizations
in 1995, and the paydown of loans receivable held for investment. Interest
income from residual interests increased $2.5 million due primarily to an
increase in the average balance of residual interests, which increased to
$23.3 million in 1996 from $15.2 million in 1995.
Interest income increased $6.0 million, or 69%, in 1995 as compared to
1994. Interest income from residual interests increased $4.0 million due to
the combined effect of an increase in the average balance of residual
interests, which increased to $15.2 million in 1995 from $10.3 million in
1994, and an increase in the weighted average effective yield on residual
interests. The increase in the weighted average effective yield in residual
interests is due primarily to the favorable performance of the residual
interests originated in 1994 as compared to assumptions used in computing
their fair value at origination. Interest income from loans held for sale
increased $0.9 million in 1995 due to an increase in the weighted average
interest rate on loans originated and purchased which increased to
approximately 10.3% in 1995 from 8.7% in 1994. Interest on loans receivable
held for investment increased $1.0 million in 1995 due to an increase in the
average balance of loans receivable held for investment.
Expense
The following table sets forth the components of the Company's expenses
for the years ended December 31:
1996 1995 1994
---------- ---------- ----------
(Dollars in thousands)
Compensation and benefits.............. $ 15,488 $ 10,416 $ 9,559
Professional services.................. 1,263 787 1,521
Advertising............................ 4,191 4,345 3,316
Subservicing and other fees............ 683 1,212 1,019
Rent................................... 1,530 1,278 974
Supplies............................... 1,575 1,214 831
Depreciation and amortization.......... 838 907 514
Interest............................... 2,655 4,167 3,744
Legal.................................. 917 1,491 7,162
Travel, relocation and training........ 1,103 788 351
Other.................................. 2,389 1,255 1,577
---------- ---------- ----------
Total expense.......................... $ 32,632 $ 27,860 $ 30,568
========== ========== ==========
Total expenses increased $4.8 million, or 17%, in 1996 as compared to
1995 due primarily to increases in compensation and benefits. Total
expenses decreased $2.7 million to $27.9 million in 1995 from $30.6 million
in 1994 due primarily to decreases in legal and professional services offset
by increases in compensation and benefits and advertising.
The increases in compensation and benefits in 1996 and 1995 of $5.1
million and $0.9 million, respectively, were due primarily to increases in
personnel to support the Company's retail branch office expansion. In
addition, in 1996, the Company reduced the use of outside telemarketing
services and increased the number of employees in its internal telemarketing
operations.
21
<PAGE>
The increase in professional services of $0.5 million in 1996 as
compared to 1995 was due primarily to increased costs related to the
recruitment of employees to support the Company's retail branch office
expansion. As a result of the discontinuation of portfolio refinancing
origination programs utilizing the services of outside consultants,
professional services decreased $0.8 million in 1995 as compared to 1994.
Advertising expense as a percentage of retail branch originations was
1.5% in 1996 and 2.2% in 1995 and 1994. The decrease in 1996 as compared to
1995 is due primarily to the reduction in the use of outside telemarketing
services and the increase in the number of employees in the Company's
internal telemarketing operations.
Sub-servicing and other fees decreased 44%, or $0.5 million, in 1996 as
compared to 1995 because the servicing of adjustable rate loans, previously
sub-serviced by a third party, was transferred to the Company after the
Company had installed a new loan servicing software system which enabled it
to service such loans.
Combined, rent and supplies increased 25% in 1996 as compared to 1995,
and 38% in 1995 as compared to 1994, primarily as a result of the opening of
new retail branch offices in 1996 and 1995. The number of retail branch
offices increased from 13 at December 31, 1994 to 17 at December 31, 1995 to
23 at December 31, 1996.
Depreciation and amortization increased $0.4 million in 1995 as
compared to 1994. This increase is primarily related to the write off of
$0.2 million in 1995 of the remaining book value of the Company's loan
servicing system due to implementation of a new system.
Interest expense decreased $1.5 million in 1996 as compared to 1995 due
primarily to a decrease in interest expense on the warehouse financing
facilities of $1.8 million offset by an increase of $0.4 million in interest
expense paid to stockholders related to stockholder notes payable and S
distribution notes. Due to the increased frequency of securitizations in
1996 as compared to 1995, the average outstanding balance of the warehouse
financing facilities decreased 42% resulting in a decrease in the related
interest expense. The increase in interest expense associated with
stockholder notes payable and S distribution notes was due primarily to an
increase in the average balance outstanding during 1996 which was due to the
distribution, in anticipation of the Offering, of the S distribution notes
in 1996.
Interest expense increased $0.4 million in 1995 as compared to 1994 due
primarily to increases in interest expense on the warehouse financing
facilities of $0.3 million and interest expense related to stockholder notes
payable of $0.2 million. Increased interest expense associated with the
warehouse financing facilities was due to an increase in the weighted
average interest rate, which increased to 7.10% in 1995 from 5.96% in 1994.
Increased interest expense associated with stockholder notes payable was due
to an increase in the average balance outstanding during 1995.
Legal expense decreased $0.6 million in 1996 as compared to 1995, and
$5.7 million in 1995 as compared to 1994. The decrease in legal costs in
1996 was primarily due to a $0.8 million decrease in legal settlement costs.
During 1994, the Company recorded legal expenses and estimated settlement
costs of $7.0 million related to a class action suit filed in December of
1989 in which the Company was named as the defendant. Additionally, during
1994, the Company incurred approximately $0.4 million in legal fees as the
plaintiff in litigation for which the Company received a $1.3 million
judgment in its favor.
Travel, relocation and training increased $0.3 million and $0.4 million
in 1996 and 1995, respectively, due primarily to expenses incurred related
to the Company's retail branch office expansion.
Other expenses increased $1.1 million to $2.4 million in 1996 as
compared to $1.3 million in 1995, which had decreased from $1.6 million in
1994. The increase in 1996 and decrease in 1995 was due primarily to losses
and gains realized on real estate owned ("REO"). In 1996, losses on REO
amounted to $0.2 million as compared to gains of $0.5 million in 1995 and
$0.2 million in 1994. The losses in 1996 reflects the Company's decision to
aggressively reduce the balance of its REO portfolio which decreased to $0.3
million at December 31, 1996 from $1.5 million at December 31, 1995.
22
<PAGE>
Income Taxes
From May 1, 1988 until the close of the Offering, the Company had
elected to be treated for Federal income and certain state tax purposes as
an S corporation under Subchapter S of the Internal Revenue Code and
comparable state laws. As a result, the Company's provisions for income
taxes during that period reflected modest corporate level state income taxes
for those states in which the Company operates. The taxable income of the
Company during such periods has been included in the individual taxable
income of its stockholders for Federal and state income tax purposes.
Effective upon the closing of the Offering in July 1996, the Company's
S corporation status was terminated and the Company became subject to full
corporate Federal and state income taxes. In conjunction with the
termination of the Company's S corporation status, the Company recorded $3.1
million of net deferred tax assets related to temporary differences between
financial reporting and tax basis of assets and liabilities measured by
applying enacted tax rates and law to taxable years in which such temporary
differences are expected to be recovered or settled. Subsequent to the
Offering, the Company's effective income tax rate is anticipated to
approximate the Federal and composite state income tax rates (net of Federal
benefit). If the Company had been fully subject to Federal and state income
taxes, net income on a pro forma basis would have been $22.6 million, $18.3
million and $9.0 million in 1996, 1995 and 1994, respectively.
Servicing
At December 31, 1996, total delinquent loans were 5.5% of the Company's
servicing portfolio as compared to 5.8% at December 31, 1995 and 4.3% at
December 31, 1994. Loan losses as a percentage of the average servicing
portfolio were 0.35%, 0.03% and 0.01% in 1996, 1995 and 1994, respectively.
The increases in loan losses in 1996 were principally due to the disposition
of properties acquired through foreclosures of wholesale loans purchased in
1993 and 1994 from certain originators from whom the Company no longer
purchases loans.
The following tables provide data on loan delinquency, REO and net
losses for the Company's servicing portfolio:
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------------------------
1996 1995 1994
---------------------- --------------------- ----------------------
% of % of % of
(Dollars in Servicing (Dollars in Servicing (Dollars in Servicing
thousands) Portfolio thousands) Portfolio thousands) Portfolio
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Servicing Portfolio........ $ 641,191 $ 613,791 $ 555,685
========== ========== ==========
30-59 days delinquent...... $ 9,359 1.5% $ 8,339 1.4% $ 6,084 1.1%
60-89 days delinquent...... 6,704 1.0 6,538 1.0 4,471 0.8
90 days or more delinquent. 19,081 3.0 21,002 3.4 13,589 2.4
---------- ---------- ---------- ---------- ---------- ----------
Total delinquencies.... $ 35,144 5.5% $ 35,879 5.8% $ 24,144 4.3%
========== ========== ========== ========== ========== ==========
REO (1).................... $ 3,951 0.6% $ 7,854 1.3% $ 3,386 0.6%
========== ========== ========== ========== ========== ==========
</TABLE>
For the Year Ended December 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
(Dollars in thousands)
Average servicing portfolio (2)........ $ 615,393 $ 583,943 $ 470,628
Net losses (3)......................... 2,160 169 44
Percentage of average servicing
portfolio............................ 0.35% 0.03% 0.01%
(1) Includes REO of the Company as well as REO of the REMIC trusts serviced
by the Company; however, excludes private investor REO not serviced by
the Company.
(2) Average servicing portfolio balance equals the quarterly average of the
servicing portfolio computed as the average of the balance at the beginning
and end of each quarter.
(3) Net losses represent losses realized with respect to disposition of REO.
23
<PAGE>
Liquidity And Capital Resources
During the third quarter of 1996, the Company completed the Offering
whereby 4,025,000 shares of Class A Common Stock were sold resulting in
gross proceeds of $68.4 million. After deducting underwriting discounts and
offering costs, the net proceeds of $63.1 million were used to pay $45.0
million of S distribution notes, to pay down $12.9 million of the Company's
warehouse financing facilities and to fund current operations.
Historically, the Company has generated positive cash flow. The
Company's sources of cash include loan sales, sales of regular interests,
borrowings under its warehouse financing facilities, distributions received
from residual interests, interest income and loan servicing income. The
Company's uses of cash include the funding of loan originations and
purchases, payments of interest, repayment of its warehouse financing
facilities, funding of any initial overcollateralization deposit
requirements for securitizations, capital expenditures, operating and
administrative expenses and payment of income taxes. At origination of a
loan, the Company includes the loan origination fees in the principal
balance, and, if not utilizing available cash, borrows the approximate
principal balance of the loan under its warehousing financing facilities.
As the amount funded to the borrower is net of the loan origination fees,
the Company generates cash approximating the loan origination fees at the
time of funding of the loan under the warehouse financing facilities. Total
cash generated from the sales of loans and regular interests in securities
is then used to pay down the warehouse financing facilities. Cash provided
by operating activities plus net (repayments) borrowings on the warehouse
financing facilities was $20.2 million in 1996 as compared to $10.8 million
in 1995 and $19.0 million in 1994.
In securitizations, the portion of the gain recorded by the Company
representing the recorded value of residual interests is a non-cash gain on
which the Company is required to pay income tax. These income taxes payable
and the expenses associated with a securitization have a negative impact on
the Company's cash flow.
