<PAGE>
Filed Pursuant To Rule 424(b)(1)
Reg. Statement No. 333-32993
2,950,000 SHARES
FIRST ALLIANCE CORPORATION
CLASS A COMMON STOCK
------------------
All of the shares of the Class A Common Stock, par value $.01 per share (the
"Class A Common Stock"), of First Alliance Corporation, a Delaware corporation
(together with its subsidiaries, the "Company"), offered hereby (the "Public
Offering") are being sold by the Brian and Sarah Chisick Revocable Trust U/A
3-7-79 (the "Selling Stockholder" or the "Trust") of which Brian and Sarah
Chisick are co-trustees. Mr. Chisick is the President and Chief Executive
Officer of the Company and Chairman of its Board of Directors. Mrs. Chisick is a
director of the Company. The shares of Class A Common Stock offered hereby are
currently held by the Trust in the form of shares of the Company's Class B
Common Stock, $.01 par value per share (the "Class B Common Stock"). Such shares
of Class B Common Stock are convertible into an equal number of shares of Class
A Common Stock at the option of the Trust or upon the occurrence of certain
events, including the transfer of such shares to anyone other than certain
persons affiliated with Mr. and Mrs. Chisick. Accordingly, upon the consummation
of the Public Offering and assuming that the purchasers of the shares offered
hereby are not affiliated with Mr. and Mrs. Chisick, the shares of Class B
Common Stock currently held by the Trust will automatically convert into an
equal number of shares of Class A Common Stock and such shares of Class A Common
Stock will be delivered to the purchasers in the Public Offering.
The Class A Common Stock, which is offered hereby, has one vote per share,
and the Class B Common Stock has four votes per share. See "Description of
Capital Stock." Upon completion of the Public Offering and assuming the
Underwriters' over-allotment option is not exercised, the issued and outstanding
shares of Class A Common Stock and Class B Common Stock that will be held or
controlled by Mr. and Mrs. Chisick and certain of the executive officers and
directors of the Company and related parties will have approximately 82% of the
combined voting power of all outstanding shares of capital stock of the Company.
The Class A Common Stock is listed for trading on the Nasdaq National Market
("Nasdaq") under the symbol "FACO." On September 10, 1997, the last reported
sales price of the Class A Common Stock on Nasdaq was $28 7/16 per share. See
"Price Range of Class A Common Stock and Dividend Policy."
--------------------------
SEE "RISK FACTORS" ON PAGES 9 THROUGH 16 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) SELLING STOCKHOLDER(2)
<S> <C> <C> <C>
Per Share..................... $28.00 $1.40 $26.60
Total (3)..................... $82,600,000 $4,130,000 $78,470,000
</TABLE>
(1) See "Underwriting" for information relating to indemnification of the
Underwriters.
(2) Does not reflect expenses of the Public Offering, estimated to be $513,784,
of which the Selling Stockholder will pay an estimated $284,000 and the
Company will pay an estimated $230,000.
(3) The Selling Stockholder has granted the Underwriters an option, exercisable
within 30 days of the date hereof, to purchase up to 442,500 additional
shares of Class A Common Stock solely to cover over-allotments, if any. To
the extent that the option is exercised, the Underwriters will offer the
additional shares at the Price to Public shown above. If the option is
exercised in full, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Selling Stockholder will be $94,990,000,
$4,749,500 and $90,240,500, respectively. See "Underwriting."
--------------------------
The shares of Class A Common Stock are offered by the Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject to
the right of the Underwriters to reject any order in whole or part. It is
expected that delivery of the shares of Class A Common Stock will be made
against payment therefor at the offices of Friedman, Billings, Ramsey & Co.,
Inc., Arlington, Virginia, or in book entry form through the book entry
facilities of the Depository Trust Company, on or about September 17, 1997.
--------------------------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
BEAR, STEARNS & CO. INC.
MONTGOMERY SECURITIES
THE DATE OF THIS PROSPECTUS IS SEPTEMBER 12, 1997
<PAGE>
FIRST ALLIANCE CORPORATION
Retail Branch Office Locations
[MAP WITH FIRST ALLIANCE CORPORATION RETAIL BRANCH OFFICE LOCATIONS]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
WHICH STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CLASS A COMMON
STOCK. SUCH TRANSACTIONS MAY BE EFFECTED IN THE NASDAQ NATIONAL MARKET SYSTEM,
IN THE OVER THE COUNTER MARKET, OR OTHERWISE. SUCH STABILIZING, IF COMMENCED,
MAY BE DISCONTINUED AT ANY TIME. SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND THE SELLING
STOCKHOLDER) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE CLASS A
COMMON STOCK ON THE NASDAQ NATIONAL MARKET SYSTEM IN ACCORDANCE WITH RULE 103 OF
REGULATION M. SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS. INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS
PROSPECTUS CONTAINS "FORWARD LOOKING STATEMENTS" WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, WHICH CAN BE IDENTIFIED BY THE
USE OF FORWARD LOOKING TERMINOLOGY, SUCH AS "MAY," "WILL," "EXPECT,"
"ANTICIPATE," "ESTIMATE" OR "CONTINUE" OR THE NEGATIVE THEREOF OR OTHER
VARIATIONS THEREON OR COMPARABLE TERMINOLOGY. THE COMPANY'S ACTUAL RESULTS MAY
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE THOSE DISCUSSED UNDER "RISK
FACTORS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS" AND "BUSINESS," AS WELL AS GENERAL ECONOMIC AND BUSINESS
CONDITIONS, COMPETITION AND OTHER FACTORS DISCUSSED ELSEWHERE IN THIS
PROSPECTUS. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE ANY
REVISIONS TO THESE FORWARD-LOOKING STATEMENTS THAT MAY REFLECT EVENTS OR
CIRCUMSTANCES AFTER THE DATE HEREOF OR THE OCCURRENCE OF ANTICIPATED OR
UNANTICIPATED EVENTS.
The Company originates, purchases, sells and services non-conventional
mortgage loans secured primarily by first mortgages on single family residences.
The Company focuses on a distinct segment of the home equity lending market by
concentrating its marketing efforts on homeowners believed by management of the
Company, based on historical customer profiles, to be pre-disposed to using the
Company's products and services while satisfying its underwriting guidelines.
The Company originates loans through its retail branch network, which is
currently comprised of 27 offices in the United States (seven of which are
located in California, two of which are located in each of Florida, Illinois,
Maryland, New Jersey and New York, and one of which is located in each of
Arizona, Colorado, Georgia, Massachusetts, Ohio, Oregon, Pennsylvania, Utah,
Virginia and Washington) and four offices in the United Kingdom. The Company
intends to continue to expand its retail branch network on a national and
international basis. The Company also purchases loans from other originators.
The Company's customers, who use loans from the Company principally to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes, consist of two primary groups. The first group consists of
individuals who are unable to obtain mortgage financing from banks, savings and
loan institutions and other companies that have historically provided loans to
individuals with favorable credit characteristics ("Conventional Lending
Institutions"). These individuals often have impaired or unsubstantiated credit
characteristics and/or unverifiable income and respond favorably to the
Company's marketing. The second group consists of individuals who could qualify
for loans from Conventional Lending Institutions but instead choose to use the
Company's products and services. The Company's experience has shown that these
individuals are attracted by the Company's high degree of personalized service
and timely response to loan applications. Each category of customers has
historically been willing to pay the Company's loan origination fees and
interest rates that are typically higher than the fees and rates charged by
Conventional Lending Institutions. See "Business--Underwriting."
The Company has historically generated positive cash flow due principally to
the magnitude of its retail loan origination fees. The loan origination and
processing fees charged to the borrower are included in the principal balance of
the loan originated. The Company funds such loans out of available cash or by
drawing on either of its two secured revolving lines of credit in the United
States aggregating $150 million or its one secured revolving line of credit in
the United Kingdom of L25 million (the "Warehouse Financing Facilities"). For
loans financed through available cash, the Company receives its loan origination
and processing fees in cash upon sale of the loan. For loans financed through
the Warehouse Financing Facilities, the Company generally receives cash in the
amount of the loan origination and processing fees, subject to certain
limitations, at the time of the Warehouse Financing Facilities borrowing and
prior to the time the Company recognizes such fees for accounting purposes as a
component of loan origination and sale revenue, which occurs upon the sale of
the loan.
3
<PAGE>
The Company's substantial expansion of its retail branch network and the
ability to Securitize (as defined below) its loans have contributed
significantly to the increase in the Company's loan origination volume. From
1992 to 1996, retail originations increased at a compounded annual growth rate
of 33%, and for the first six months of 1997, retail originations increased 34%
from the corresponding period in 1996. As a result, the Company's net income, on
a pro forma basis (treating the Company as a C corporation for all periods),
increased at a compounded annual growth rate of 38% from 1992 to 1996. For the
first six months of 1997, net income increased 54% from pro forma net income for
the corresponding period in 1996.
In a securitization ("Securitization"), the Company pools and sells its
loans to a real estate mortgage investment conduit trust (a "REMIC Trust") in
exchange for securities issued by the REMIC Trust. The REMIC Trust securities
are either senior rights to receive scheduled interest and principal ("Regular
Interests") or a subordinated right to receive certain excess cash flow
generated by the Securitized loans (a "Residual Interest"). The Company
generally sells immediately to the public the Regular Interests it receives from
the REMIC Trusts and retains the Residual Interest.
During 1996 and the first six months of 1997, the Company's Securitization
volume as a percentage of loan sales was 79% and 69%, respectively. The Company
anticipates that it will continue to Securitize a majority of its loan
originations in the future and sell those originations which do not satisfy the
Company's criteria for Securitization. Such loans are sold on a servicing
released basis to unaffiliated wholesale purchasers on either a bulk or flow
basis. These wholesale loan sales enable the Company to realize a return on all
loans generated by its marketing efforts by retaining loan origination fees
without retaining the associated credit risk. As the Company continues to
service loans sold through Securitizations, the Company's loan servicing
portfolio (the "Servicing Portfolio") has increased from $240.2 million at
December 31, 1992 to $692.2 million at June 30, 1997.
RECENT DEVELOPMENTS
HIGH LTV PROGRAM. In July 1997, the Company entered into an agreement with
Mego Mortgage Corporation ("Mego") under which the Company will originate loan
products ("High LTV Loans") according to Mego's underwriting guidelines for
purposes of debt consolidation and/or home improvement at loan-to-value ratios
("LTVs") of up to 125%. The Company will sell such High LTV Loans on a servicing
released basis to Mego soon after funding. The Company believes the origination
and sale of High LTV Loans, which would not otherwise satisfy the Company's
underwriting guidelines, will allow the Company to realize additional revenue
from leads already generated by its marketing efforts.
CREDIT CARD PROGRAM. The Company has entered into a credit card
relationship with Fidelity Federal Bank, A Federal Savings Bank ("Fidelity").
Under this relationship, Fidelity will issue real estate secured credit cards
("Affinity Cards") that bear the Company's name and that the Company will market
and service. The Company believes the terms of the Affinity Cards, including the
tax deductibility of interest paid on outstanding balances for most customers,
will be attractive to potential borrowers.
Fidelity will fund the Affinity Card balances, on which it will earn a
guaranteed yield. Fidelity will pay the Company for its solicitation, customer
relations and collection services and for the credit enhancement of the credit
card balances provided by the Company. Under the terms of this credit
enhancement, the Company has guaranteed a minimum yield to Fidelity and has
agreed to indemnify Fidelity for any losses it may incur as a result of the
Affinity Card program.
The Company intends to market the Affinity Card using marketing procedures
and underwriting guidelines substantially similar to those used by the Company
in marketing its mortgage loan products. Accordingly, the Company expects that
many of the individuals solicited for mortgage loan products may also be
solicited for the Affinity Card, thereby resulting in relatively lower marketing
expenditures for the Affinity Card than would otherwise be expected.
4
<PAGE>
ACQUISITION OF BANK. In June 1997, the Company entered into a definitive
agreement to acquire Standard Pacific Savings, F.A., a federally chartered
savings association based in Newport Beach, California (the "Bank") with
deposits insured by the Federal Deposit Insurance Corporation (the "FDIC"). The
cost of the acquisition, which will be $0.6 million in excess of the Bank's
stockholder's equity at the date of acquisition, is currently estimated to be
$9.0 million. The acquisition is subject to the approval of the Office of Thrift
Supervision (the "OTS").
Although the Company expects the Bank to continue to accept deposits and
provide other financial services, the primary purpose of the acquisition is to
expand the Company's credit card finance business. Initially, the credit card
products offered by the Bank will be limited to a real estate secured credit
card product with substantially the same features as the Affinity Card. The
Company intends to market this credit card in the same manner as the Affinity
Card. While the Company expects, for the immediate future, to conduct the
Affinity Card program concurrently with any credit card program conducted by the
Bank, it is anticipated that the Company will transfer the Affinity Card
program, and any outstanding balances thereunder, from Fidelity to the Bank
during the first year of operation. See "Business-- General" and "Regulation."
RETAIL BRANCH NETWORK EXPANSION. As a part of its continuing retail branch
network expansion, since the Company's initial public offering of equity in July
1996 (the "Initial Public Offering"), the Company has opened eight branch
offices in four states and four branch offices in the United Kingdom.
The Company maintains its principal office at 17305 Von Karman Avenue,
Irvine, California 92614-6203. Its telephone number is (714) 224-8500.
5
<PAGE>
THE PUBLIC OFFERING
<TABLE>
<S> <C>
Class A Common Stock offered by
the Selling Stockholder: 2,950,000 shares (1)
Capital Stock to be Outstanding after the Public Offering:
Class A Common Stock............ 6,705,343 shares (1)(2)
Class B Common Stock............ 7,770,715 shares (1)(3)
Total......................... 14,476,058 shares
Voting Rights..................... Each share of Class A Common Stock is entitled to one
vote and each share of Class B Common Stock is entitled
to four votes on most matters requiring a shareholder
vote. See "Description of Capital Stock--Common Stock."
Nasdaq National Market Symbol for
the Class A Common Stock........ FACO
Risk Factors...................... See "Risk Factors" for a discussion of certain material
factors that should be considered in connection with an
investment in the Class A Common Stock offered hereby.
</TABLE>
- ------------------------
(1) Does not give effect to exercise of the over-allotment option for 442,500
shares.
(2) Excludes 607,707 shares of Class A Common Stock reserved for issuance upon
the exercise of options granted or available for grants under the Company's
stock incentive plan. See "Description of Capital Stock."
(3) Class B Common Stock is convertible into Class A Common Stock on a one for
one basis at the option of the holder and in certain other circumstances.
See "Description of Capital Stock."
RISK FACTORS
See "Risk Factors" for a description of certain factors that should be
considered carefully in evaluating an investment in the shares of Class A Common
Stock offered by this Prospectus. Such risks include, among others, a possible
decline of collateral value, the Company's focus on credit impaired borrowers,
interest rate risks, regulatory and legislative risks, including risks
associated with becoming a savings and loan holding company, a possible
reduction in the availability of funding sources, the Company's dependence on
Securitizations and the possible inaccuracy of its valuation of mortgage
servicing rights and Residual Interests, competition, the concentration of the
Company's operations in California, the possible inability of the Company to
continue its growth strategy, loan delinquencies and defaults, risks associated
with implementation of the Affinity Card program, the possible termination of
the Company's servicing rights, the anti-takeover effect of the Company's
capital structure, the Company's dependence on key personnel, the possible
volatility of the stock price, the effect on share price of shares available for
future sale, the control of the Company by certain stockholders and no
expectation of cash dividends.
6
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1992 1993 1994(1) 1995 1996(2) 1996 1997
--------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Gain (loss) on sale of loans......... $ 1,731 $ 2,056 $ (1,547) $ 8,982 $ 10,965 $ 3,256 $ 10,436
Origination fees and other........... 18,275 20,433 29,449 26,484 37,206 17,995 21,350
Servicing and other fee revenue...... 7,145 8,989 9,106 8,614 8,854 4,487 3,855
Interest revenue..................... 2,285 4,452 8,650 14,624 13,562 6,035 9,034
Total revenue........................ 29,468 35,950 45,802 58,880 70,871 31,834 44,681
Interest expense..................... 871 2,106 3,744 4,167 2,655 1,787 712
Noninterest expense.................. 17,934 22,881(3) 26,824(3) 23,693 29,977 12,881 17,941
Income before income tax provision... 10,663 10,963 15,234 31,020 38,239 17,166 26,028
Net income........................... 10,395 10,741 14,871 30,542 32,139 16,909 15,550
Net income per share................. 0.98 1.01 1.40 2.87 2.59 1.59 1.05
Pro forma net income (4)............. 6,291 6,468 8,988 18,302 22,561 10,128 -
Pro forma net income per share (4)... 0.43 0.44 0.61 1.24 1.53 0.69 -
Income before income tax provision as
a % of revenue..................... 36.2% 30.5% 33.3% 52.7% 54.0% 53.9% 58.3%
Dividends declared................... $ 3,987 $ 5,853 $ 17,341 $ 12,205 $ 60,080(5) $ 59,121(5) -
STATEMENT OF FINANCIAL CONDITION DATA:
Cash and cash equivalents............ $ 1,111 $ 4,387 $ 5,298 $ 4,019 $ 27,414 $ 8,858 $ 17,093
Loans held for sale.................. 10,080 74,196 18,676 24,744 11,023 12,718 18,075
Residual interests................... 2,792 6,879 11,645 19,705 29,253 22,354 37,377
Total assets......................... 24,517 99,855 48,266 66,911 87,457 64,180 99,974
Total borrowings..................... 966 68,773 14,839 19,356 131 55,285 109
Stockholders' equity................. 21,566 26,454 23,984 42,321 77,978 109(5) 88,451
OTHER DATA:
Loan originations and purchases:
Retail originations................ $ 93,596 $ 195,907 $ 221,839 $ 216,566 $ 291,807 $ 135,147 $ 181,681
Wholesale purchases................ 13,622 84,034 91,826 24,078 32,681 20,791 38,441
--------- --------- --------- --------- --------- --------- ---------
Total............................ $ 107,218 $ 279,941 $ 313,665 $ 240,644 $ 324,488 $ 155,938 $ 220,122
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Average retail origination loan
size............................... $ 36 $ 54 $ 66 $ 69 $ 83 $ 83 $ 87
Number of retail branches............ 11 11 13 17 23 19 29
Weighted average interest rate on
loan originations and purchases.... 13.6% 9.5% 8.7% 10.3% 9.6% 9.5% 9.4%
Weighted average initial combined
loan-to-value ratio................ 48.5% 55.2% 56.2% 59.3% 62.2% 62.4% 63.5%
Loan sales:
Securitizations.................... $ 39,024 $ 141,795 $ 350,331 $ 167,974 $ 267,661 $ 127,675 $ 148,003
Whole loan sales................... 69,298 70,554 22,857 65,251 71,864 42,400 66,518
--------- --------- --------- --------- --------- --------- ---------
Total............................ $ 108,322 $ 212,349 $ 373,188 $ 233,225 $ 339,525 $ 170,075 $ 214,521
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Servicing portfolio.................. $ 240,221 $ 385,570 $ 555,685 $ 613,791 $ 641,191 $ 603,851 $ 692,243
Total delinquencies as a % of the
servicing portfolio................ 5.0% 4.0% 4.3% 5.8% 5.5% 6.1% 4.1%
Real estate owned as a % of the
servicing portfolio................ 0.6% 0.9% 0.6% 1.3% 0.6% 1.1% 0.7%
Losses on real estate owned as a % of
the average servicing portfolio
during the period.................. 0.02% 0.02% 0.01% 0.03% 0.35% 0.26%(6) 0.30%(6)
</TABLE>
- ------------------------------
In June 1997, the Company entered into a definitive agreement to acquire the
Bank. For pro forma condensed consolidated financial statements reflecting
such acquisition see "Unaudited Pro Forma Condensed Consolidated Financial
Information."
(1) The Company typically Securitizes or sells most of its loan originations 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 Warehouse
7
<PAGE>
Financing Facilities. 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.
(2) During 1996, the Company completed the 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 that of a C corporation. The
Company received $63 million of net proceeds from the Initial Public
Offering, of which $45 million was used to pay the S Distribution Notes (as
defined in Note 5 below).
(3) 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 1989.
(4) 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. The Company ceased to be an S corporation concurrent with the
Initial Public Offering in July 1996. Pro forma net income per share assumes
that the total number of shares outstanding upon completion of the Initial
Public Offering were outstanding in all prior periods.
(5) Included in dividends in 1996 is $45 million of S distribution dividends
made in the form of promissory notes (the "S Distribution Notes") in
anticipation of the Initial Public Offering. Stockholders' equity as of June
30, 1996 reflects this dividend. Historical dividends include dividends used
by the stockholders to pay income taxes on the Company's S corporation
earnings and are not indicative of the Company's present dividend policy.
(6) Annualized.