The Company's ability to continue to originate and purchase loans is
dependent upon adequate credit facilities and upon its ability to sell the
loans in the secondary market in order to generate cash proceeds for new
originations and purchases. The value of and market for the Company's loans
are dependent upon a number of factors, including general economic
conditions, interest rates and governmental regulations. Adverse changes in
such factors may affect the Company's ability to sell loans for acceptable
prices within a reasonable period of time. A prolonged, substantial
reduction in the size of the secondary market for loans of the type
originated or purchased by the Company may adversely affect the Company's
ability to sell loans in the secondary market with a consequent adverse
impact on the Company's results of operations, financial condition and
ability to fund future originations and purchases.
The Company's $125 million warehouse financing facility, which is
secured by loans originated or purchased by the Company and currently bears
interest at a rate of 0.80% over 30 day London Interbank Offered Rate
("LIBOR"), expires on March 31, 1997. The Company's $25 million warehouse
financing facility, which is secured by loans originated or purchased by the
Company and currently bears interest at a rate of 0.80% over 30 or 90 day
LIBOR, expires on March 3, 1998. Management expects, although there can be
no assurance, that the Company will be able to maintain these warehouse
financing facilities (or obtain replacement or additional financing) in the
future.
In February 1997 the Company entered into agreements to provide
warehouse financing facilities to two mortgage banking companies
("Borrowers") that were controlled by family members of the Company's
principal stockholder. These lines of credit are secured by loans
originated by the Borrowers and by personal guarantees provided by
stockholders of the Borrowers, bear interest at 10%, have a combined
borrowing limit of $15 million and expire on July 31, 1998.
As of December 31, 1996, the Company had commitments to fund loans of
$7.5 million. Historically, approximately 55% of such commitments have
ultimately been funded. Capital expenditures totaled $2.3 million, $1.0
million and $0.9 million in 1996, 1995, and 1994, respectively. The
increase in capital expenditures in 1996 relates primarily to the
acquisition of a new loan servicing system and the Company's move to new
administration offices.
The Company paid dividends, including amounts to be used by the
stockholders for the payment of personal income tax on the earnings of the S
corporation, of $15.1 million, $12.2 million and $17.3 million in 1996, 1995
and 1994, respectively. In addition, in 1996, in anticipation of the
termination of the Company's S corporation status at the time of the
Offering, the Company distributed S distribution notes to the stockholders
of the Company totaling $45.0 million. Proceeds from the Offering were used
to pay the S distributions notes in 1996. No dividends have been declared
since the Company completed the Offering.
24
<PAGE>
The Company believes that cash flows from operations, net proceeds from
securitizations and whole loan sales and the availability of funds under the
warehouse financing facilities will be sufficient to fund operating needs
and capital expenditures for the ensuing 12 months.
Effects Of Recent Accounting Pronouncements
In 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123 "Accounting for Stock-
Based Compensation"("SFAS 123"), which encourages companies to account for
stock compensation awards based on their fair value at the date the awards
are granted. SFAS 123 does not require the application of the fair value
method for stock compensation granted to employees and allows for
continuance of current accounting practice, which requires accounting for
stock compensation awards based on their intrinsic value as of the date of
grant. However, SFAS 123 requires pro forma disclosure of net income and
net income per share, as if the fair value based method of accounting
defined in SFAS 123 had been applied. In 1996, the Company adopted all the
provisions of SFAS 123 except for the fair value provisions for transactions
with employees.
In 1996, FASB issued Statement of Financial Accounting Standards No.
125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" which becomes effective for transactions
occurring after December 31, 1996. The adoption of this standard is not
expected to have a material effect on the Company's financial condition or
results of operations.
Item 8. Financial Statements and Supplementary Data.
See Consolidated Financial Statements beginning on Page F-1 of this
Annual Report on Form 10-K.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
25
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by this Item is set forth under the caption
"Management" in the Company's definitive Proxy Statement (the "Proxy
Statement"), which will be filed with the Securities and Exchange Commission
pursuant to Regulation 14A under the Securities and Exchange Act of 1934 and
is incorporated herein by reference.
Item 11. Executive Compensation.
The information required by this Item is set forth under the caption
"Executive Compensation" in the Proxy Statement, which will be filed with
the Securities and Exchange Commission pursuant to Regulation 14A under the
Securities Act of 1934 and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item is set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Proxy Statement, which will be filed with the Securities and Exchange
Commission pursuant to Regulation 14A under the Securities Exchange Act of
1934 and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item is set forth under the caption
"Certain Relationships and Related Transactions" in the Proxy Statement,
which will be filed with the Securities and Exchange Commission pursuant to
Regulation 14A under the Securities and Exchange Act of 1934 and is
incorporated herein by reference.
26
<PAGE>
PART IV
Item 14. Exhibits and Financial Statement Schedules, Reports on Form 8-K
(a) 1. Financial Statements:
Consolidated Statements of Financial Condition:
December 31, 1996 and 1995 F-1
Consolidated Statements of Income:
For each of the three years in the period
ended December 31, 1996 F-2
Consolidated Statements of Stockholders' Equity:
For each of the three years in the period
ended December 31, 1996. F-3
Consolidated Statements of Cash Flows:
For each of the three years in the period
ended December 31, 1996. F-4
Notes to Consolidated Financial Statements:
For each of the three years in the period
ended December 31, 1996. F-6
Independent Accountants' Report F-18
2. Financial Statement Schedules:
None Required.
3. Exhibits
Exhibit
No. Description of Exhibit
--- ----------------------
3.1 Certificate of Incorporation of the Company (Incorporated by
reference to Exhibit 3.1 to the Company's Registration Statement on Form
S-1, Commission File No. 333-3633)
3.2 Bylaws of the Company (Incorporated by reference to Exhibit 3.2 to
the Company's Registration Statement on Form S-1, Commission File No.
333-3633)
4.1 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1
to the Company's Registration Statement on Form S-1, Commission File
No. 333-3633)
4.1.1 Form of Incentive Stock Option Agreement for use with 1996 Stock
Incentive Plan *
4.1.2 Form of Non-qualified Stock Option Agreement for use with 1996 Stock
Incentive Plan*
10.1 Warehouse Financing Facility dated October 29, 1993 (Incorporated
by reference to Exhibit 10.1 to the Company's Registration Statement
on Form S-1, Commission File No. 333-3633)
10.2 Form of Pooling and Servicing Agreement (Incorporated by reference
to Exhibit 10.2 to the Company's Registration Statement on Form S-1,
Commission File No. 333-3633)
10.3 Corporate Headquarters Lease (Incorporated by reference to Exhibit
10.3 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.4 S Distribution Notes (Incorporated by reference to Exhibit 10.4 to
the Company's Registration Statement on Form S-1, Commission File No.
333-3633)
10.5 Mason Employment Agreement (Incorporated by reference to Exhibit
10.5 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.5.1 Mason Loan*
10.6 Form of Directors' and Officers' Indemnity Agreement (Incorporated
by reference to Exhibit 10.7 to the Company's Registration Statement
on Form S-1, Commission File No. 333-3633)
10.7 Mortgage Loan Master Transfer Agreement dated as of June 30, 1995
between Nationscapital Mortgage Corporation and the Company
(Incorporated by reference to Exhibit 10.8 to the Company's
Registration Statement on Form S-1, Commission File No. 333-3633)
10.8 Mortgage Loan Master Transfer Agreement dated as of June 30, 1995
between Coast Security Mortgage Inc. and the Company (Incorporated by
reference to Exhibit 10.9 to the Company's Registration Statement on
Form S-1, Commission File No. 333-3633)
<PAGE>
Exhibit
No. Description of Exhibit
--- ----------------------
10.9 Chisick Employment Agreement (Incorporated by reference to Exhibit
10.10 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.10 Reimbursement Agreement (Incorporated by reference to Exhibit
10.11 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.11 Warehouse Financing Facility dated September 5, 1996 (Incorporated
by reference to Exhibit 10.12 to the Company's Quarterly Report on
Form 10-Q for the period ended September 30, 1996, Commission File
No. 0-28706)
11.1 Statement re: computation of net income per share for each of the
three years in the period ended December 31, 1996*
21 Subsidiaries of the Registrant*
27 Financial Data Schedule*
- --------------------
* Filed herewith.
(b) Reports on Form 8-K
None
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of 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.
Date: March 20, 1997
FIRST ALLIANCE CORPORATION
By:/S/ BRIAN CHISICK
------------------------
Brian Chisick
President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on date indicated.
Signature Title Date
--------- ----- ----
/S/_BRIAN CHISICK___ President and Chief Executive Officer, March 20, 1997
Brian Chisick Director, Principal Executive Officer
/S/_MARK MASON______ Executive Vice President and March 20, 1997
Mark Mason Chief Financial Officer, Director,
Principal Accounting Officer
/S/_JEFFREY_W._SMITH_ Executive Vice President and March 20, 1997
Jeffrey W. Smith Chief Operating Officer, Director
/S/_SARAH_CHISICK____ Vice President, Director March 20, 1997
Sarah Chisick
/S/_MERRILL_BUTLER___ Director March 20, 1997
Merrill Butler
/S/_GEORGE_GIBBS,_JR. Director March 20, 1997
George Gibbs, Jr.
/S/_ALBERT_L._LORD___ Director March 20, 1997
Albert L. Lord
<PAGE>
FIRST ALLIANCE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition
As of December 31, 1996 and 1995 F-1
Consolidated Statements of Income
For each of the three years in the period ended December 31, 1996 F-2
Consolidated Statements of Stockholder's Equity
For each of the three years in the period ended December 31, 1996 F-3
Consolidated Statements of Cash Flows
For each of the three years in the period ended December 31, 1996 F-4
Notes to Consolidated Financial Statements
For each of the three years in the period ended December 31, 1996 F-6
Independent Accountants' Report F-18
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
December 31,
-----------------------
1996 1995
---------- ----------
ASSETS
Cash and cash equivalents........................ $ 27,414 $ 4,019
Receivable from trusts........................... 2,671 4,664
Loans held for sale.............................. 11,023 24,744
Loans receivable held for investment............. 2,432 2,261
Residual interests in securities at fair value... 29,253 19,705
Mortgage servicing rights........................ 6,025 4,021
Real estate owned, net........................... 312 1,474
Property, net.................................... 3,098 2,141
Deferred taxes................................... 3,101 73
Prepaid expenses and other assets................ 2,128 3,809
---------- ----------
Total assets................................... $ 87,457 $ 66,911
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facilities................... $ $ 18,233
Accounts payable and accrued liabilities......... 3,952 5,234
Income taxes payable............................. 5,396
Notes payable.................................... 131 1,123
---------- ----------
Total liabilities.............................. 9,479 24,590
---------- ----------
Commitments and contingencies
Stockholders' equity:
Preferred Stock $.01 par value: 1,000,000 shares
authorized; no shares outstanding
Class A Common Stock, $.01 par value; 25,000,000
shares authorized; shares issued and outstanding:
4,025,000 at December 31, 1996, no shares at
December 31,1995.............................. 40
Class B Common Stock, $.01 par value; 15,000,000
shares authorized; shares issued and outstanding:
10,750,000 at December 31, 1996, 10,642,500 at
December 31, 1995............................. 108 42
Additional paid in capital....................... 64,643
Retained earnings................................ 14,338 42,279
Deferred stock compensation...................... (1,113)
Foreign currency translation..................... (38)
---------- ----------
Total stockholders' equity..................... 77,978 42,321
---------- ----------
Total liabilities and stockholders' equity....... $ 87,457 $ 66,911
========== ==========
See notes to consolidated financial statements.
F-1
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands except per share amounts)
Year ended December 31,
------------------------------------
1996 1995 1994
---------- ---------- ----------
REVENUE:
Loan origination and sale.......... $ 48,171 $ 35,466 $ 27,902
Loan servicing and other fees...... 8,854 8,614 9,106
Interest........................... 13,562 14,624 8,650
Other.............................. 284 176 144
---------- ---------- ----------
Total revenue.................... 70,871 58,880 45,802
---------- ---------- ----------
EXPENSE:
Compensation and benefits.......... 15,488 10,416 9,559
Professional services.............. 1,263 787 1,521
Advertising........................ 4,191 4,345 3,316
Subservicing and other fees........ 683 1,212 1,019
Rent............................... 1,530 1,278 974
Supplies........................... 1,575 1,214 831
Depreciation and amortization...... 838 907 514
Interest........................... 2,655 4,167 3,744
Legal.............................. 917 1,491 7,162
Travel, relocation and training.... 1,103 788 351
Other.............................. 2,389 1,255 1,577
---------- ---------- ----------
Total expense.................... 32,632 27,860 30,568
---------- ---------- ----------
INCOME BEFORE INCOME TAX PROVISION... 38,239 31,020 15,234
INCOME TAX PROVISION................. 6,100 478 363
---------- ---------- ----------
NET INCOME........................... $ 32,139 $ 30,542 $ 14,871
========== ========== ==========
NET INCOME PER SHARE................. $ 2.59 $ 2.87 $ 1.40
========== ========== ==========
Weighted average number of common
shares outstanding................. 12,420,295 10,650,407 10,650,407
See notes to consolidated financial statements.
F-2
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands)
<CAPTION>
Additional
Class A Common Stock Class B Common Stock Paid in Retained
Shares Amount Shares Amount Capital Earnings
---------- ------ ---------- ------ -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance January 1, 1994 10,642,500 $ 42 $ 26,412
Dividends...................... (17,341)
Net income..................... 14,871
---------- ------ ---------- ------ -------- --------
Balance December 31, 1994 10,642,500 42 23,942
Dividends...................... (12,205)
Net income..................... 30,542
---------- ------ ---------- ------ -------- --------
Balance December 31, 1995 10,642,500 42 42,279
Dividends...................... (15,085)
Distribution of S
distribution notes......... (44,995)
Net income..................... 32,139
Issuance of restricted stock... 107,500 66 $ 1,534
Initial public offering
of stock.................. 4,025,000 $ 40 63,109
Amortization of deferred
stock compensation........
Foreign currency translation
adjustment................
---------- ------ ---------- ------ -------- --------
Balance December 31, 1996...... 4,025,000 $ 40 10,750,000 $ 108 $ 64,643 $ 14,338
========== ====== ========== ====== ======== ========
<CAPTION>
Foreign
Deferred Currency Total
Stock Translation Stockholders'
Compensation Adjustment Equity
------------- ------------ ----------
<S> <C> <C> <C>
Balance January 1, 1994 $ 26,454
Dividends...................... (17,341)
Net income..................... 14,871
------------- ------------ -----------
Balance December 31, 1994 23,984
Dividends...................... (12,205)
Net income..................... 30,542
------------- ------------ -----------
Balance December 31, 1995 42,321
Dividends...................... (15,085)
Distribution of S
distribution notes......... (44,995)
Net income..................... 32,139
Issuance of restricted stock... $ (1,600)
Initial public offering of
of stock.................. 63,149
Amortization of deferred
stock compensation........ 487 487
Foreign currency translation
adjustment................ $ (38) (38)
------------- ------------ -----------
Balance December 31, 1996...... $ (1,113) $ (38) $ 77,978
============= ============ ===========
</TABLE>
See notes to consolidated financial statements
F-3
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Year Ended December 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................. $ 32,139 $ 30,542 $ 14,871
Adjustments to reconcile net income to
net cash provided by operating activities:
Loan origination and sale revenue,
net of other fees.................. (47,871) (34,372) (26,783)
Deferred income taxes................ (3,028) 73 (63)
Net accretion of residual interests
in securities...................... (850) (2,048) (1,128)
Deferred stock compensation.......... 487
Accretion of discounts on loan receivable (268) (1,022)
Amortization of mortgage servicing rights 1,813 638 683
Depreciation and amortization........ 838 907 514
Foreign currency transaction gains... (188)
Loss (gain) on sales of real estate
owned and property................. 414 46 (78)
Loans originated or purchased for sale,
net of loan fees................... (290,773) (213,903) (289,338)
Sales of regular interests in securities 267,370 167,899 347,500
Proceeds from sales of loans......... 70,605 64,400 20,503
Changes in assets and liabilities:
Receivable from trusts............. 1,993 (758) 163
Prepaid expenses and other assets.. 1,681 (2,253) 802
Accounts payable and accrued
liabilities...................... (1,282) (4,169) 4,775
Income taxes payable............... 5,396
---------- ---------- ----------
Net cash provided by operating activities 38,476 5,980 72,421
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................... (2,286) (978) (851)
Loans receivable issued................ (1,579) (1,949)
Collections on loans receivable........ 1,784 2,880 1,341
Additions to real estate owned......... (355)
Proceeds from sales of real estate
owned and property................. 1,748 552 3,566
---------- ---------- ----------
Net cash provided by investing activities 1,246 520 2,107
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings on warehouse
financing facilities................. (18,233) 4,843 (53,445)
Payments on notes payable.............. (1,163) (417) (2,831)
Cash dividends......................... (15,085) (12,205) (17,341)
Proceeds from issuance of notes
payable to stockholders.............. 1,000 4,500 3,000
Payments on notes payable to stockholders (1,000) (4,500) (3,000)
Proceeds from issuance of stock
(net of issuance costs).............. 63,149
Payments on S distribution notes....... (44,995)
---------- ---------- ----------
Net cash used in financing activities.. (16,327) (7,779) (73,617)
---------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS.................... 23,395 (1,279) 911
CASH AND CASH EQUIVALENTS,
beginning of period................. 4,019 5,298 4,387
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of period $ 27,414 $ 4,019 $ 5,298
========== ========== ==========
See notes to consolidated financial statements.
F-4
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued)
(Dollars in Thousands)
Year Ended December 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
SUPPLEMENTAL INFORMATION:
Interest paid.......................... $ 2,735 $ 4,114 $ 3,605
========== ========== ==========
Income taxes paid...................... $ 3,686 $ 486 $ 100
========== ========== ==========
SUPPLEMENTAL INFORMATION ON NONCASH INVESTING
AND FINANCING ACTIVITIES:
Exchange of loans for regular and
residual interests in securities..... $ 267,661 $ 167,974 $ 350,331
========== ========== ==========
Distribution of S distribution notes... $ 44,995
==========
Initial grant of restricted stock...... $ 1,600
==========
Transfer of loans held for sale to
loans receivable held for investment. $ 1,421
==========
Acquisition of real estate through
foreclosure of loans................. $ 261
==========
Transfer of property to real estate owned $ 260
==========
Assumption of debt by acquisition of
real estate through foreclosure...... $ 171 $ 91 $ 2,342
========== ========== ==========
Loans issued to facilitate sales of
real estate owned.................... $ 19 $ 290
========== ==========
See notes to consolidated financial statements.
F-5
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The consolidated financial statements include the
accounts of First Alliance Corporation ("FACO") and its subsidiaries
(collectively the "Company"). The Company is a financial services
organization principally engaged in mortgage loan origination, purchases,
sales and servicing. The majority of the Company's loans are made to owners
of single family residences who use the loan proceeds for such purposes as
debt consolidation and financing of home improvements. The Company sells
loans to investors and wholesale purchasers or securitizes them in the form
of a Real Estate Mortgage Investment Conduit (REMIC). A significant portion
of the mortgages are securitized with the Company retaining the right to
service the loans. The Company is currently licensed as a consumer finance
lender in thirteen states and in the United Kingdom. The Company's business
may be affected by many factors including real estate and other asset
values, the level of and fluctuations in interest rates, changes in the
securitization market and competition.
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles. All significant intercompany
accounts and transactions have been eliminated in consolidation.
On July 31, 1996, FACO completed an initial public offering (the
"Offering") whereby 3,500,000 shares of its Class A Common Stock were sold
to the public resulting in gross proceeds of $59.5 million. Concurrently,
10,750,000 shares of the Class B Common Stock of FACO were issued in
exchange for all of the issued and outstanding shares of First Alliance
Mortgage Company ("FAMCO") as part of a reorganization whereby FAMCO became
a wholly owned subsidiary of FACO. On August 9, 1996, the underwriters'
over-allotment option to purchase 525,000 shares of Class A Common Stock was
exercised resulting in additional gross proceeds of $8.9 million. The
acquisition of FAMCO has been accounted for similar to a pooling of
interests. The consolidated financial position and results of operations of
the Company for periods prior to the date of the reorganization
substantially consist of those of FAMCO. After deducting underwriting
discounts and offering costs of $5.3 million, net proceeds from the Offering
were $63.1 million.
Cash and Cash Equivalents - The Company considers all highly liquid debt
instruments purchased with an original maturity of three months or less to
be cash equivalents.
Receivable From Trusts - In the normal course of servicing loans
previously sold or securitized, the Company may advance payments and other
costs to REMICs or private investor trusts on behalf of borrowers. In such
cases, funds advanced are reflected in the consolidated statements of
financial condition as receivable from trusts. Advances are recovered
through subsequent collections from trusts or borrowers.
Loans - Loans held for sale are loans the Company plans to sell or
securitize which are carried at the lower of aggregate cost or market value.
Loan origination and processing fees and related direct origination costs
are deferred until the related loan is sold. Loans receivable held for
investment are loans the Company has purchased or originated and has the
intent and ability to hold to maturity. Loan origination and commitment
fees and direct loan origination costs associated with loans receivable held
for investment are deferred and offset against the related loans, and the
net fee or cost is amortized into interest income over the contractual lives
of the related loans. Loans transferred from loans held for sale to loans
receivable held for investment are transferred at the lower of cost or
market value. When a loan becomes over 90 days contractually delinquent, it
is placed on non-accrual status and unpaid interest income is reversed.
While a loan is on non-accrual status, interest is recognized only as cash
is received.
Allowances for Estimated Losses on Loans and Real Estate Owned - The
allowances for estimated losses on loans and real estate owned (REO)
represent the Company's estimate of identified and unidentified losses.
These estimates, while based upon historical loss experience and other
relevant data, are ultimately subjective and inherently uncertain. The
Company has established valuation allowances for estimated losses on
specific loans and REO. When these estimated losses are determined to be
permanent, such as when a loan is foreclosed and the related property is
transferred to REO, specific valuation allowances are charged off and are
then reflected as writedowns.
F-6
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
Residual Interests in Securities - The Company securitizes a majority of
loans held for sale in the form of a REMIC trust. A REMIC trust is a
multi-class security, with certain tax advantages to investors, which
derives its cash flow from a pool of underlying mortgages. The regular
interests of the REMICs are sold and the residual interests are retained by
the Company. The documents governing the Company's securitizations require
the Company to establish initial overcollateralization or build
overcollateralization levels through retention of distributions by the REMIC
trust otherwise payable to the Company as the residual interest holder.
This overcollateralization causes the aggregate principal amount of the
loans in the related pool and/or cash reserves to exceed the aggregate
principal balance of the outstanding regular interests. Such excess amounts
serve as credit enhancement for the regular interests of the related REMIC
trust. To the extent that borrowers default on the payment of principal or
interest on the loans, losses will reduce the overcollateralization to the
extent that funds are available. If payment defaults exceed the amount of
overcollateralization, as applicable, the insurance policy maintained by the
related REMIC trust will pay any further losses experienced by holders of
the regular interests in the related REMIC trust. The Company does not have
any recourse obligations for credit losses in the REMIC trust.