8
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING
FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING AN INVESTMENT IN THE SHARES
OF CLASS A COMMON STOCK OFFERED BY THIS PROSPECTUS.
DECLINE OF COLLATERAL VALUE MAY ADVERSELY AFFECT LOAN-TO-VALUE RATIOS
The Company's business may be adversely affected by declining real estate
values. Any material decline in real estate values reduces the ability of
borrowers to use home equity to support borrowings and increases the LTVs of
loans previously made by the Company, thereby weakening collateral coverage and
increasing the possibility of a loss in the event of a borrower default.
Further, delinquencies, foreclosures and losses generally increase during
economic slowdowns or recessions. Because of the Company's focus on, among
others, borrowers who are unable to obtain mortgage financing from conventional
mortgage sources, the actual rates of delinquencies, foreclosures and losses on
such loans could be higher under adverse economic conditions than those
currently experienced in the mortgage lending industry in general. Any sustained
period of such increased delinquencies, foreclosures or losses could adversely
affect the Company's results of operations and financial condition.
CREDIT IMPAIRED BORROWERS MAY RESULT IN INCREASED DELINQUENCY RATES
Loans made to borrowers who may be unable to obtain mortgage financing from
conventional sources may entail a higher risk of delinquency and higher losses
than loans made to borrowers who utilize conventional mortgage sources. As of
March 31, 1997 and December 31, 1996, total delinquent loans as a percentage of
the Company's Servicing Portfolio were 4.4% and 5.5%, respectively, as compared
to 4.4% as of both such dates for the portfolios of the mortgage banking
industry as a whole according to the Mortgage Bankers Association. While the
Company employs underwriting criteria and collection methods to mitigate the
higher risks inherent in loans made to these borrowers, no assurance can be
given that such criteria or methods will afford adequate protection against such
risks. In the event that pools of loans sold and serviced by the Company
experience higher delinquencies, foreclosures or losses than anticipated, the
Company's results of operations or financial condition could be adversely
affected.
IMPACT OF REGULATION AND LEGISLATION; REGULATORY ENFORCEMENT
The Company's business is subject to extensive regulation, supervision and
licensing by governmental authorities in the United States (including federal,
state and local authorities) and the United Kingdom. The Company is also subject
to various laws, regulations and judicial and administrative decisions imposing
requirements and restrictions on part or all of its operations. The Company's
consumer lending activities are subject to the Truth-in-Lending Act (including
the Home Ownership and Equity Protection Act of 1994), the Fair Housing Act, the
Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Real Estate
Settlement Procedures Act ("RESPA"), the Home Mortgage Disclosure Act and the
Fair Debt Collection Practices Act and regulations promulgated thereunder and
the United Kingdom Consumer Credit Act of 1974, as well as other United States
federal and state and United Kingdom statutes and regulations affecting the
Company's activities. The Company is also subject to the rules and regulations
of, and examinations by, state and United Kingdom regulatory authorities with
respect to originating, processing, underwriting, selling, Securitizing and
servicing loans. These rules and regulations, among other things, (i) impose
licensing obligations on the Company, (ii) establish eligibility criteria for
mortgage loans, (iii) prohibit discrimination, (iv) provide for inspections and
appraisals of properties, (v) require credit reports on loan applicants, (vi)
regulate assessment, collection, foreclosure and claims handling, investment and
interest payments on escrow balances and payment features, (vii) mandate certain
disclosures and notices to borrowers and (viii) in some cases, fix maximum
interest rates, fees and mortgage loan amounts. Failure to comply with these
requirements can lead to termination or suspension of the Company's servicing
rights without compensation to the Company, demands for indemnification or
mortgage loan repurchases, certain rights of rescission for mortgage loans,
class action lawsuits and
9
<PAGE>
administrative enforcement actions. Recent Federal legislation, the Riegle
Community Development and Regulatory Improvement Act (the "Riegle Act"), has
focused additional regulation on mortgage loans having relatively higher
origination fees and interest rates, such as those made by the Company, and the
Company expects its business to be the focus of additional United States federal
and state legislation, regulation and possible enforcement in the future. In
addition, the United Kingdom Office of Fair Trade recently has expressed
regulatory concern with respect to certain mortgage loan products and practices,
which may include those utilized by the Company.
The Company's placement of insurance covering improvements on real property
that secures the Company's loan to a borrower is subject to state and federal
statutes and regulations applicable to "force placed" insurance. The Company
receives a fee in connection with its placement of such insurance in California,
which activity is not required to be licensed. Historically, the Company also
received a fee in connection with the placement of such insurance outside
California. While the Company does not believe, based on the advice of
regulatory counsel, that it was required to be licensed in connection with such
activity, a state insurance regulator or a court could take a different
interpretation. The rules and regulations governing force placed insurance
impose certain disclosure and notice requirements on the Company prior to
effecting such insurance coverage, impose limitations on the Company's ability
to accept or reject insurance coverage offered by a borrower and impose
restrictions on the fees and costs which the Company may charge the borrower
with respect to such insurance. The Company's sale of credit life insurance and
credit disability insurance in California is subject to statutes and regulations
in that state applicable to insurance producers. Failure to comply with any of
the foregoing state and federal requirements could lead to imposition of civil
penalties on the Company, class action lawsuits and administrative enforcement
actions.
The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and certain of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently enacted regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the regulations to which the Company is subject may lead to
regulatory investigations or enforcement actions and private causes of action,
such as class action lawsuits, with respect to the Company's compliance with the
applicable laws and regulations. As a mortgage lender, the Company has been, and
expects to continue to be, subject to regulatory enforcement actions and private
causes of action from time to time with respect to its compliance with
applicable laws and regulations. The Company's lending practices have in the
past been and currently are under regulatory review by various state
authorities. Although the Company utilizes systems and procedures to facilitate
compliance with these legal requirements and believes that it is in compliance
in all material respects with applicable laws, rules and regulations, there can
be no assurance that more restrictive laws, rules and regulations will not be
adopted in the future, or that existing laws and regulations will not be
interpreted in a more restrictive manner, which could make compliance more
difficult or expensive. See "Business-- Regulation."
RISKS RELATING TO ACQUISITION OF THE BANK
If the acquisition of the Bank is consummated, First Alliance Corporation
("FACO") will become a unitary savings and loan holding company. As such, FACO
will be subject to a complex body of laws and regulations, which could impose
substantial compliance burdens on the Company and expose it to material risks.
Among others, these regulations would restrict the extent of transactions that
could be entered into between the Bank and its subsidiaries, on the one hand,
and FACO and its non-bank subsidiaries, on the other hand. In addition, the
Company's operating subsidiary, First Alliance Mortgage Company ("FAMCO"), would
be subject to the possibility of examination and supervision by the OTS as an
"affiliate" of the Bank. If the Bank fails to satisfy certain requirements of
applicable law and regulation relating to the amount of its assets dedicated to
residential mortgage finance and credit card activities, the
10
<PAGE>
Bank could be converted to a commercial bank, in which case FACO would become a
bank holding company subject to a more restrictive body of law and regulation
imposing even greater compliance burdens on the Company and exposing it to
greater risks than those applicable to the Company as a unitary savings and loan
holding company. See "Business--Regulation and Supervision--Bank."
RISKS RELATING TO SECURED CREDIT CARD PROGRAM
The Company's credit card relationship with Fidelity provides, among other
things, for the Company to guarantee the yield to be earned by Fidelity and to
indemnify Fidelity against losses Fidelity may incur as a result of the Affinity
Card program. Accordingly, the Company is subject to certain risks with respect
to such guarantee and indemnification. Changes in laws and regulations
applicable to the Affinity Cards could adversely affect the demand for
acquisition and use of Affinity Cards by consumers and therefore could adversely
affect the benefits of the Affinity Card program or result in losses to the
Company. Such changes in laws and regulations similarly could reduce or
eliminate the anticipated benefit to the Company of the acquisition of the Bank,
which acquisition is being undertaken by the Company in large part because of
the potential benefit to the Company from the proposed issuance of secured
credit cards by the Bank.
ELIMINATION OF DEDUCTIBILITY OF MORTGAGE INTEREST COULD ADVERSELY AFFECT RESULTS
OF OPERATIONS
Members of Congress, government officials and political candidates have from
time to time suggested the elimination of the mortgage interest deduction for
federal income tax purposes, either entirely or in part, based on borrower
income, type of loan or principal amount. Because many of the Company's loans
are made to borrowers for the purpose of consolidating consumer debt or
financing other consumer needs, the competitive advantages of tax deductible
interest, when compared with alternative sources of financing, could be
eliminated or seriously impaired by such government action. Accordingly, the
reduction or elimination of these tax benefits could have a material adverse
effect on the demand for mortgage loans of the kind offered by the Company and
with respect to the Company's real estate secured credit card programs.
RISK OF LITIGATION
In the ordinary course of its business, the Company is subject to claims
made against it by borrowers and investors who have purchased loans from the
Company arising from, among other things, losses that are claimed to have been
incurred as a result of alleged breaches of fiduciary obligations,
misrepresentations, errors and omissions of employees, officers and agents of
the Company (including its appraisers), incomplete documentation and failures by
the Company to comply with various laws and regulations applicable to its
business. The Company believes that liability with respect to any currently
asserted claims or legal actions is not likely to be material to the Company's
consolidated results of operations or financial condition; however, any claims
asserted in the future may result in legal expenses or liabilities that could
have a material adverse effect on the Company's results of operations and
financial condition and could distract members of management from the operations
of the Company.
FLUCTUATIONS IN INTEREST RATES MAY ADVERSELY AFFECT PROFITABILITY
The profitability of the Company is likely to be adversely affected during
any period of rapid changes in interest rates. A substantial and sustained
increase in interest rates could adversely affect the spread between the rate of
interest received by the Company on its loans and the interest rates payable
under the Warehouse Financing Facilities during the period of time between the
funding or purchase of a mortgage loan and its sale (the "Warehousing Period")
or the pass-through rate for Regular Interests issued in Securitizations. Such
interest rate increases could also affect the ability of the Company to
originate and purchase loans. A significant decline in interest rates could
decrease the Servicing Portfolio by increasing the level of loan prepayments.
11
<PAGE>
Although the Company employs a hedging strategy to diminish the impact of
interest rate changes on its business, an effective hedging strategy is complex
and no hedging strategy can completely insulate the Company from interest rate
risks. The nature and timing of hedging transactions may impact the
effectiveness of hedging strategies. Poorly designed strategies or improperly
executed transactions may increase rather than mitigate risk. In addition,
hedging involves transaction and other costs, and such costs could increase as
the period covered by the hedging protection increases or in periods of rising
and fluctuating interest rates. Therefore, the Company may be prevented from
effectively hedging its interest rate risks, which could have a material adverse
effect on the Company's results of operations and financial condition. See
"Business--Interest Rate Risk Management."
DEPENDENCE ON SECURITIZATIONS AND IMPACT ON QUARTERLY OPERATING RESULTS
Gain on sale of loans generated by the Company's Securitizations represents
a significant portion of the Company's revenues and net income. Furthermore, the
Company relies significantly on Securitizations to generate cash proceeds for
repayment of its Warehouse Financing Facilities and enable the Company to
originate and purchase additional loans. Several factors affect the Company's
ability to complete Securitizations, including conditions in the securities
markets generally, conditions specifically in the markets for securities that
are backed by financial assets, such as home equity, credit card or trade
receivables, equipment or automobile loans or leases ("Asset-Backed
Securities"), the credit quality of the Company's Servicing Portfolio and the
Company's ability to obtain credit enhancement. Any substantial reductions in
the size or availability of the Securitization market for the Company's loans
could have a material adverse effect on the Company's results of operations and
financial condition.
The Company's revenues and net income have fluctuated in the past and are
expected to fluctuate in the future principally as a result of the timing and
size of its Securitizations. Several factors affecting the Company's business
can cause significant variations in its quarterly results of operations. In
particular, variations in the volume of the Company's loan originations and
purchases, the differences between the Company's cost of funds and the average
interest rates of originated or purchased loans, the effectiveness of the
Company's hedging strategies, the pass-through rate for Regular Interests issued
in Securitizations, and the timing and size of Securitizations can result in
significant increases or decreases in the Company's revenues from quarter to
quarter. A delay in closing a Securitization during a particular quarter would
postpone recognition of gain on sale of loans. In addition, unanticipated delays
in closing a Securitization could also increase the Company's exposure to
interest rate fluctuations by increasing the Warehousing Period for its loans.
If the Company were unable to profitably Securitize a sufficient number of its
loans in a particular reporting period, the Company's revenues for such period
would decline and would result in lower net income and possibly a net loss for
such period, and could have a material adverse effect on the Company's results
of operations and financial condition. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
LOSS OF HISTORICAL LOAN ORIGINATION FEES COULD ADVERSELY AFFECT RESULTS OF
OPERATIONS
The Company has historically generated positive cash flow due, in large
part, to its customary loan origination fees. Net loan origination fees
constituted 49.2%, 52.1%, 43.1% and 61.9% of the Company's total revenues for
the first six months of 1997 and for the years 1996, 1995 and 1994,
respectively. Any reduction in the amount of the Company's loan origination
fees, whether by reason of regulation, competition or otherwise, will negatively
impact the Company's cash flow and could have a material adverse effect on the
Company's results of operations and financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
COMPETITION COULD ADVERSELY AFFECT RESULTS OF OPERATIONS
Competition in the mortgage financing business is intense. The mortgage
financing market is highly fragmented and has been serviced by mortgage brokers,
mortgage banking companies, commercial banks,
12
<PAGE>
credit unions, savings institutions, and finance companies. Many of these
competitors have greater financial resources and may have significantly lower
costs of funds than the Company. Even after the Company has made a loan to a
borrower, the Company's competitors may seek to refinance the Company's loan in
order to offer additional loan amounts or reduce payments. Furthermore, the
profitability of the Company and other similar lenders is attracting additional
competitors into this market, with the possible effect of reducing the Company's
ability to charge its customary origination fees and interest rates. In
addition, as the Company expands into new geographic markets, it will face
competition from lenders with established positions in these locations. There
can be no assurance that the Company will be able to continue to compete
successfully in the markets it serves. Such an event could have a material
adverse effect on the Company's results of operations and financial condition.
See "Business-- Competition."
LOSS OF FUNDING SOURCES COULD ADVERSELY AFFECT RESULTS OF OPERATIONS
The Company funds substantially all of the loans which it originates or
purchases through borrowings under the 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 the
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 results of operations and
financial condition. 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 results of operations and financial
condition. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
IMPAIRMENT OF VALUE OF RESIDUAL INTERESTS AND MORTGAGE SERVICING RIGHTS
The Company records gains on sale of loans through Securitization based in
part on the fair value of the Residual Interests received in the REMIC Trust by
the Company and on the fair value of retained mortgage servicing rights related
to such loans. The fair values of such Residual Interests and retained mortgage
servicing rights are in turn based in part on market interest rates and
projected loan prepayment and credit loss rates. Increases in interest rates or
higher than anticipated rates of loan prepayments or credit losses of these or
similar securities may require the Company to write down the value of such
Residual Interests and mortgage servicing rights and result in a material
adverse impact on the Company's results of operations and financial condition.
The Company is not aware of an active market for the Residual Interests. No
assurance can be given that the Residual Interests could in fact be sold at
their carrying value, if at all. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Certain Accounting
Considerations."
LOSS OF CREDIT ENHANCEMENT COULD RESULT IN INCREASED INTEREST COSTS
In order to gain access on favorable terms to the public Securitization
market, the Company has relied on credit enhancement to achieve a "AAA/Aaa"
rating for the Regular Interests in its Securitizations. The credit enhancement
has generally been in the form of an insurance policy issued by a monoline
insurance company (the "Certificate Insurer") insuring the repayment of Regular
Interests in each of the REMIC Trusts sponsored by the Company. The Certificate
Insurer is not required to insure future Securitizations nor is the Company
restricted in its ability to obtain credit enhancement from providers other than
the Certificate Insurer or to use other forms of credit enhancement. There can
be no assurance that the Company will be able to obtain credit enhancement in
any form from the Certificate Insurer or any other provider of credit
enhancement on acceptable terms or that future Securitizations will be similarly
rated. A downgrading of Regular Interests already outstanding or the Certificate
Insurer's credit rating or its
13
<PAGE>
withdrawal of credit enhancement could result in higher interest costs for
future Securitizations. Such events could have a material adverse effect on the
Company's results of operations and financial condition.
CONCENTRATION OF OPERATIONS IN CALIFORNIA
Approximately 58.9% of the dollar volume of the Servicing Portfolio at June
30, 1997, and approximately 22.5% and 37.9% of the dollar volume of loans
originated or purchased by the Company during the six months ended June 30, 1997
and the year ended December 31, 1996, respectively, were secured by properties
located in California. Although the Company is expanding its retail branch
network outside California, the Company's Servicing Portfolio and loan
originations and purchases are likely to remain concentrated in California for
the foreseeable future. Consequently, the Company's results of operations and
financial condition are dependent upon general trends in the California economy
and its residential real estate market. Residential real estate market declines
may adversely affect the values of the properties securing loans such that the
principal balances of such loans, together with any primary financing on the
mortgaged properties, will equal or exceed the value of the mortgaged
properties. In addition, California historically has been vulnerable to certain
natural disaster risks, such as earthquakes and erosion-caused mudslides, which
are not typically covered by the standard hazard insurance policies maintained
by borrowers. Uninsured disasters may adversely impact borrowers' ability to
repay loans made by the Company. The existence of adverse economic conditions or
the occurrence of such natural disasters in California could have a material
adverse effect on the Company's results of operations and financial condition.
ABILITY OF THE COMPANY TO CONTINUE ITS GROWTH STRATEGY
The Company's growth strategy is dependent upon its ability to increase its
loan origination volume through the growth of its retail branch network while
maintaining its customary origination fees, interest rate spreads and
underwriting criteria with respect to such increased loan origination and
purchase volume. This strategy includes national and international expansion and
will depend in large part on the Company's ability to: (i) expand its retail
branch network in markets with a sufficient concentration of borrowers meeting
the Company's underwriting criteria; (ii) obtain adequate financing on favorable
terms to fund its growth strategy; (iii) profitably Securitize its loans in the
secondary market on a regular basis; (iv) hire, train and retain skilled
employees; and (v) continue to expand in the face of increasing competition from
other mortgage lenders. The Company's failure with respect to any or all of
these factors could impair its ability successfully to continue its growth
strategy which could have a material adverse effect on the Company's results of
operations and financial condition. See "Business--Current Markets and Expansion
Plans."
LOAN DELINQUENCIES AND DEFAULTS MAY REDUCE VALUE OF RESIDUAL INTERESTS
After a loan has been originated or purchased by the Company, the loan is
held as part of the Servicing Portfolio and is subject to sale or
Securitization. During the period a loan is so held, the Company is at risk for
loan delinquencies and defaults. Following the sale of the loan on a servicing
released basis, the Company's loan delinquency and default risk with respect to
such loan is limited to those circumstances in which it is required to
repurchase such loan due to a breach of a representation or warranty in
connection with the loan sale. On Securitized loans, the Company also has this
risk of loan delinquency or default to the extent that losses are paid out of
reserve accounts or by reducing the over-collateralization to the extent that
funds are available. Such losses may result in a reduction in the value of the
Residual Interests held by the Company and could have a material adverse effect
on the Company's results of operations and financial condition. See
"Business--Loan Sales."
14
<PAGE>
TERMINATION OF SERVICING RIGHTS MAY ADVERSELY AFFECT RESULTS OF OPERATIONS
At June 30, 1997, approximately 91.1% of the dollar volume of the Company's
Servicing Portfolio consisted of loans Securitized by the Company and sold to
REMIC Trusts. The Company's form of pooling and servicing agreement for each of
these REMIC Trusts provides that the Certificate Insurer may terminate the
Company's servicing rights under particular circumstances. With respect to six
of the Company's Securitizations (with loan balances of $175.6 million at June
30, 1997), the Certificate Insurer may terminate the servicing rights of the
Company if, among other things, the number of loans in the REMIC Trust that are
delinquent 91 days or more (including foreclosures and real estate owned ("REO")
properties) exceeds 10.0% of the total number of loans in the REMIC Trust for
four consecutive months.
With respect to the Company's nine most recent Securitizations, the
Certificate Insurer may terminate the servicing rights of the Company if, among
other things, (i) the three month average of the quotient of the principal
balance of all loans that are delinquent 91 days or more (including foreclosures
and REO properties) divided by the pool principal balance for the related period
exceeds 7.0%; (ii) the annual cumulative realized losses for any year exceed
2.0% of the average pool principal balance for the same year; or (iii) with
respect to the two transactions completed in 1995, if within the first five
years of the REMIC Trust, the cumulative losses exceed 5.75% of the original
principal balance of the REMIC Trust or if cumulative losses after year five
exceed 8.63% of the original principal balance of the REMIC Trust. The first two
Securitizations in 1996 include language that modifies the cumulative loss
figures to 6.63% within the first five years and 9.94% after year five. The four
most recent Securitizations include language that modifies the cumulative loss
figures to 5.0% within the first five years and 6.5% after year five.