The Company classifies residual interests as trading securities which are
carried at fair value with any unrealized gains or losses recorded in the
results of operations in the period of the change in fair value. 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 underlying mortgages over the sum of the
pass-through interest rates on the regular interests of the related REMIC
trust, servicing fees, trustee fees, insurance fees, and an estimate of
annual future loan losses. These cash flows are projected over the life of
the loans using 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 based upon constant prepayment rates ranging from 25.0% to
40.0%, estimated annual loan losses of 0.5% of the outstanding principal
balance and weighted average discount rates of 18.0%, 18.0% and 23.6% for
the years ended December 31, 1996, 1995, and 1994, respectively, to value
residual interests. 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 these residual interests. The range of
possible values attributable to the factors used in determining fair value
is broad. Accordingly, the Company's estimate of fair value is subjective.
Mortgage Servicing Rights - Effective January 1, 1995, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 122, "Accounting
for Mortgage Servicing Rights", which requires that upon sale or
securitization of servicing retained mortgages, companies capitalize the
cost associated with the right to service mortgage loans based on their
relative fair values. The Company determines fair value based on the
present value of estimated net future cash flows related to servicing
income. The cost allocated to the mortgage servicing rights is amortized in
proportion to and over the period of estimated net future servicing fee
income.
F-7
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
The Company capitalized, at fair value, $3,817,000 and $3,896,000 of
mortgage servicing rights for the years ended December 31, 1996 and 1995,
respectively. During the same periods, related amortization of such
mortgage servicing rights was $1,631,000 and $208,000, respectively. The
Company periodically evaluates capitalized mortgage servicing rights for
impairment, which is measured as the excess of unamortized cost over fair
value. This review is performed on a disaggregated basis based on loan
type. The Company generally makes loans to credit impaired borrowers whose
borrowing needs may not be met by traditional financial institutions due to
credit exceptions. The Company has found that credit impaired borrowers are
payment sensitive rather than interest rate sensitive. Therefore, the
Company does not consider interest rates a predominant risk characteristic
for purposes of evaluating impairment. Impairment, if it occurs, is
recognized in a valuation allowance for each pool in the period of
impairment.
Property - Property is stated at cost and depreciated over the estimated
useful lives of the assets using accelerated methods. Leasehold
improvements are amortized on the straight-line method over the lesser of
the useful lives of the assets or the terms of the related leases. Useful
lives generally range from three to seven years.
Real Estate Owned - Real estate acquired in settlement of loans generally
results when property collateralizing a loan is foreclosed upon or otherwise
acquired by the Company in satisfaction of the loan. Real estate acquired
through foreclosure is carried at either the lower of fair value less costs
to dispose or the recorded investment in the loan. Fair value is based on
the net amount that the Company could reasonably expect to receive for the
asset in a current sale between a willing buyer and a willing seller, that
is, other than in a forced or liquidation sale.
Adjustments to the carrying value of REO are made through valuation
allowances and chargeoffs recognized through a charge to earnings.
Revenue Recognition - The Company derives its revenue principally from
gains on sale of loans including fees for the origination of loans, loan
servicing fees and interest income. The Company sells its loans through
securitization and other loan sales. Revenue from loans pooled and
securitized or sold in the secondary market is recognized when such loan
pools are sold. The Company retains the right to service all loans it
securitizes. The Company receives a management fee for servicing loans
based on a fixed percentage of the declining balance of securitized loan
pools and other ancillary and prepayment fees associated with the servicing
of such loans. Through securitizations, the Company retains a residual
interest in the excess of the weighted average coupon on each pool of
underlying mortgages over the sum of the pass-through interest rates on the
senior classes of the related REMIC, servicing fees, trustee fees, insurance
fees and loan losses.
Loan origination and sale revenue includes all mortgage related income
other than loan servicing and other fees, interest and other income.
Loan servicing and other fees are recorded as earned.
Interest income is recorded as earned. Interest income represents the
interest earned on loans held for sale during the period prior to their
securitization or sale, loans receivable held for investment, residual
interests and cash equivalents. At the end of each quarter, in accordance
with Emerging Issues Task Force Issue No. 89-4, the Company computes an
effective yield based on the carrying amount of each residual interest and
its then-current estimate of future cash flows. This yield is then used to
accrue interest income on the residual interest in the subsequent quarter.
As of December 31, 1996, the weighted average effective yield of the
Company's residual interests was 34%.
Income Taxes - Deferred tax assets and liabilities are determined based on
temporary differences between financial reporting and tax basis of assets
and liabilities and are measured by applying enacted tax rates and laws to
taxable years in which such temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that includes
the enactment date.
F-8
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
Net Income per Share - Net income per share has been computed by dividing
net income by the weighted average number of shares of common stock and
common stock equivalents outstanding during the period. In accordance with
regulations of the Securities and Exchange Commission, which require that
stock issued within a one year period prior to the initial filing of a
registration statement relating to an initial public offering be treated as
outstanding for all reported periods, the weighted average number of common
shares for all periods includes the dilutive impact of the restricted stock
issued in June 1996. The dilutive impact has been computed using the
treasury stock approach, with the Offering price of $17 per share used as
the repurchase price for all periods prior to the date of the Offering. In
addition, the dilutive effect of the options issued under the Company's
stock incentive plan has been included in computing earnings per share for
the year ended December 31, 1996. Because the Company was an S corporation
in 1994 and 1995, and in 1996 up to the date of the Offering, net income and
net income per share are not necessarily indicative of results of operations
of the ongoing entity.
Supplementary Net Income Per Share - Assuming that the 4,025,000 shares of
Class A Common Stock issued in the Offering were issued at the beginning of
1994, net income per share would have been $2.22, $2.08 and $1.01 for the
years ended December 31, 1996, 1995 and 1994, respectively. The computation
of supplementary net income per share assumes that proceeds from the
Offering would have been used to pay the S distribution notes at the date of
their issuance in May 1996. Therefore, the interest expenses incurred on
the S distribution notes, net of tax benefits, of $0.6 million for the year
ended December 31, 1996 was added to net income for purposes of computing
supplementary net income per share.
Use of Estimates in the Preparation of Financial Statements - The
preparation of 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 and disclosure of
contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
Foreign Currency Translation - The financial statements of the Company's
United Kingdom subsidiary were prepared in pounds sterling, its functional
currency, and translated into dollars at the current exchange rate at the
end of the period for the statements of financial condition and at a
weighted average rate for the period on the statements of income.
Translation adjustments are reflected as foreign currency translation
adjustments in stockholders' equity and accordingly have no effect on
income. Foreign currency transaction gains and losses for the Company's
United Kingdom subsidiary are included in income.
Recent Accounting Pronouncements - In 1996, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 123 "Accounting for Stock-Based
Compensation"("SFAS 123"), which encourages companies to account for stock
compensation awards based on their fair value at the date the awards are
granted. SFAS 123 does not require the application of the fair value method
for stock compensation granted to employees and allows for continuance of
current accounting practice, which requires accounting for stock
compensation awards based on their intrinsic value as of the date of grant.
However, SFAS 123 requires pro forma disclosure of net income and net income
per share, as if the fair value based method of accounting defined in SFAS
123 had been applied. In 1996, the Company adopted all the provisions of
SFAS 123 except for the fair value provisions for transactions with
employees.
In 1996, FASB issued SFAS No. 125 "Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities" which becomes
effective for transactions occurring after December 31, 1996. The adoption
of this standard is not expected to have a material effect on the Company's
financial position or results of operations.
Reclassifications - Certain reclassifications have been made to conform the
1995 and 1994 consolidated financial statements to the 1996 presentation.
F-9
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 2. LOANS RECEIVABLE HELD FOR INVESTMENT
Loans receivable held for investment are secured principally by single
family residences. The loans bear interest at fixed rates ranging up to
15.95% per annum and are due in monthly installments of principal and
interest through August 2026.
NOTE 3. PROPERTY
Property consists of the following at December 31:
1996 1995
---------- ----------
(Dollars in thousands)
Office equipment............................ $ 4,218 $ 4,245
Vehicles.................................... 396 388
Leasehold improvements...................... 78 160
Computer software........................... 647 1,119
Building.................................... 141 406
Land........................................ 98
---------- ----------
Property, gross............................. 5,480 6,416
Less accumulated depreciation and amortization ( 2,382) (4,275)
---------- ----------
Property, net............................... $ 3,098 $ 2,141
========== ==========
NOTE 4. SERVICING PORTFOLIO
Trust and other custodial funds, relating to loans serviced for others,
amounted to approximately $14.5 million, $5.8 million and $2.4 million at
December 31, 1996, 1995 and 1994, respectively. Such funds, which are
maintained in separate bank accounts, are excluded from the Company's assets
and liabilities.
Total loans serviced amounted to $641,191,000 and $613,791,000 at
December 31, 1996 and 1995, respectively.
NOTE 5. WAREHOUSE FINANCING FACILITIES
The Company has two revolving lines of credit with secured asset-based
lenders. The first line of credit allows the Company to borrow and repay
during a 90 day revolving period up to $125 million. The second line of
credit allows the Company to borrow and repay during the term of the line of
credit up to $25 million. Both lines of credit bear interest at a variable
rate based upon the London Interbank Offered Rate (LIBOR) payable monthly.
The first line of credit is renewable by the lender on a quarterly basis and
currently expires on March 31, 1997. The second line of credit expires on
March 3, 1998. Outstanding borrowings under both lines of credit are
collateralized by loans held for sale. Upon the sale or securitization of
loans, borrowings are repaid. These lines of credit contain certain
affirmative, negative and financial covenants, with which the Company was in
compliance at December 31, 1996.
F-10
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
The following table presents data on the lines of credit for the year
ended December 31:
1996 1995 1994
--------- --------- ---------
(Dollars in thousands)
Weighted average interest rate for the period 6.30% 7.10% 5.96%
Interest rate at the end of the period 6.30% 6.56% 7.38%
Average amount outstanding for the period $ 30,507 $ 52,610 $ 58,139
Maximum amount outstanding at any month-end $ 65,262 $ 108,217 $ 110,551
NOTE 6. NOTES PAYABLE
Notes payable principally represent amounts owed related to senior liens
on properties foreclosed upon by the Company. The notes bear fixed and
variable interest at rates ranging from 7.33% to 9.00% per annum at December
31, 1996 and are payable $4,000 in each of the years 1997 through 2001, and
$111,000 thereafter.
NOTE 7. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) defined contribution plan, which was established
in 1994, available to all employees who have been with the Company for six
months and have reached the age of 21. Employees may generally contribute
up to 15% of their salary each year and the Company, at its discretion, may
match up to 25% of the first 7% contributed by the employee. The Company's
contribution expense was $120,000, $97,000 and $45,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
NOTE 8. INCOME TAXES
Through the date of the Offering in 1996, and in 1995 and 1994, the
Company elected to be treated for Federal income and certain state tax
purposes as an S corporation whereby its taxable income was included in the
individual returns of the stockholders. As an S corporation, the Company
was subject to certain state taxes, primarily in California. Upon
consummation of the Offering, the Company became a C corporation subject to
Federal and state income taxes. The income tax provision for 1996
represents S corporation taxes prior to the Offering, C corporation taxes
subsequent to the Offering and net deferred tax assets recognized upon the
conversion from an S corporation to a C corporation.
Taxes for 1995 and 1994 represent certain state taxes. The reconciliation
of income tax from continuing operations computed at the Federal statutory
tax rate to the Company's effective income tax rate for the year ended
December 31, 1996 is as follows:
Tax at Federal statutory rate......................... 35.0 %
Benefit for S corporation period taxation............. (14.5)
Effect of conversion to C corporation................. (8.4)
State income taxes, net of Federal benefit............ 3.9
---------
Effective rate........................................ 16.0 %
=========
F-11
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
The components of the provision for income taxes for the years ended
December 31 are as follows:
1996 1995 1994
-------- -------- --------
(Dollars in thousands)
Current:
Federal................................... $ 7,204
State..................................... 1,924 $ 405 $ 426
-------- -------- --------
Total current.............................. 9,128 405 426
-------- -------- --------
Deferred:
Federal.................................. (3,289)
State.................................... 261 73 (63)
-------- -------- --------
Total deferred............................. (3,028) 73 (63)
-------- -------- --------
Total...................................... $ 6,100 $ 478 $ 363
======== ======== ========
Deferred tax assets and liabilities reflect the temporary differences
between financial reporting and tax basis of assets and liabilities and are
measured by applying enacted tax rates and laws to taxable years in which
such temporary differences are expected to be recovered or settled.
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1996 are as follows:
(Dollars in thousands)
Deferred tax assets:
Residual interests....................................$ 3,209
Legal expenses........................................ 1,393
Mark to market on loans held for sale................. 700
State taxes........................................... 535
Other................................................. 579
------------
Total....................................................$ 6,416
============
Deferred tax liabilities:
Mortgage servicing rights.............................$ 2,585
Other................................................. 730
------------
Total....................................................$ 3,315
============
NOTE 9. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK
The Company's operations are conducted from leased facilities located in
various areas of the United States and the United Kingdom. These leases
have clauses which provide for increases in rent based on increases in the
cost of living index and options for renewal. The future minimum lease
payments are as follows:
(Dollars in thousands)
Year ending December 31:
1997.................................................$ 1,384
1998................................................. 1,110
1999................................................. 904
2000................................................. 812
2001................................................. 686
Thereafter........................................... 565
F-12
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
In the ordinary course of business, the Company has liability under
representations and warranties made to purchasers and insurers of mortgage
loans. Under certain circumstances, the Company may become liable for the
unpaid principal and interest on defaulted loans or other loans if there has
been a breach of representation or warranties.
The Company has negotiated employment agreements with certain officers.
These agreements provide for the payment of base salaries, the issuance of
common stock subject to certain restrictions and the payment of severance
benefits upon termination.
In December 1989, a class action suit was filed on behalf of certain
borrowers related to the origination of their loans by the Company. The
Company, without admitting to any wrong-doing, agreed to settle the case in
December 1994. The terms of the settlement provide for cash payments to the
plaintiffs in the amount $6,850,000, which is to be paid out over a three-
year period. Remaining future payments to plaintiffs of $333,000 are
included in accrued liabilities at December 31, 1996.
The Company is involved in certain litigation arising in the normal course
of business. The Company believes that any liability with respect to such
legal actions, individually or in the aggregate, is not likely to be
material to the Company's consolidated financial position or consolidated
results of operations.
At December 31, 1996, loans related to property located in the state of
California comprised approximately 67% of the total serviced loan portfolio
while no other state comprised more than 7%.
Availability of Funding Sources - The Company funds substantially all of
the loans which it originates or purchases through borrowings under its
warehouse financing facilities and internally generated funds. These
borrowings are in turn repaid with the proceeds received by the Company from
selling such loans through loan sales or securitizations. Any failure to
renew or obtain adequate funding under those warehouse financing facilities,
or other borrowings, or any substantial reduction in the size of or pricing
in the markets for the Company's loans, could have a material adverse effect
on the Company's operations. To the extent that the Company is not
successful in maintaining or replacing existing financing, it would have to
curtail its loan production activities or sell loans earlier than is
optimal, thereby having a material adverse effect on the Company's
consolidated financial condition and consolidated results of operations.
Dependence on Securitizations - Since 1992, the Company has pooled and
sold through securitizations an increasing percentage of the loans which it
originates. The Company derives a significant portion of its income by
recognizing gains upon the sale of loans through securitizations. These
gains are due in part to the value recorded at the time of sale of residual
interests and retained mortgage servicing rights. Adverse changes in the
securitization market could impair the Company's ability to purchase and
sell loans through securitizations on a favorable or timely basis. Any such
impairment could have a material adverse effect upon the Company's
consolidated financial condition and consolidated results of operations.
The Company has relied on credit enhancement to achieve a "AAA/aaa" rating
for the senior classes of the REMICs in its securitizations. The credit
enhancement has generally been in the form of an insurance policy issued by
an insurance company insuring the timely repayment of the senior classes in
each of the REMIC trusts. There can be no assurance that the Company will
be able to obtain credit enhancement in any form from the current insurer or
any other provider of credit enhancement on acceptable terms or that future
securitizations will be similarly rated. A downgrading of the insurer's
credit rating or its withdrawal of credit enhancement could have a material
adverse effect on the Company's consolidated financial condition and
consolidated results of operations.
F-13
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 10. STOCKHOLDERS' EQUITY
The Company's shares of Class A and Class B Common Stock are identical,
except with respect to voting rights and the right to convert Class B Common
Stock to Class A Common Stock. Holders of Class A Common Stock are entitled
to one vote for each share held of record, and holders of Class B Common
Stock are entitled to four votes for each share held of record. Each share
of Class B Common Stock is freely convertible into one share of Class A
Common at the option of the Class B stockholder. Shares of Class B Common
Stock shall be automatically converted to Class A Common Stock upon the
transfer of Class B Common Stock to a third party or when the number of
shares of Class B Common Stock represents less than 10% of the total number
of shares of Common Stock outstanding.
During 1996, FAMCO distributed S distribution notes of $45.0 million to
its stockholders. Such amount has been recorded as a dividend to Class B
common stockholders. In 1996, payments on the S distribution notes of $45.0
million were made by the Company using proceeds from the Offering.
On May 11, 1996, the Company's Board of Directors approved a stock split
of its common stock whereby approximately 710 shares of common stock were
issued for each outstanding share of common stock. All share and per share
amounts included in the accompanying consolidated financial statements and
footnotes have been restated to reflect the stock split.
In June 1996, FAMCO granted 107,500 shares of restricted common stock to
an officer of the Company. These shares, which were exchanged for 107,500
shares of FACO Class B Common Stock in conjunction with the Offering, vest
over a period of five years or earlier upon the occurrence of certain
events. A value of $1.6 million has been ascribed to such shares by the
Company. This amount has been recorded in the accompanying financial
statements as increases to Class B Common Stock and paid in capital with an
offsetting amount included in deferred stock compensation. In 1996, 29,285
shares of such restricted Class B Common Stock vested as a result of the
Offering. During 1996, $0.5 million of compensation expense was recognized.
On July 24, 1996, the shareholders approved a stock incentive plan, which
enables directors, officers and other key employees of the Company to
participate in the ownership of the Company. Under the stock incentive
plan, 642,500 shares of Common Stock were available for grant on July 24,
1996. On July 25, 1996, the Company granted options to acquire an aggregate
of 529,065 shares of Class A Common Stock at an exercise price, equal to the
market price, of $17.00 per share. These options vest 25% six months from
the date of grant and 25% each year thereafter until fully vested and expire
on the earlier of ten years from the date of grant or 90 days after an
optionee's termination of service. As of December 31, 1996, no options
granted had been exercised or forfeited.
The Company accounts for its stock incentive plan based on the intrinsic
value of a grant as of the date of the grant in accordance with Accounting
Principles Board Opinion No. 25. Accordingly, no compensation expense has
been recognized in 1996 for options granted under the Company's stock
incentive plan. Had compensation cost been recognized in accordance with
the fair value provisions of SFAS 123, pro forma net income and net income
per share would have been $30.7 million and $2.48, respectively. The fair
value of each option grant, $12.86 for options granted in 1996, is estimated
on the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants in 1996: no dividend
yield; expected volatility of 58.78%; risk-free interest rate of 7.00%; and
expected lives of 10 years.
F-14
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 11. RELATED PARTY TRANSACTIONS
The following amounts represent related party transactions for the years
ended December 31:
1996 1995 1994
-------- -------- --------
(Dollars in thousands)
Loans sold to principal stockholder of
the Company.............................. $ 515 $ 3,188 $6,783
Loans purchased from an entity in which
the Company's principal stockholder has
a controlling interest................... 15,126 91,501
Loans purchased from companies owned by
family members of the Company's principal
stockholder:
Loans purchased....................... 31,033 9,841
Premiums paid......................... 1,208 193
Other fees received from an entity in which
the Company's principal stockholder has a
controlling interest and companies owned
by family members of the Company's principal
stockholder.............................. 186 715
Payments to companies owned by the Company's
principal stockholder:
Rent payments............................ 464 18 18
Consulting fees.......................... 76 161
Interest paid to stockholders on notes payable
to stockholder and S distribution notes.. 612 223 10
The following amounts represent related party
balances as of December 31:
1996 1995
-------- --------
(Dollars in thousands)
Loans serviced for related parties.......... $ 7,044 $12,909
Receivable from officer of the Company...... 319
Balance outstanding on warehouse line to
companies owned by family members of the Company's
principal stockholder................... 525
NOTE 12. FINANCIAL INSTRUMENTS
The Company regularly securitizes and sells fixed and variable rate
mortgage loans. As part of its interest rate risk management strategy, the
Company may from time to time hedge its interest rate risk related to its
loans held for sale and origination commitments by selling short United
States Treasury securities. For accounting purposes, selling short United
States Treasury securities is not considered to be a hedge. Therefore, the
Company has recognized realized and unrealized gains and losses on hedging
activities in the period in which they occur. Gains and (losses) on hedging
activities were $434,000, $(255,000) and $800,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
F-15
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
The following disclosures of the estimated fair value of financial
instruments as of December 31, 1996 and 1995 are made in accordance with the
requirements of SFAS No. 107, "Disclosure 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 and methodologies may have a
material effect on the estimated fair value amounts.
1996 1995
------------------ ------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- -------- -------- --------
(Dollars in thousands)
Assets:
Cash and cash equivalents.......... $27,414 $27,414 $ 4,019 $ 4,019
Loans held for sale................ 11,023 12,912 24,744 25,610
Loans receivable held for investment 2,432 2,771 2,261 2,340
Residual interests................. 29,253 29,253 19,705 19,705
Liabilities:
Warehouse financing facilities..... 18,233 18,233
Notes payable...................... 131 131 1,123 1,174
The estimated fair value of loans is based upon prices paid by the Company
for loans it purchases.
The fair value of residual interests are determined based on estimates of
their fair value using discounted cash flows.
Rates currently available to the Company for debt with similar terms and
remaining maturities were used to estimate the fair value of the warehouse
financing facilities and notes payable.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1996 and 1995.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these consolidated financial
statements since that date and, therefore, current estimates of fair value
may differ significantly from the amounts presented herein.
Off-Balance Sheet Activities - The Company is exposed to on-balance sheet
credit risk related to its loans held for sale, residual interests and loans
receivable held for investment. The Company is exposed to off-balance sheet
credit risk related to loans which the Company has committed to originate or
buy.