At June 30, 1997, none of the REMIC Trusts exceeded the foregoing
delinquency or loss calculations. There can be no assurance that delinquency and
loss rates with respect to the Company's Securitized loans will not exceed these
rates in the future or, if exceeded, that the servicing rights would not be
terminated. Any termination of servicing rights could have a material adverse
effect on the Company's results of operations and financial condition. See
"Business--Servicing."
DEPENDENCE ON KEY PERSONNEL
The Company's growth and development to date have been largely dependent
upon the services of Brian Chisick, Chief Executive Officer and President of the
Company. Although the Company has been able to hire and retain other qualified
and experienced management personnel, the loss of Brian Chisick's services for
any reason could have a material adverse effect on the Company. The Company has
entered into an employment agreement with Brian Chisick. The Company does not
carry "key man" life insurance on the life of Brian Chisick.
ANTI-TAKEOVER EFFECT OF CAPITAL STRUCTURE; VOTING CONTROL OF COMPANY
The Company has two classes of authorized Common Stock, Class A Common
Stock, which is offered hereby, and Class B Common Stock. While the holder of
each share of Class A Common Stock is entitled to one vote per share, the holder
of each share of Class B Common Stock is entitled to four votes per share. The
Class A Common Stock and the Class B Common Stock generally vote together as a
single class. Brian Chisick and his wife, Sarah Chisick, and the grantor trusts
for which they have the beneficial voting interests (collectively, the "Chisick
Trusts") are the beneficial owners of substantially all of the outstanding Class
B Common Stock. As a result of the Public Offering, the percentage of the voting
power of the outstanding Common Stock controlled by the Chisick Trusts will
decline from 91% to 82% (assuming the Underwriters' over-allotment option is not
exercised). This will continue to allow the Chisick Trusts to control all
actions to be taken by the stockholders, including the election of all directors
to the Board of Directors. The Board of Directors is expected to be comprised
entirely of designees of the Chisick Trusts. This voting control may have the
effect of discouraging offers to acquire the Company because the consummation of
any such acquisition would require the consent of the Chisick Trusts. In
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<PAGE>
addition, the Board of Directors is authorized to issue shares of preferred
stock from time to time with such rights and preferences as the Board may
determine; such preferred stock could be issued in the future with terms and
conditions that could further discourage offers to acquire the Company. See
"Principal and Selling Stockholders" and "Description of Capital Stock."
ANTI-TAKEOVER EFFECT OF DELAWARE LAW
The Company is a Delaware corporation and is subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law. In general,
Section 203 prevents an "interested stockholder" (defined generally as a person
owning 15% or more of the Company's outstanding voting stock) from engaging in a
"business combination" with the Company for three years following the date that
person became an interested stockholder unless the business combination is
approved in a prescribed manner. This statute could make it more difficult for a
third party to acquire control of the Company. See "Description of Capital
Stock--Certain Provisions of Delaware Law."
ENVIRONMENTAL LIABILITIES
In the course of its business, the Company has acquired, and may acquire in
the future, properties securing loans that are in default. There is a risk that
hazardous substances or waste, contaminants, pollutants or sources thereof could
be discovered on such properties after acquisition by the Company. In such
event, the Company may be required by law to remove such substances from the
affected properties at its sole cost and expense. There can be no assurance that
(i) the cost of such removal would not substantially exceed the value of the
affected properties or the loans secured by the properties, (ii) the Company
would have adequate remedies against the prior owner or other responsible
parties or (iii) the Company would not find it difficult or impossible to sell
the affected properties either prior to or following such removal.
RESTRICTIONS ON FUTURE SALES BY STOCKHOLDERS; EFFECT ON SHARE PRICE OF SHARES
AVAILABLE FOR FUTURE SALE
Shares of Class B Common Stock are not being offered hereby. The Chisick
Trusts are the record and beneficial holders of substantially all of the
outstanding shares of Class B Common Stock and will be subject to certain
lock-up restrictions with respect to their ability to sell or otherwise dispose
of any of their shares of Class B Common Stock (which shares, upon transfer by
the Chisick Trusts to unrelated parties, convert to Class A Common Stock)
without the prior written consent of the representatives of the Underwriters
("Representatives"). When such lock-up restrictions lapse (120 days after the
date of this Prospectus), such shares of Class B Common Stock may be sold to the
public or otherwise disposed of, subject to compliance with applicable
securities laws. The Company's Certificate of Incorporation authorizes the
issuance of 25,000,000 shares of Class A Common Stock and 15,000,000 shares of
Class B Common Stock. Upon completion of the Public Offering, there will be
outstanding 6,705,343 shares of Class A Common Stock and 7,770,715 shares of
Class B Common Stock (assuming no exercise of the Underwriters' over-allotment
option). Sales of a substantial number of shares of Class B Common Stock, or the
perception that such sales could occur, could adversely affect prevailing market
prices for the Class A Common Stock. See "Shares Eligible for Future Sale."
NO CASH DIVIDENDS
Following the Public Offering, the Company intends to retain its earnings,
if any, for use in its business and does not anticipate declaring or paying any
cash dividends in the foreseeable future. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources" and "Price Range of Class A Common Stock and Dividend Policy."
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<PAGE>
PRICE RANGE OF CLASS A COMMON STOCK AND DIVIDEND POLICY
The Class A Common Stock of the Company is listed for trading on Nasdaq
under the symbol "FACO." The following table sets forth the high and low closing
prices for the Class A Common Stock for the periods indicated:
<TABLE>
<CAPTION>
HIGH LOW
----- ---
<S> <C> <C>
1996
3rd Quarter (from July 31, 1996).............................................. 251/4 187/8
4th Quarter................................................................... 301/2 22
1997
1st Quarter................................................................... 301/4 221/2
2nd Quarter................................................................... 291/4 181/4
3rd Quarter (through September 10, 1997)...................................... 301/8 271/4
</TABLE>
The closing price of the Class A Common Stock on September 10, 1997 was
$28 7/16 per share. As of such date there were approximately 8 record holders of
Class A Common Stock. The Company believes its Class A Common Stock is
beneficially held by more than 2,200 stockholders.
The Company intends to retain its earnings, if any, for use in its business
and does not anticipate declaring or paying any cash dividends in the
foreseeable future. See "Management's Discussion and Analysis of Financial
Condition and Results of Operation--Liquidity and Capital Resources."
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<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company at June 30,
1997 and as adjusted as of that date to give effect to the sale of 2,950,000
shares of Class A Common Stock by the Selling Stockholder in the Public
Offering. The information below should be read in conjunction with the Company's
audited financial statements and the notes thereto which are included elsewhere
herein. See also "Selected Consolidated Financial Data," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Description of Capital Stock."
<TABLE>
<CAPTION>
JUNE 30, 1997
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Long-term debt:
Notes payable........................................................................... $ 109 $ 109
--------- -----------
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: 4,044,024 (actual); 7,028,458 (as adjusted)............ 40 70
Class B common stock, $.01 par value; 15,000,000 shares authorized;
shares issued and outstanding: 10,750,000 (actual); 7,770,715 (as adjusted)........... 108 78
Additional paid in capital.............................................................. 65,041 65,041
Retained earnings....................................................................... 29,888 29,888
Treasury stock--at cost: 259,500 shares................................................. (5,612) (5,612)
Deferred stock compensation............................................................. (1,011) (1,011)
Foreign currency translation............................................................ (3) (3)
--------- -----------
Total stockholders' equity............................................................ 88,451 88,451
--------- -----------
Total capitalization................................................................ $ 88,560 $ 88,560
--------- -----------
--------- -----------
</TABLE>
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<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1992 1993 1994(1) 1995 1996(2) 1996 1997
--------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Gain (loss) on sale of loans........... $ 1,731 $ 2,056 $ (1,547) $ 8,982 $ 10,965 $ 3,256 $ 10,436
Origination fees and other............. 18,275 20,433 29,449 26,484 37,206 17,995 21,350
Servicing and other fee revenue........ 7,145 8,989 9,106 8,614 8,854 4,487 3,855
Interest revenue....................... 2,285 4,452 8,650 14,624 13,562 6,035 9,034
Total revenue.......................... 29,468 35,950 45,802 58,880 70,871 31,834 44,681
Interest expense....................... 871 2,106 3,744 4,167 2,655 1,787 712
Noninterest expense.................... 17,934 22,881(3) 26,824(3) 23,693 29,977 12,881 17,941
Income before income tax provision..... 10,663 10,963 15,234 31,020 38,239 17,166 26,028
Net income............................. 10,395 10,741 14,871 30,542 32,139 16,909 15,550
Net income per share................... 0.98 1.01 1.40 2.87 2.59 1.59 1.05
Pro forma net income (4)............... 6,291 6,468 8,988 18,302 22,561 10,128 -
Pro forma net income per share (4)..... 0.43 0.44 0.61 1.24 1.53 0.69 -
Income before income tax provision as a
% of revenue......................... 36.2% 30.5% 33.3% 52.7% 54.0% 53.9% 58.3%
Dividends declared..................... $ 3,987 $ 5,853 $ 17,341 $ 12,205 $ 60,080(5) $ 59,121(5) -
STATEMENT OF FINANCIAL CONDITION DATA:
Cash and cash equivalents.............. $ 1,111 $ 4,387 $ 5,298 $ 4,019 $ 27,414 $ 8,858 $ 17,093
Loans held for sale.................... 10,080 74,196 18,676 24,744 11,023 12,718 18,075
Residual interests..................... 2,792 6,879 11,645 19,705 29,253 22,354 37,377
Total assets........................... 24,517 99,855 48,266 66,911 87,457 64,180 99,974
Total borrowings....................... 966 68,773 14,839 19,356 131 55,285 109
Stockholders' equity................... 21,566 26,454 23,984 42,321 77,978 109(5) 88,451
OTHER DATA:
Loan originations and purchases:
Retail originations.................. $ 93,596 $ 195,907 $ 221,839 $ 216,566 $ 291,807 $ 135,147 $ 181,681
Wholesale purchases.................. 13,622 84,034 91,826 24,078 32,681 20,791 38,441
--------- --------- --------- --------- --------- --------- ---------
Total.............................. $ 107,218 $ 279,941 $ 313,665 $ 240,644 $ 324,488 $ 155,938 $ 220,122
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Average retail origination loan size... $ 36 $ 54 $ 66 $ 69 $ 83 $ 83 $ 87
Number of retail branches.............. 11 11 13 17 23 19 29
Weighted average interest rate on loan
originations and purchases........... 13.6% 9.5% 8.7% 10.3% 9.6% 9.5% 9.4%
Weighted average initial combined
loan-to-value ratio.................. 48.5% 55.2% 56.2% 59.3% 62.2% 62.4% 63.5%
Loan sales:
Securitizations...................... $ 39,024 $ 141,795 $ 350,331 $ 167,974 $ 267,661 $ 127,675 $ 148,003
Whole loan sales..................... 69,298 70,554 22,857 65,251 71,864 42,400 66,518
--------- --------- --------- --------- --------- --------- ---------
Total.............................. $ 108,322 $ 212,349 $ 373,188 $ 233,225 $ 339,525 $ 170,075 $ 214,521
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Servicing portfolio.................... $ 240,221 $ 385,570 $ 555,685 $ 613,791 $ 641,191 $ 603,851 $ 692,243
Total delinquencies as a % of the
servicing portfolio.................. 5.0% 4.0% 4.3% 5.8% 5.5% 6.1% 4.1%
Real estate owned as a % of the
servicing portfolio.................. 0.6% 0.9% 0.6% 1.3% 0.6% 1.1% 0.7%
Losses on real estate owned as a % of
the average servicing portfolio
during the period.................... 0.02% 0.02% 0.01% 0.03% 0.35% 0.26%(6) 0.30%(6)
</TABLE>
- ------------------------------
In June 1997, the Company entered into a definitive agreement to acquire the
Bank. For pro forma condensed consolidated financial statements reflecting
such acquisition see "Unaudited Pro Forma Condensed Consolidated Financial
Information."