The Company is party to financial instruments with off-balance sheet
credit risk in the normal course of business. These financial instruments
include commitments to extend credit to borrowers and commitments to
purchase loans from others. The Company has a first or second lien position
on substantially all of its loans, and the maximum combined loan-to-value
(CLTV) permitted by the Company's underwriting guidelines is 85%. The CLTV
represents the combined mortgage balances as a percentage of the appraised
value of the mortgaged property. A title insurance policy is required for
all loans.
As of December 31, 1996, the Company had outstanding commitments to
extend credit or purchase loans in the amounts of $7,524,000.
F-16
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 13. SELECTED QUARTERLY FINANCIAL DATA (Unaudited)
(Dollars in thousand except per share amounts)
- ----------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
---------------------------------------------
1996
Total revenue........... $ 14,810 $ 17,024 $ 18,922 $ 20,115
Income before income tax
provision............. 7,860 9,306 9,891 11,182
Net income.............. 7,742 9,167 8,633 6,597
Net income per share.... 0.73 0.86 0.64 0.44
1995
Total revenue........... $ 5,963 $ 18,174 $ 8,280 $ 26,463
Income (loss) before income tax
provision............. (300) 11,346 1,391 18,583
Net income (loss)....... (295) 11,175 1,370 18,292
Net income (loss) per share (0.03) 1.05 0.13 1.72
F-17
<PAGE>
Independent Accountants' Report
To the Board of Directors and Stockholders of
First Alliance Corporation
We have audited the accompanying consolidated statements of financial
condition of First Alliance Corporation and subsidiaries (the Company) as of
December 31, 1996 and 1995, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of First Alliance Corporation
and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
As described in Note 1, on January 1, 1995, the Company adopted Statement of
Financial Accounting Standards No. 122, Accounting for Mortgage Servicing
Rights.
DELOITTE & TOUCHE LLP
Costa Mesa, California
January 20, 1997
F-18
<PAGE>
EXHIBIT 4.1.1. INCENTIVE STOCK OPTION AGREEMENT
FIRST ALLIANCE CORPORATION
INCENTIVE STOCK OPTION AGREEMENT
This Incentive Stock Option Agreement ("Option Agreement") is between
First Alliance Corporation, a Delaware corporation (the "Company"), and the
employee named in Section 1 below (the "Optionee").
W I T N E S S E T H:
-------------------
WHEREAS, the Company has adopted the First Alliance Corporation 1996
Stock Incentive Plan (the "Plan") for the purpose of encouraging ownership
of the Class A Common Stock, $.01 par value ("Common Stock"), of the Company
by eligible key employees, directors and independent contractors of the
Company and its subsidiaries, of providing increased incentive for such
persons to render services and to exert maximum effort for the business
success of the Company, and of further strengthening the identification of
such persons with the stockholders; and
WHEREAS, Section 422 of the Internal Revenue Code provides that an
employee shall not be taxed upon the exercise of an option that qualifies as
an incentive stock option, provided that the employee does not dispose of
the shares acquired upon exercise of such option until two years after the
option is granted to the employee and one year after the option is
exercised; and
WHEREAS, the Company, acting through the Stock Incentive Committee of
its Board of Directors (the "Committee") and through its stockholders, has
determined that its interests will be advanced by the issuance to Optionee
of an incentive stock option under the Plan;
NOW, THEREFORE, for and in consideration of these premises it is agreed
as follows:
1. IDENTIFYING PROVISIONS: As used in this Option Agreement, the
following terms shall have the following respective meanings:
(a) Optionee: ____________________________________________
(b) Date of Grant: _____________ ("Date of Grant")
(c) Number of shares subject to Option Agreement: ___________
(d) Exercise Price per share: $17.00 ("Exercise Price")
(e) Expiration Date: ________________ ("Expiration Date")
2. OPTION. Subject to the terms and conditions contained herein and to
stockholder approval of the Plan, the Company hereby grants to Optionee the
right and option ("Option") to purchase from the Company up to that number
of shares of its Common Stock specified in Section 1(c) of this Option
Agreement, at a price per share equal to the Exercise Price. This Option is
intended to qualify to the maximum extent possible as an incentive stock
option under Section 422 of the Internal Revenue Code, as amended (the
"Code") and therefore meets the following requirements: (i) the Exercise
Price is not less than the fair market value of the Common Stock on the date
when the Company completed the corporate action constituting an offer of
stock for sale to the Optionee; (ii) the Option is not exercisable more than
one year after the employee ceases to be employed because of death or a
disability (as defined in Section 22(e)(3) of the Code) or more than three
months after the Optionee otherwise ceases to be an employee of the Company
or its parent or a subsidiary, and (iii) the Optionee does not own stock
possessing more than ten percent of the total combined voting power of all
classes of stock of the Company (or, if the Optionee does own such voting
power, such further conditions required under Code Section 422 have been
satisfied). The Plan has been approved by the Company's stockholders.
<PAGE>
3. OPTION PERIOD. The Option herein granted may not be exercised, and
is not exercisable, after the Expiration Date. This Option shall not be
exercisable on the Date of Grant but, subject to such further terms and
limitations set forth herein, upon the expiration of six months after the
Date of Grant (the "Vesting Date"), and thereafter on each anniversary of
the Vesting Date this Option shall become exercisable to purchase, and shall
vest with respect to, a number of shares of Common Stock (rounded to the
nearest whole share) such that the aggregate number of shares of Common
Stock as to which this Option has become exercisable shall equal the total
number of shares subject to this Option Agreement (as specified in
Section 1(c)), multiplied by the percentage set forth below with respect to
the specified anniversary of the Vesting Date:
Additional Total
Percentage Percentage of
of Option Option
Date Exercisable Exercisable
---- ------------- -------------
Six months after the Date of Grant
(the "Vesting Date"): 25% 25%
On the first anniversary of the Vesting Date: 25% 50%
On the second anniversary of the Vesting Date: 25% 75%
On the third anniversary of the Vesting Date: 25% 100%
4. PROCEDURE FOR EXERCISE. The Option herein granted may be exercised
by written notice by Optionee to the Secretary of the Company setting forth
the number of shares of Common Stock with respect to which the Option is to be
exercised, and specifying such further information regarding delivery of
such shares as the Secretary of the Company may reasonably request. Payment
shall be by means of (i) cash, cashier's check or bank draft, payable to the
order of the Company, (ii) a non-cancellable commitment from a brokerage
firm acceptable to the Secretary of the Company to pay the aggregate
Exercise Price from the proceeds of a sale of Common Stock issuable upon
exercise of the Option, (iii) at the option of the Optionee, in Common Stock
theretofore owned by such Optionee for at least six months, or (iv) a
combination of cash, cashier's check or bank draft and Common Stock. As
promptly as practicable after exercise of this Option, the Company shall
issue or cause to be issued to Optionee the number of shares of Common Stock
with respect to which the Option has been so exercised. The Option may not
be exercised with respect to less than 25 shares.
5. TERMINATION OF EMPLOYMENT. If Optionee's employment with the Company
is terminated prior to the Expiration Date for any reason, including death or
disability, the Option shall immediately terminate to the extent it is not
exercisable on the date of Optionee's termination of employment. To the
extent that the Option is exercisable on the date of Optionee's termination
of employment for any reason, including death or disability, the Option may
be exercised at any time on or before the earlier of (i) the close of
business on the ninetieth (90th) day after such date of termination of
employment, and (ii) the Expiration Date.
6. TRANSFERABILITY. This Option shall not be transferable by Optionee
otherwise than by Optionee's will or by the laws of descent and
distribution. During the lifetime of Optionee, the Option shall be
exercisable only by him. Any heir or legatee of Optionee shall take rights
under this Option subject to the terms and conditions of this Option
Agreement. No such transfer of this Option Agreement to heirs or legatees
of Optionee shall be effective to bind the Company unless the Company shall
have been furnished with written notice thereof and a copy of such evidence
as the Committee may deem necessary to establish the validity of the
transfer and the acceptance and assumption by the transferee or transferees
of the obligations of the Optionee and of the other terms and conditions
hereof.
7. NO RIGHTS AS STOCKHOLDER. Optionee shall have no rights as a
stockholder with respect to any shares of Common Stock covered by this
Option Agreement until the date of issuance of shares of Common Stock
purchased pursuant to this Option Agreement. Until such time, Optionee
shall not be entitled to dividends or to vote at meetings of the
stockholders of the Company. Except as provided in paragraph 8 hereof, no
adjustment shall be made for dividends (ordinary or extraordinary, whether
in cash or securities or other property) paid or distributions or other
rights granted in respect of any share of Common Stock for which the record
date for such payment, distribution or grant is prior to the date upon which
the Optionee shall have been issued share certificates, as provided
hereinabove.
<PAGE>
8. ADJUSTMENTS. If the outstanding shares of Common Stock are increased,
decreased or exchanged for or converted into cash, property or a
different number or kind of shares or securities, or if cash, property or
shares or securities are distributed in respect of such shares of Common
Stock, in either case as a result of a reorganization, merger, consolidation,
recapitalization, restructuring, reclassification, dividend (other than a
regular, quarterly cash dividend) or other distribution, stock split,
reverse stock split, spin-off or the like, or if substantially all of the
property and assets of the Company are sold, then, unless the terms of such
transaction shall provide otherwise, the Committee shall make appropriate
and proportionate adjustments in the number and type of shares or other
securities or cash or other property that may be acquired pursuant to the
Option and the exercise or settlement price of the Option, to the extent
permitted by Sections 162(m) and 422 of the Code, respectively.
9. COMPLIANCE WITH SECURITIES LAWS. Upon the acquisition of any shares
pursuant to the exercise of the Option herein granted, Optionee (or any
person acting under paragraph 6 of this Agreement) shall enter into such
written representations, warranties and agreements as the Company may
reasonably request in order to comply with applicable securities laws or
with this Option Agreement.
10. COMPLIANCE WITH LAWS. Notwithstanding any of the other provisions
hereof, Optionee agrees not to exercise the Option granted hereby, and that
the Company will not be obligated to issue any shares pursuant to this
Option Agreement, if the exercise of the Option or the issuance of such
shares of Common Stock would constitute a violation by the Optionee or by
the Company of any provision of any law or regulation of any governmental
authority. The certificates representing the shares of Common Stock
acquired pursuant to the exercise of the Option will be stamped or otherwise
imprinted with legends in such form as the Company or its counsel may
require with respect to any applicable restrictions on sale or transfer and
the stock transfer records of the Company will reflect stop-transfer
instructions with respect to such shares.
11. NOTICE OF SALE; WITHHOLDING OF TAX. Optionee shall promptly notify the
Company of the sale of any stock issued upon the exercise of the Option if
such sale takes place either within one year of the date of such exercise or
within two years of the Date of Grant. If the Company becomes obligated to
withhold an amount on account of any tax imposed as a result of the exercise
of the Option or the disposition of shares of Common Stock acquired by
exercise of this Option, including, without limitation, any federal, state,
local or other income tax, or any F.I.C.A., state disability insurance tax
or other employment tax, the Optionee shall be obligated, as of the first
date on which the Company is so obligated, to pay such amounts to the
Company in cash or check, or other property acceptable to the Secretary of
the Company in his sole discretion; and, if the Optionee fails to make such
payment as and when due, the Company is hereby authorized by the Optionee
(i) to withhold from any payments then or thereafter payable to the
Optionee, any such amounts, and (ii) to refuse to issue or transfer any
shares otherwise required to be issued or transferred pursuant to the terms
hereof until all such amounts have been paid. The Committee may, in its
sole discretion, allow the Optionee to pay any such amounts through the
surrender of whole shares of Common Stock or by having the Company withhold
whole shares of Common Stock otherwise issuable upon the exercise of this
Option. Any such shares surrendered or withheld shall be valued at their
market value, determined by such method as the Secretary of the Company in
his sole discretion shall determine, and have a market value, as of the date
on which the amount of tax to be withheld is determined, which is equal to
the sums required to be withheld.