(1) The Company typically Securitizes or sells most of its loan originations 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 Warehouse
19
<PAGE>
Financing Facilities. 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.
(2) During 1996, the Company completed the 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 that of a C corporation. The
Company received $63 million of net proceeds from the Initial Public
Offering, of which $45 million was used to pay the S Distribution Notes.
(3) 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 1989.
(4) 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. The Company ceased to be an S corporation concurrent with the
Initial Public Offering in July 1996. Pro forma net income per share assumes
that the total number of shares outstanding upon completion of the Initial
Public Offering were outstanding in all prior periods.
(5) Included in dividends in 1996 is $45 million of S distribution dividends
made in the form of the S Distribution Notes in anticipation of the Initial
Public Offering. Stockholders' equity as of June 30, 1996 reflects this
dividend. Historical dividends include dividends used by the stockholders to
pay income taxes on the Company's S corporation earnings and are not
indicative of the Company's present dividend policy.
(6) Annualized.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with "Selected
Consolidated Financial Data," the financial statements of the Company and the
notes thereto included elsewhere in this Prospectus.
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 27 offices in
the United States (seven of which are located in California, two of which are
located in each of Florida, Illinois, Maryland, New Jersey and New York, and one
of which is located in each of Arizona, Colorado, Georgia, Massachusetts, Ohio,
Oregon, Pennsylvania, Utah, Virginia and Washington) and four offices in the
United Kingdom. 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.
During the third quarter of 1996, FACO completed the Initial Public 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 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, to a
lesser extent, through whole loan sales in which the Company does not retain
servicing rights. The Company's underwriting guidelines generally 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
deferred net 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. In accordance with SFAS No. 125, 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
21
<PAGE>
Securitized and the Residual Interests and mortgage servicing rights retained by
the Company based upon their relative fair values. At origination, the Company
classifies the Residual Interests as trading securities, which are carried at
fair value. The difference between the fair value of Residual Interests and
their allocated cost is recorded as gain on securities and is included in loan
origination and sale revenue.
In a Securitization, the Company exchanges loans for Regular Interests and a
Residual Interest in the REMIC Trust. The Regular Interests are immediately sold
by the Company to the public for cash. As the holder of the Residual Interest,
the Company is entitled to receive certain excess cash flows. These excess cash
flows are the difference between (a) principal and interest paid by borrowers
and (b) the sum of (i) scheduled 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 begins receiving these
excess cash flows 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 inherently 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 life-to-date CPR on Securitized
loans ranging from 10.8% to 53.1%. Non-conventional mortgage loans, such as the
Company's loans, historically prepay at a faster rate than conventional mortgage
loans. At origination, the Company has utilized prepayment assumptions ranging
from 25.0% to 40.0%, an estimated annual loss assumption of 0.5% and weighted
average discount rates of 15.0% for the six months ended June 30, 1997, and 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 June 30, 1997, the Company's investments in Residual
Interests totaled $37.4 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 has found that non-conventional 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 June 30, 1997, the Company's investment in mortgage
servicing rights totaled $7.2 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 deferred net origination fees. A significant portion of loan
origination and sale revenue is the recognition upon sale of deferred net
origination fees, which were $21.4 million, or 67% of loan origination and sale
revenue for the first six months of 1997.
22
<PAGE>
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 estimated future cash flows. This
effective yield is used to accrue interest income in the subsequent quarter.
LOAN ORIGINATION AND PURCHASES
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED DECEMBER 31, ENDED JUNE 30,
---------------------------------- ----------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Loan originations and purchases:
Retail originations................................ $ 221,839 $ 216,566 $ 291,807 $ 135,147 $ 181,681
Wholesale purchases................................ 91,826 24,078 32,681 20,791 38,441
---------- ---------- ---------- ---------- ----------
Total originations and purchases................. $ 313,665 $ 240,644 $ 324,488 $ 155,938 $ 220,122
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Number of retail branches as of the end of the
period:
United States:
California....................................... 11 7 7 6 7
Other states..................................... 2 10 15 13 19
United Kingdom..................................... - - 1 - 3
---------- ---------- ---------- ---------- ----------
Total............................................ 13 17 23 19 29
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Weighted average initial interest rate............... 8.7% 10.3% 9.6% 9.5% 9.4%
Weighted average initial combined loan-to-value
ratio.............................................. 56.2% 59.3% 62.2% 62.4% 63.5%
Weighted average loan origination and processing fees
as a percentage of retail originations............. 13.0% 15.1% 14.2% 14.0% 15.0%
Average retail origination loan size................. $ 66 $ 69 $ 83 $ 83 $ 87
</TABLE>
For the six months ended June 30, 1997, originations and purchases increased
41% as compared to the corresponding period in 1996. Retail originations
increased 34% for the six months ended June 30, 1997 as compared the
corresponding period in 1996 primarily as a result of origination volume of the
new retail branch offices opened in 1997 and 1996. Wholesale purchases for the
six months ended June 30, 1997 increased 85% as compared to the corresponding
period in 1996, as increased premiums available in the secondary market allowed
the Company to purchase and sell wholesale loans profitably. Prior to 1997, all
wholesale purchases were Securitized by 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 originations increased
35% and decreased 2% in 1996 and 1995, respectively, as compared to the
corresponding prior year amounts. The increase in retail originations in 1996 is
primarily the result of new retail branch offices opened in 1996. 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.
23
<PAGE>
LOAN SALES
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED DECEMBER 31, ENDED JUNE 30,
---------------------------------- ----------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Securitizations...................................... $ 350,331 $ 167,974 $ 267,661 $ 127,675 $ 148,003
Whole loan sales..................................... 22,857 65,251 71,864 42,400 66,518
---------- ---------- ---------- ---------- ----------
Total.............................................. $ 373,188 $ 233,225 $ 339,525 $ 170,075 $ 214,521
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
</TABLE>
Loan sales, including Securitizations of loans, for the six months ended
June 30, 1997 increased 26% over the corresponding period in 1996. The increases
in loan sales for the six months ended June 30, 1997 is the result of sales of
the increased volume of loan originations and purchases. 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 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, partially offset by the increase in retail originations.
24
<PAGE>
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 periods indicated.
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR
ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
REVENUE:
Loan origination and sale:
Gain (loss) on sale of loans....................... (3.4)% 15.3% 15.5% 10.2% 23.4%
Net loan origination and other fees................ 64.3 45.0 52.5 56.5 47.8
Loan servicing and other fees........................ 19.9 14.6 12.5 14.1 8.6
Interest and other................................... 19.2 25.1 19.5 19.2 20.2
--------- --------- --------- --------- ---------
Total revenue...................................... 100.0% 100.0% 100.0% 100.0% 100.0%
--------- --------- --------- --------- ---------
EXPENSE:
Compensation and benefits............................ 20.9% 17.7% 21.9% 21.1% 19.9%
Advertising.......................................... 7.2 7.4 5.9 5.5 5.9
Professional services and other fees................. 5.5 3.4 2.8 2.9 3.2
Rent................................................. 2.1 2.2 2.2 2.3 1.9
Supplies............................................. 1.8 2.1 2.2 2.0 2.5
Depreciation and amortization........................ 1.1 1.5 1.2 1.0 0.8
Interest............................................. 8.2 7.1 3.7 5.6 1.6
Legal................................................ 15.6 2.5 1.3 1.4 1.7
Travel and training.................................. 0.8 1.3 1.6 1.3 1.6
Other................................................ 3.5 2.1 3.2 3.0 2.6
--------- --------- --------- --------- ---------
Total expense...................................... 66.7 47.3 46.0 46.1 41.7
--------- --------- --------- --------- ---------
Income before income tax provision..................... 33.3 52.7 54.0 53.9 58.3
Income tax provision (1)............................... 0.8 0.8 8.7 0.8 23.5
--------- --------- --------- --------- ---------
Net income............................................. 32.5% 51.9% 45.3% 53.1% 34.8%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
- ------------------------
(1) As a result of the Company's Initial Public Offering, completed during the
third quarter of 1996, the Company's tax status changed from that of an S
corporation to that of a C corporation. As a C corporation, the Company is
subject to federal and state income taxes. As an S corporation, the
Company's taxable income was included in the individual returns of the
stockholders, and the Company was only subject to certain state taxes,
primarily in California.
25
<PAGE>
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996
REVENUE
The following table sets forth the components of the Company's revenue for the
six months ended June 30:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Loan origination and sale:
Gain on sale of loans (1)............................................ $ 3,256 $ 10,436
Net loan origination and other fees.................................. 17,995 21,350
Loan servicing and other fees.......................................... 4,487 3,855
Interest and other..................................................... 6,096 9,040
--------- ---------
Total revenue...................................................... $ 31,834 $ 44,681
--------- ---------
--------- ---------
</TABLE>
- ------------------------
(1) Excluding net loan origination and other fees.