12. RESOLUTION OF DISPUTES. As a condition of the grant of the Option
hereby and of the ability to exercise the Option, the Optionee and his or
her heirs and successors agree that any dispute or disagreement which may
arise hereunder shall be determined by the Committee in its sole discretion
and judgment, and that any such determination and any interpretation by the
Committee of the terms of this Option Agreement shall be final and shall be
binding and conclusive, for all purposes, upon the Company, the Optionee and
his or her heirs, successors and personal representatives.
<PAGE>
13. NOTICES. Every notice hereunder shall be in writing and shall
conclusively be deemed to be given only if given by personal delivery, by
courier or by registered or certified mail. All notices of the exercise of
any Option hereunder shall be directed to First Alliance Corporation, 17305
Von Karman Avenue, Irvine, California 92614-6203, Attention: Corporate
Secretary. Any notice given by the Company to Optionee directed to
Optionee's address on file with the Company shall be effective to bind
Optionee and any other person who shall have acquired rights hereunder. The
Company shall be under no obligation whatsoever to advise Optionee of the
existence, maturity or termination of any of Optionee's rights hereunder and
Optionee shall be deemed to have familiarized him- or herself with all
matters contained herein and in the Plan which may affect any of Optionee's
rights or privileges hereunder.
14. CONSTRUCTION AND INTERPRETATION. Whenever the term "Optionee" is
used herein under circumstances applicable to any other person or persons to
whom this award, in accordance with the provisions of Section 6 hereof, may
be transferred, the word "Optionee" shall be deemed to include such person or
persons. References to the masculine gender herein also include the
feminine gender for all purposes. This Option Agreement shall be
administered, interpreted and enforced under the laws of the State of
Delaware, without regard to its choice of law provisions.
15. AGREEMENT SUBJECT TO PLAN. This Option Agreement is subject to the
Plan (including any subsequent amendments thereto). In the event of a
conflict between any term or provision contained herein and a term or
provision of the Plan, the applicable terms and provisions of the Plan will
govern and prevail. All definitions of words and terms contained in the
Plan shall be applicable to this Option Agreement.
16. EMPLOYMENT RELATIONSHIP. For purposes of this Option Agreement, an
employee shall be considered to be in the employment of the Company as long
as Optionee remains an employee of the Company or any of its subsidiaries.
Any questions as to whether and when there has been a termination of such
employment and the cause of such termination shall be determined by the
Committee, and its determination shall be final. Nothing contained herein
shall be construed as conferring upon the Optionee the right to continue in
the employ of the Company, nor shall anything contained herein be construed
or interpreted to limit the 'employment at will' relationship between the
Optionee and the Company.
17. BINDING EFFECT. This Option Agreement shall be binding upon and
inure to the benefit of any successors to the Company.
IN WITNESS WHEREOF, this Option Agreement has been executed as of _________
________________, 199__.
FIRST ALLIANCE CORPORATION
By:________________________________
OPTIONEE
___________________________________
<PAGE>
EXHIBIT 4.1.2. NONQUALIFIED STOCK OPTION AGREEMENT
FIRST ALLIANCE CORPORATION
NONQUALIFIED STOCK OPTION AGREEMENT
This Nonqualified Stock Option Agreement ("Option Agreement") is between
First Alliance Corporation, a Delaware corporation (the "Company"), and the
individual named in Section 1 below (the "Optionee").
W I T N E S S E T H:
----------------------
WHEREAS, the Company has adopted the First Alliance Corporation 1996 Stock
Incentive Plan (the "Plan") for the purpose of encouraging ownership of the
Class A Common Stock, $.01 par value ("Common Stock"), of the Company by
eligible key employees, directors and independent contractors of the Company,
including any of its subsidiaries, of providing increased incentive for such
persons to render services and to exert maximum effort for the business
success of the Company, and of further strengthening the identification of
such persons with the stockholders; and
WHEREAS, the Company, acting through the Stock Incentive Committee of its
Board of Directors (the "Committee") and through its stockholders, has
determined that its interests will be advanced by the issuance to Optionee of
a non-qualified stock option under the Plan.
NOW, THEREFORE, for and in consideration of these premises it is agreed as
follows:
1. IDENTIFYING PROVISIONS: As used in this Option Agreement, the following
terms shall have the following respective meanings:
(a) Optionee: __________________
(b) Date of Grant: _____________ ("Date of Grant")
(c) Number of shares subject to Option Agreement: ___________
(d) Exercise Price per share: $__________ ("Exercise Price")
(e) Expiration Date: __________ ("Expiration Date")
2. OPTION. Subject to the terms and conditions contained herein and to
stockholder approval of the Plan, the Company hereby grants to Optionee the
right and option ("Option") to purchase from the Company up to that number of
shares of its Common Stock specified in Section 1(c) of this Option
Agreement, at a price per share equal to the Exercise Price specified in
Section 1(d) of this Option Agreement. This Option is not intended to
qualify as an incentive stock option under Section 422 of the Internal
Revenue Code, as amended (the "Code"). The Plan has been approved by the
Company's stockholders.
3. OPTION PERIOD. The Option herein granted may not be exercised, and is
not exercisable, after the Expiration Date specified in Section 1(e) of this
Option Agreement. This Option shall not be exercisable on the Date of Grant,
but, subject to such further terms and limitations set forth herein, shall
become fully exercisable upon the expiration of six months after the Date of
Grant (the "Vesting Date")
<PAGE>
4. PROCEDURE FOR EXERCISE. The Option herein granted may be exercised by
written notice by Optionee to the Secretary of the Company setting forth the
number of shares of Common Stock with respect to which the Option is to be
exercised, and specifying such further information regarding delivery of such
shares as the Secretary of the Company may reasonably request. Payment shall
be by means of (i) cash, or a cashier's check or bank draft, payable to the
order of the Company, (ii) a commitment from a brokerage firm acceptable to
the Secretary of the Company to pay the aggregate Exercise Price from
proceeds of a sale of Common Stock issuable upon exercise of the Option,
(iii) at the option of the Optionee, in Common Stock theretofore owned by
such Optionee for at least six months, or (iv) a combination of cash,
cashier's check or bank draft and Common Stock. As promptly as practicable
after exercise of this Option, the Company shall issue or cause to be issued
to Optionee the number of shares of Common Stock with respect to which the
Option has been so exercised. The Option may not be exercised with respect
to less than 25 shares.
5. TRANSFERABILITY. This Option shall not be transferable by Optionee
otherwise than by Optionee's will or by the laws of descent and distribution,
or pursuant to a domestic relations order, as defined in the Code or in Title
I of the Employee Retirement Income Security Act, or the rules thereunder.
Except pursuant to the terms of such a domestic relations order, during the
lifetime of Optionee the Option shall be exercisable only by him. Any heir
or legatee of Optionee shall take rights under this Option subject to the
terms and conditions of this Option Agreement. No such transfer of rights
and obligations under this Option Agreement to heirs or legatees of Optionee,
or other transferees pursuant to a domestic relations order, shall be
effective to bind the Company unless the Company shall have been furnished
with written notice thereof and a copy of such evidence as the Committee may
deem necessary to establish the validity of the transfer and the acceptance
and assumption by the transferee or transferees of the obligations of the
Optionee and of the other terms and conditions hereof.
6. NO RIGHTS AS STOCKHOLDER. Optionee shall have no rights as a stockholder
with respect to any shares of Common Stock covered by this Option Agreement
until the date of issuance of shares of Common Stock purchased pursuant to
this Option Agreement. Until such time, Optionee shall not be entitled to
dividends or to vote at meetings of the stockholders of the Company. Except
as provided in paragraph 9 hereof, no adjustment shall be made for dividends
(ordinary or extraordinary, whether in cash or securities or other property)
paid or distributions or other rights granted in respect of any share of
Common Stock for which the record date for such payment, distribution or
grant is prior to the date upon which the Optionee shall have been issued
share certificates, as provided herein above.
7. ADJUSTMENTS. If the outstanding shares of Common Stock are increased,
decreased or exchanged for or converted into cash, property or a different
number or kind of shares or securities, or if cash, property or shares or
securities are distributed in respect of such shares of Common Stock, in
either case as a result of a reorganization, merger, consolidation,
recapitalization, restructuring, reclassification, dividend (other than a
regular, quarterly cash dividend) or other distribution, stock split, reverse
stock split, spin-off or the like, or if substantially all of the property
and assets of the Company are sold, then, unless the terms of such
transaction shall provide otherwise, the Committee shall make appropriate and
proportionate adjustments in the number and type of shares or other
securities or cash or other property that may be acquired pursuant to the
Option and the exercise or settlement price of the Option to the extent
permitted by Section 162(m) of the Code.
8. COMPLIANCE WITH SECURITIES LAWS. Upon the acquisition of any shares
pursuant to the exercise of the Option herein granted, Optionee (or any
person acting under paragraph 6 of this Agreement) shall enter into such
written representations, warranties and agreements as the Company may
reasonably request in order to comply with applicable securities laws or with
this Option Agreement.
<PAGE>
9. COMPLIANCE WITH LAWS. Notwithstanding any of the other provisions
hereof, Optionee agrees not to exercise the Option granted hereby, and that
the Company will not be obligated to issue any shares pursuant to this Option
Agreement, if the exercise of the Option or the issuance of such shares of
Common Stock would constitute a violation by the Optionee or by the Company
of any provision of any law or regulation of any governmental authority. The
certificates representing the shares of Common Stock acquired pursuant to
exercise of the Option will be stamped or otherwise imprinted with legends in
such form as the Company or its counsel may require with respect to any
applicable restrictions on sale or transfer and the stock transfer records of
the Company will reflect stop-transfer instructions with respect to such
shares.
10. WITHHOLDING OF TAX. If the Company becomes obligated to withhold an
amount on account of any tax imposed as a result of the exercise of the
Option, including, without limitation, any federal, state, local or other
income tax, or any F.I.C.A., state disability insurance tax or other
employment tax, the Optionee shall be obligated, as of the first date on
which the Company is so obligated, to pay such amounts to the Company in cash
or check, or other property acceptable to the Secretary of the Company in his
sole discretion; and, if the Optionee fails to make such payment as and when
due, the Company is hereby authorized by the Optionee (i) to withhold from
any payments then or thereafter payable to the Optionee, any such amounts,
and (ii) to refuse to issue or transfer any shares otherwise required to be
issued or transferred pursuant to the terms hereof until all such amounts
have been paid. The Committee may, in its sole discretion, allow the
Optionee to pay any such amounts through the surrender of whole shares of
Common Stock or by having the Company withhold whole shares of Common Stock
otherwise issuable upon the exercise of this Option. Any such shares
surrendered or withheld shall be valued at their market value, determined by
such method as the Secretary of the Company in his sole discretion shall
determine, and have a market value, as of the date on which the amount of tax
to be withheld is determined, which is equal to the sums required to be
withheld.
11. RESOLUTION OF DISPUTES. As a condition of the grant of the Option
hereby and of the ability to exercise the Option, the Optionee and his heirs
and successors agree that any dispute or disagreement which may arise
hereunder shall be determined by the Committee in its sole discretion and
judgment, and that any such determination and any interpretation by the
Committee of the terms of this Option Agreement shall be final and shall be
binding and conclusive, for all purposes, upon the Company, the Optionee and
his or her heirs, successors and personal representatives.