Total revenue increased 40.4% or $12.8 million for six months ended June 30,
1997 as compared to the corresponding period in 1996 primarily due to higher
loan origination and sale revenue and higher interest income from Residual
Interests and loans held for sale.
Loan origination and sale revenue increased $10.5 million to $31.8 million
for six months ended June 30, 1997, from the corresponding period in 1996,
primarily due to increases in loan sales and increases in premiums received on
loan sales.
Gain on sale of loans increased $7.2 million for six months ended June 30,
1997 from the corresponding period in 1996 as a result of increases in the
volume of loans sold and increases in the weighted average gain on sale of
loans. For the six months ended June 30, 1997 the weighted average gain on sale
of loans as a percentage of loan principal balances sold increased to 4.9% from
1.9% for the corresponding period in 1996. Gain on sales of Securitized loans
increased to 5.2% for the six months ended June 30, 1997 from 2.3% for the six
months ended June 30, 1996. This increase is primarily due to increases in the
weighted average initial interest rate spreads (the difference between the
initial weighted average loan interest rates for the loans included in the
Securitization and the initial weighted average pass-through rates paid to
holders of the Regular Interests in the Securitization) for Residual Interests
originated to 3.2% for the six months ended June 30, 1997 from 2.5% for the six
months ended June 30, 1996. In addition, the weighted average gain on whole loan
sales increased to 4.1% for the six months ended June 30, 1997 as compared to
0.6% for the six months ended June 30, 1996. The Company's whole loan sales
consist of bulk sales, for which the Company receives a premium over the stated
amount of the loans, and flow sales, which are sales of smaller groups of loans
that the Company sells at the stated amount of the loans. The increase in the
weighted average gain on whole loan sales is primarily a result of increases in
premiums available in the secondary market and increases in the percentage of
whole loan sales sold through bulk sales.
During the six months ended June 30, 1997, net loan origination and other
fees increased 19% due primarily to a 23% increase in sales of retail
originations.
Loan servicing and other fees as an annualized percentage of the average
Servicing Portfolio decreased to 1.2% for the six months ended June 30, 1997 as
compared to 1.5% for the corresponding period in 1996. As an annualized
percentage of the average Servicing Portfolio, servicing fees and prepayment
penalties decreased by 0.1% and the amortization of mortgage servicing rights
increased by 0.1% for the six months ended June 30, 1997 as compared to the
corresponding period in 1996. The Company earns higher servicing fees on loans
serviced for private investors and for certain Securitizations originated prior
to 1996 as compared to loans serviced for Securitizations originated since 1996.
As the proportion of loans serviced for private investors and Securitizations
originated prior to 1996 decreases as a percentage of the total Servicing
Portfolio, the Company's weighted average servicing fee has decreased.
26
<PAGE>
The decrease in prepayment penalties is primarily the result of decreases in the
level of prepayments received during the six months ended June 30, 1997 as
compared to the six months ended June 30, 1996. The increase in the amortization
of mortgage servicing rights was primarily due to the adoption in January 1995
of SFAS No. 122, "Accounting For Mortgage Servicing Rights," which requires the
Company to capitalize the fair value of originated mortgage servicing rights and
amortize the capitalized amount over the life of such assets.
Interest income increased 50% to $9.0 million for the six months ended June
30, 1997 from $6.0 million for the six months ended June 30, 1996. As a result
of increases in the average balances of loans held for sale and Residual
Interests, interest income from loans held for sale increased $1.2 million and
interest income from Residual Interests increased $0.9 million for the six
months ended June 30, 1997, as compared to the corresponding period in 1996.
Additionally, interest income from investments increased $0.9 million for the
six months ended June 30, 1997 primarily due to increases in the balance of
available cash as a result of the net proceeds from the Initial Public Offering
and cash generated from operations. Cash and cash equivalents increased from
$4.0 million at December 31, 1995 to $17.1 million at June 30, 1997.
EXPENSE
The following table sets forth the components of the Company's expenses for
the six months ended June 30:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Compensation and benefits.............................................. $ 6,727 $ 8,906
Advertising............................................................ 1,758 2,657
Professional services and other fees................................... 927 1,448
Rent................................................................... 742 833
Supplies............................................................... 641 1,095
Depreciation and amortization.......................................... 317 376
Interest............................................................... 1,787 712
Legal.................................................................. 452 779
Travel and training.................................................... 409 710
Other.................................................................. 908 1,137
--------- ---------
Total expense........................................................ $ 14,668 $ 18,653
--------- ---------
--------- ---------
</TABLE>
Total expense increased 27% to $18.7 million for the six months ended June
30, 1997 from $14.7 million for the corresponding period in 1996. This increase
is primarily due to increases in compensation and benefits and advertising
related to the Company's increased retail loan origination operations which were
offset by decreases in interest expense.
Compensation and benefits increased $2.2 million for the six months ended
June 30, 1997 as compared to the corresponding period in 1996 as a result of an
increase in personnel to support the Company's retail branch office expansion.
Advertising expense increased 51% for the six months ended June 30, 1997 as
compared to the corresponding period in 1996 primarily due to increased
marketing activities resulting from the Company's retail branch office
expansion.
Professional services and other fees increased $0.5 million for six months
ended June 30, 1997 as compared to the corresponding period in 1996 primarily
due to increases in recruiting costs associated with the Company's ongoing
retail branch office expansion and increases in costs associated with management
of delinquent loans and foreclosure activities.
27
<PAGE>
Interest expense decreased $1.1 million for the six months ended June 30,
1997 as compared to the six months ended June 30, 1996. The additional cash and
cash equivalents available at the beginning of the first quarter of 1997 were
used to fund loan originations and purchases resulting in decreases in the
average balance outstanding on the Warehouse Financing Facilities in the first
six months of 1997 as compared to the corresponding period in 1996. In addition,
during the six months ended June 30, 1996 the Company paid interest on an S
Distribution Note of $0.4 million. No such notes were outstanding in 1997.
The increases in supplies, legal and travel and training expenses for the
six months ended June 30, 1997 as compared to the corresponding period in 1996
are primarily due to the increased activity arising from the increase in the
number of retail branch offices and the related increase in loan originations.
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:
<TABLE>
<CAPTION>
1994 1995 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Loan origination and sale:
Gain (loss) on sale of loans (1)........................... $ (1,547) $ 8,982 $ 10,965
Net loan origination and other fees........................ 29,449 26,484 37,206
Loan servicing and other fees................................ 9,106 8,614 8,854
Interest and other........................................... 8,794 14,800 13,846
--------- --------- ---------
Total revenue.............................................. $ 45,802 $ 58,880 $ 70,871
--------- --------- ---------
--------- --------- ---------
</TABLE>
- ------------------------
(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.
28
<PAGE>
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 0.81% of the related Regular Interests balances, in 1994
to $0.1 million, or 0.04% 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.
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 $1.1 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.
29
<PAGE>
EXPENSE
The following table sets forth the components of the Company's expenses for
the years ended December 31:
<TABLE>
<CAPTION>
1994 1995 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Compensation and benefits.................................... $ 9,559 $ 10,416 $ 15,488
Professional services and other fees......................... 2,540 1,999 1,946
Advertising.................................................. 3,316 4,345 4,191
Rent......................................................... 974 1,278 1,530
Supplies..................................................... 831 1,214 1,575
Depreciation and amortization................................ 514 907 838
Interest..................................................... 3,744 4,167 2,655
Legal........................................................ 7,162 1,491 917
Travel and training.......................................... 351 788 1,103
Other........................................................ 1,577 1,255 2,389
--------- --------- ---------
Total expense................................................ $ 30,568 $ 27,860 $ 32,632
--------- --------- ---------
--------- --------- ---------
</TABLE>
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.
The decrease in professional services and other fees of $0.5 million in 1995
as compared to 1994 was due primarily to the discontinuation of portfolio
refinancing origination programs utilizing the services of outside consultants.
Advertising expense as a percentage of retail branch originations was 1.4%
in 1996, 2.0% in 1995 and 1.5% in 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.
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
30
<PAGE>
Notes was due primarily to an increase in the average balance outstanding during
1996 which was due to the distribution, in anticipation of the Initial Public
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 and training expenses 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 REO. In 1996, losses on REO amounted to $0.2 million as compared to
gains of $0.5 million in 1995 and $0.3 million in 1994. The losses in 1996
reflect 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.
INCOME TAXES
From May 1, 1988 until the closing of the Initial Public 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.
The Company's S corporation status was terminated in July 1996 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. Since the Initial
Public Offering, the Company's effective income tax rate has approximated 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.
The Chisick Trusts have agreed to reimburse the Company for any increase in
the Company's federal or state income tax liability for 1996 and future years
that may be triggered as a result of possible Internal Revenue Service and state
taxing authority audit adjustments ("Audit Adjustments") to the Company's
taxable income for the years during which the Company was an S corporation.
Conversely, the Company has agreed to reimburse the Chisick Trusts for any
decrease in the Company's federal or state income tax liability for 1996 and
future years that may be triggered as a result of possible Audit Adjustments to
the Company's taxable income for the years during which the Company was an S
corporation.
31
<PAGE>
SERVICING
The following tables provide the dollar amount and percentage of Servicing
Portfolio data on loan delinquency, REO and net losses for the Company's
Servicing Portfolio:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------------
AS OF
1995 1996 JUNE 30, 1997
-------------------------- -------------------------- --------------------------
(DOLLARS IN THOUSANDS)
% OF % OF % OF
SERVICING SERVICING SERVICING
PORTFOLIO PORTFOLIO PORTFOLIO
------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Servicing portfolio......................... $ 613,791 $ 641,191 $ 692,243
----------- ----------- -----------
----------- ----------- -----------
30-59 days delinquent....................... $ 8,339 1.4% $ 9,359 1.5% $ 7,100 1.0%
60-89 days delinquent....................... 6,538 1.0 6,704 1.0 5,350 0.8
90 days or more delinquent.................. 21,002 3.4 19,081 3.0 16,075 2.3
-- -- --
----------- ----------- -----------
Total delinquencies....................... $ 35,879 5.8% $ 35,144 5.5% $ 28,525 4.1%
-- -- --
-- -- --
----------- ----------- -----------
----------- ----------- -----------
REO (1)..................................... $ 7,854 1.3% $ 3,951 0.6% $ 4,989 0.7%
-- -- --
-- -- --
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, FOR THE SIX
---------------------------------- MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
---------- ---------- ---------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Average servicing portfolio (2)........................... $ 470,628 $ 583,943 $ 615,393 $ 666,437
Net losses (3)............................................ 44 169 2,160 1,000
Percentage of average servicing portfolio................. 0.01% 0.03% 0.35% 0.30%(4)
</TABLE>
- ------------------------
(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.