12. NOTICES. Every notice hereunder shall be in writing and shall
conclusively be deemed to be given only if given by personal delivery, by
courier or by registered or certified mail. All notices of the exercise of
any Option hereunder shall be directed to First Alliance Corporation, 17305
Von Karman Avenue, Irvine, California 92614-6203, Attention: Corporate
Secretary. Any notice given by the Company to Optionee directed to
Optionee's address on file with the Company shall be effective to bind him
and any other person who shall have acquired rights hereunder. The Company
shall be under no obligation whatsoever to advise Optionee of the existence,
maturity or termination of any of Optionee's rights hereunder and Optionee
shall be deemed to have familiarized him- or herself with all matters
contained herein and in the Plan which may affect any of Optionee's rights or
privileges hereunder.
13. CONSTRUCTION AND INTERPRETATION. Whenever the term "Optionee" is used
herein under circumstances applicable to any other person or persons to whom
this award, in accordance with the provisions of paragraph 6 hereof, may be
transferred, the word "Optionee" shall be deemed to include such person or
persons. References to the masculine gender herein also include the feminine
gender for all purposes. This Option Agreement shall be administered,
interpreted and enforced under the laws of the State of Delaware, without
regard to its choice of law provisions.
14. AGREEMENT SUBJECT TO PLAN. This Option Agreement is subject to the Plan
(including any subsequent amendments thereto). In the event of a conflict
between any term or provision contained herein and a term or provision of the
Plan, the applicable terms and provisions of the Plan will govern and
prevail. All definitions of words and terms contained in the Plan shall be
applicable to this Option Agreement.
15. BINDING EFFECT. This Option Agreement shall be binding upon and inure
to the benefit of any successors to the Company.
IN WITNESS WHEREOF, this Option Agreement has been executed as of
_______________, 199__.
FIRST ALLIANCE CORPORATION
By:___________________________
OPTIONEE
______________________________
<PAGE>
EXHIBIT 10.5.1. MASON LOAN
FIRST ALLIANCE CORPORATION
SECURED PROMISSORY NOTE
$318,777.18 Irvine, California
December 31, 1996
FOR VALUE RECEIVED, the undersigned, Mark K. Mason ("Maker"), hereby
promises to pay to the order of First Alliance Corporation, a Delaware
corporation (the "Company"), at such place or to such other party or parties
as the holder of this Secured Promissory Note (this "Note") may from time to
time designate, the principal sum of $318,777.18, together with interest
thereon from the date hereof upon the terms and conditions specified below.
1. PRINCIPAL AND INTEREST. The principal amount outstanding under this
Note shall be payable in full, together with all accrued but unpaid interest
thereon, upon the earlier of (i) an Event of Default (as defined below) or
(ii) August 8, 1997. All payments shall be in lawful money of the United
States of America. Interest shall be due and payable in arrears upon the
maturity of this Note.
2. INTEREST RATE. Interest shall accrue under the Note at a fixed annual
rate of ten percent (10%), compounded annually.
3. APPLICATION OF PAYMENTS. All payments made hereunder shall be applied
by the holder of this Note as follows:
(i) First, to the payment of fees, costs and expenses, if any, then
due hereunder and/or under the Pledge Agreement (as defined below);
(ii) Second, to the payment of accrued and unpaid interest hereunder; and
(iii) Third, to the payment of principal hereunder;
or in any other reasonable manner deemed appropriate by the holder of this
Note. The priority of application elected by the holder of this Note on any
one occasion shall not determine any such election in the future.
4. PREPAYMENT. Maker shall have the right at any time and without penalty
or premium to prepay any or all of the outstanding principal balance of this
Note and any accrued and unpaid interest thereon.
5. ACCELERATION. The entire unpaid principal sum and accrued and unpaid
interest on this Note shall become immediately due and payable upon the
occurrence of a material default by Maker of his obligations under the Stock
Pledge Agreement securing this Note or of any obligation secured thereby.
<PAGE>
6. SECURITY. This Note is secured by a first priority lien on 29,285
shares of the Company's Class B Common Stock (the "Pledged Shares") pursuant
to that certain Stock Pledge Agreement by and between the Company and Maker,
dated as of the date hereof (the "Pledge Agreement"). Notwithstanding the
foregoing, this Note is a full recourse obligation of the Maker, and Maker
shall be liable for all principal hereunder and interest thereon without
regard to the Pledged Shares or any other collateral securing this Note.
7. COLLECTION. If this Note is not paid when due, whether at maturity or
by acceleration, Maker promises to pay on demand all costs of collection
(including, but not limited to, attorneys' fees) and all expenses incurred
in connection with the protection or realization of any collateral incurred
by the holder hereof, on account of any such collection, protection or
realization, whether or not suit is filed hereon or on the Pledge Agreement
or any other instrument granting a security interest securing this Note.
8. WAIVER BY MAKER. Maker expressly waives presentment, protest and
demand, notice of protest, demand and dishonor and nonpayment of this Note
and all other notices or demands of any kind in connection with the
delivery, acceptance, performance or enforcement of this Note, and consents
and expressly agrees to any extensions of time (including multiple
extensions and extensions for longer than the original term of this Note),
renewals, releases of any person or entity liable for the payment of all or
any portion of this Note, releases of the Pledged Shares or any other
collateral securing this Note, and waivers or modifications or other
indulgences that may be granted or consented to by the holder of this Note
in respect of the loan evidenced by this Note, in each case without in any
way affecting the liability of Maker or any endorsers hereof. To the
fullest extent permitted by law, the defense of the statute of limitations
in any action on this Note is waived by Maker.
9. NO WAIVER BY COMPANY. No single or partial exercise of any power
hereunder shall preclude other or further exercise thereof or the exercise
of any other power. No delay or omission on the part of the holder hereof
in exercising any right hereunder shall operate as a waiver of such right or
of any other right under this Note. Acceptance of any sum by the holder
that is less than full payment shall not be construed as a waiver of any
default in the payment of this Note.
10. USURY PROTECTION. All agreements between Maker and the holder hereof
are expressly limited so that in no contingency or event whatsoever, whether
by reason of advancement of the proceeds hereof, acceleration of maturity of
the unpaid principal balance hereof, or otherwise, shall the amount paid or
agreed to be paid to the holder hereof for the use, forbearance or detention
of the money to be advanced hereunder exceed the highest lawful rate
permissible under applicable usury laws. If, from any circumstances
whatsoever, fulfillment of any provision hereof, at the time performance of
such provision shall be due, shall involve transcending the limit of
validity prescribed by law that a court of competent jurisdiction may deem
applicable hereto, then ipso facto, the obligation to be fulfilled shall be
reduced to the limit of such validity, and if from any circumstances the
holder shall ever receive as interest an amount that would exceed the
highest lawful rate, such amount that would be excessive interest shall be
applied to the reduction of the unpaid principal balance due hereunder and
not to the payment of interest. This provision shall control every other
provision of all agreements between Maker and the holder hereof with respect
to the foregoing
<PAGE>
11. GOVERNING LAW. This Note is to be governed by and construed according
to the laws of the State of California, except to the extent that such laws
are preempted by federal law.
12. AMENDMENT. This Note may from time to time be extended or renewed,
with or without notice to Maker, and any related right may be waived,
exchanged, surrendered or otherwise dealt with, all without affecting the
liability of Maker.
____________________________________
Mark K. Mason
<PAGE>
<TABLE>
EXHIBIT 11.1 COMPUTATION OF NET INCOME PER SHARE
FIRST ALLIANCE CORPORATION
COMPUTATION OF NET INCOME PER SHARE
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
(Dollars in thousands except per share amounts)
<CAPTION>
For the Year Ended December 31,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
DATA AS TO EARNINGS - Net Income............................................... $ 32,139 $ 30,542 $ 14,871
============ ============ =============
DATA AS TO NUMBER OF COMMON AND COMMON EQUIVALENT
SHARES - PRIMARY NET INCOME PER SHARE
Weighted average number of shares outstanding
Class A and Class B Common Stock........................................... 12,478,484 10,750,000 10,750,000
Reduction of outstanding shares assuming average balance of deferred stock
compensation plus tax benefits credited to capital on assumed exercise used as
proceeds invested in treasury stock (at average market prices during each period) (81,122) (99,593) (99,593)
Common equivalent shares assuming issuance of shares represented by outstanding
stock options:
Additional shares assumed to be issued..................................... 229,840
Reduction of such additional shares assuming proceeds plus tax benefits credited
to capital on assumed exercise invested in treasury stock (at average market
prices during each period)................................................. (206,907)
------------ ----------- ------------
Weighted average number of common and common equivalent shares outstanding..... 12,420,295 10,650,407 10,650,407
============ =========== ============
PRIMARY NET INCOME PER SHARE................................................... $ 2.59 $ 2.87 $ 1.40
============ =========== ============
DATA AS TO NUMBER OF COMMON AND COMMON EQUIVALENT
SHARES - FULLY DILUTED NET INCOME PER SHARE:
Weighted average number of shares outstanding
Class A and Class B Common Stock........................................... 12,478,484 10,750,000 10,750,000
Reduction of outstanding shares assuming ending balance of deferred stock
compensation plus tax benefits credited to capital on assumed exercise used as
proceeds invested in treasury stock (at market prices at the end of each period) (52,365) (99,593) (99,593)
Common equivalent shares assuming issuance of shares represented by outstanding
stock options:
Additional shares assumed to be issued..................................... 229,840
Reduction of such additional shares assuming proceeds plus tax benefits credited to
capital on assumed exercise invested in treasury stock (at market prices at the end of
each period)............................................................... (170,442)
------------ ----------- ------------
Weighted average number of common and common equivalent shares outstanding..... 12,485,517 10,650,407 10,650,407
============ =========== ============
FULLY DILUTED NET INCOME PER SHARE............................................. $ 2.57 $ 2.87 $ 1.40
============ =========== ============
Reference is made to ITEM 8. Financial Statements and Supplementary Data: Notes to Consolidated Financial Statements - Note 1
</TABLE>
<PAGE>
EXHIBIT 21. SUBSIDIARIES OF THE REGISTRANT
FIRST ALLIANCE CORPORATION
SUBSIDIARIES OF THE REGISTRANT
First Alliance Mortgage Company
Incorporated in California
Names under which the subsidiary also does business: First Alliance Credit
Corporation and Pacific Reconveyance.
First Alliance Services
Incorporated in California
First Alliance Residual Holding Company
Incorporated in Delaware
First Alliance Acceptance Corporation
Incorporated in Delaware
First Alliance Mortgage Company Limited
Incorporated in the United Kingdom
First Alliance Corporation, Limited
Incorporated in the United Kingdom
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 27,414
<SECURITIES> 0
<RECEIVABLES> 2,671
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 43,236
<PP&E> 3,098
<DEPRECIATION> 0
<TOTAL-ASSETS> 87,457
<CURRENT-LIABILITIES> 9,348
<BONDS> 0
0
0
<COMMON> 148
<OTHER-SE> 77,830
<TOTAL-LIABILITY-AND-EQUITY> 87,457
<SALES> 48,171
<TOTAL-REVENUES> 70,871
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 32,632
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,655
<INCOME-PRETAX> 38,239
<INCOME-TAX> 6,100
<INCOME-CONTINUING> 32,139
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 32,139
<EPS-PRIMARY> 2.59
<EPS-DILUTED> 2.57
</TABLE>