(4) Annualized.
The increase in loan losses in 1996 was 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.
LIQUIDITY AND CAPITAL RESOURCES
During the third quarter of 1996, the Company completed its Initial Public
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
Initial Public 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
32
<PAGE>
Financing Facilities, capital expenditures, operating and administrative
expenses and payment of income taxes.
The loan origination and processing fees charged to the borrower are
included in the principal balance of the loan originated. The Company funds such
loans out of available cash or through its Warehouse Financing Facilities. For
loans financed through available cash, the Company receives its loan origination
and processing fees in cash upon sale of the loan. For loans financed through
the Warehouse Financing Facilities, the Company generally receives cash in the
amount of the loan origination and processing fees at the time of the Warehouse
Financing Facility borrowing and prior to the time the Company recognizes such
fees for accounting purposes as a component of loan origination and sale
revenue, which occurs upon the sale of the loan. The Company's Warehouse
Financing Facilities provide, in the aggregate, up to $150 million in the United
States and up to L25 million in the United Kingdom in secured revolving lines of
credit which are used to finance loan originations and purchases. Cash provided
by operating activities plus the change in loans held for sale was $10.4 million
for the six months ended June 30, 1997, and $24.8 million, $12.0 million and
$16.9 million for the years ended 1996, 1995 and 1994, respectively.
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 Warehouse Financing Facilities consist of three separate lines
of credit: a $125 million facility, a $25 million facility and a L25 million
facility. 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 June 30, 1998. 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 5, 1998. The Company's L25 million Warehouse Financing Facility, which is
secured by loans originated or purchased by the Company in the United Kingdom
and currently bears interest at a rate of 0.925% over 30 day sterling
denominated LIBOR, expires on August 31, 1998. Management expects, although
there can be no assurance, that the Company will be able to maintain these
Warehouse Financing Facilities (or obtain comparable 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 related parties. 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% per annum, have a combined borrowing
limit of $15 million and expire on July 31, 1998. As of June 30, 1997, an
aggregate of $7.2 million was outstanding on these lines. In late August 1997
the Company increased the amount of one of these lines by $2 million for a
period of up to 30 days.
In April 1997, the Board of Directors of the Company authorized management
to repurchase, from time to time, up to one million shares of Class A Common
Stock in open market transactions. In connection with such program, the Company
repurchased 333,000 shares of its Class A Common Stock for $7.7 million during
the second and third quarters of 1997.
As of June 30, 1997, the Company had commitments to fund loans of $6.1
million. Historically, approximately 55% of such commitments have ultimately
been funded. Capital expenditures totaled $2.1
33
<PAGE>
million for the six months ended June 30, 1997, and $2.3 million, $1.0 million
and and $0.9 million in 1996, 1995, and 1994, respectively. In July 1997, the
Company purchased an office building for $3.4 million. This facility will be
used by the Company's telemarketing operations, which are currently located in
two leased facilities.
The estimated purchase price for the Bank of $9.0 million is expected to be
funded by the Company from available cash.
When it was an S corporation, 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 Initial
Public Offering, the Company distributed S Distribution Notes to the
stockholders of the Company totaling $45.0 million. Proceeds from the Initial
Public Offering were used to pay the S Distribution Notes in 1996. Since the
completion of the Company's Initial Public Offering in July 1996 the Company has
been taxed as a C corporation and no dividends have been declared.
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 February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128 "Earnings Per Share" which is effective for annual and interim
periods ending after December 15, 1997. It supersedes the presentation of
primary earnings per share with a presentation of basic earnings per share which
does not consider the effect of common stock equivalents. The computation of
diluted earnings per share, which gives effect to all dilutive potential common
shares that were outstanding during the period, is consistent with the
computation of fully diluted earnings per share per Accounting Principles Board
Opinion No. 15. The adoption of this standard is not expected to have a material
effect on the Company's earnings per share.
In June 1997, FASB issued SFAS No. 130 "Reporting Comprehensive Income"
which is effective for annual and interim periods ending after December 15,
1997. This statement requires that all items that are required to be recognized
under accounting standards as comprehensive income be reported in a financial
statement that is displayed with the same prominence as others financial
statements.
In June 1997, FASB issued SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" which is effective for annual and interim
periods ending after December 15, 1997. This statement establishes standards for
the method that public entities report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
product and services, geographical areas and major customers. The adoption of
this standard is not expected to have a material effect on the Company's
financial reporting.
34
<PAGE>
BUSINESS
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 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 rapid funding capability. The Company
sells loans to wholesale purchasers or Securitizes them in the form of a 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 to
engage in the mortgage finance business in 16 states, the District of Columbia
and 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 distinct segments of the home equity lending market. These segments
include 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 ("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 31 retail branch offices in 16 states and the United Kingdom and
has identified additional national and international locations in which it may
open new retail branch offices in the future.
The Company is primarily a retail originator of loans, with 83% of its loan
volume for the first six months of 1997 coming from its retail branch
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 addition, the predominant portion of the
Company's loan originations carry relatively low LTVs, which mitigates the
credit risk associated with such obligations. In conjunction with the Company's
aggressive collection and foreclosure procedures, this approach has allowed the
Company historically to maintain low delinquency and loan losses relative to
others in the industry.
RECENT DEVELOPMENTS
HIGH LTV PROGRAM
In July 1997, the Company entered into an agreement with Mego under which
the Company will originate High LTV Loans according to Mego's underwriting
guidelines, for purposes of debt consolidation and/or home improvement, at LTVs
of up to 125%. The Company will sell such High LTV Loans on a
35
<PAGE>
servicing released basis to Mego soon after funding. The Company believes the
origination and sale of the High LTV Loans, which would not otherwise satisfy
the Company's underwriting guidelines, will allow the Company to realize revenue
from leads already generated by its marketing efforts.
CREDIT CARD PROGRAM
The Company has entered into a credit card relationship with Fidelity. Under
this relationship, Fidelity will issue Affinity Cards that bear the Company's
name and that the Company will market and service. The Company believes the
terms of the Affinity Cards, including the tax deductibility of interest paid on
outstanding balances for most customers, will be attractive to potential
borrowers.
Fidelity will fund the Affinity Card balances, on which it will earn a
guaranteed yield. Fidelity will pay the Company for its solicitation, customer
relations and collection services and for the credit enhancement of the credit
card balances provided by the Company. Under the terms of this credit
enhancement, the Company has agreed to indemnify Fidelity for any losses it may
incur as a result of the Affinity Card program.
The Company intends to market the Affinity Card using marketing procedures
and underwriting guidelines substantially similar to those used by the Company
in marketing its mortgage loan products. Accordingly, the Company expects that
many of the individuals solicited for mortgage loan products may also be
solicited for the Affinity Card, thereby resulting in relatively lower marketing
expenditures for the Affinity Card than would otherwise be expected.
ACQUISITION OF BANK
In June 1997, the Company entered into a definitive agreement to acquire the
Bank. The cost of the acquisition, which will be $0.6 million in excess of the
Bank's stockholder's equity at the date of acquisition, is currently estimated
to be $9.0 million. The acquisition is subject to the approval of the OTS.
Although the Company expects the Bank to continue to accept deposits and
provide other financial services, the primary purpose of the acquisition is to
expand the Company's credit card finance business. Initially, the credit card
products offered by the Bank will be limited to a real estate secured credit
card product with substantially the same features as the Affinity Card. The
Company intends to market this credit card in the same manner as the Affinity
Card. While the Company expects, for the immediate future, to conduct the
Affinity Card program concurrently with any credit card program conducted by the
Bank, it is anticipated that the Company will transfer the Affinity Card
program, and any outstanding balances thereunder, from Fidelity to the Bank
during the first year of operation. See "--General" and
"--Regulation."
RETAIL BRANCH NETWORK EXPANSION
As a part of its continuing retail branch network expansion, since the
Initial Public Offering, the Company has opened eight branch offices in four
states and four branch offices in the United Kingdom.
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, satisfy 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.
36
<PAGE>
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 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 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 are indications that 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 LTV 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 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 Homeowners produces
a greater yield for its marketing expenditures and leads to more opportunities
for loan originations. The majority of 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.
FOCUSED MARKETING STRATEGY
By focusing its marketing efforts on Homeowners in distinct segments of the
home equity market who are likely to satisfy the Company's underwriting
guidelines, the Company expends fewer resources on identifying Homeowners and
properties that do 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 application,
focusing on Homeowners whose overall qualifications and properties satisfy such
guidelines.
MAILING CAMPAIGNS AND TELEMARKETING
The Company's mailing and telemarketing campaigns focus on Homeowners in the
communities surrounding its 31 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 1.7 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 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 Homeowners and existing customers. Substantially all of the
inbound calls are from 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
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
37
<PAGE>
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.
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
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 describe the
benefits of the Company's products and services, obtain information about the
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
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 many 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 typically 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, income
information and information regarding other bills to be refinanced with the new
loan.
Senior 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 LTV
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 in the United States, 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.
38
<PAGE>
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.
In the United Kingdom, the Company uses independent third party appraisers
who utilize private data bases and who warranty their appraisals. However, the
Company's own surveyors visit the borrowers' home generally within 48 hours of
the initial contact to meet with the borrowers and to inspect their properties.
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.
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. Prior to each Sales Appointment, the retail branch loan officer or
branch manager will run a credit report for each applicant. The Company utilizes
a credit score ("FICO Score") derived from a credit scoring model developed by
an independent third party. Based upon the applicant's FICO Score, an applicant
is preliminarily designated as an "A," "B," "C" or "D" risk. This designation is
reviewed by the Company's centralized quality control and underwriting
department before final approval.
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. Retail branch office sales personnel are
required to attend quarterly regional sales and technical training meetings.
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. 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.
39
<PAGE>
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 generally are not less restrictive than
representations and warranties required of the Company for the Securitization of
its own loan originations. The Company recently has expanded its purchase of
wholesale loans with a concentration on low LTV loans made to Homeowners located
in its current or potential market areas. The Company intends to solicit these
Homeowners for additional borrowings.
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. Every 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 18 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 and underwriting
personnel inform retail branch office personnel of any additional requirements
that must be fulfilled to complete the loan file.
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, decline or modify 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 LTV; however, the Company will originate loans with a combined LTV
of up to 90% for loans expected to be sold on a whole loan basis. Loans secured
by second mortgages are limited to a maximum 80% combined LTV. 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 FICO Score, (ii) combined LTVs 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 due to the
40
<PAGE>
increased risk inherent in the loan. 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:
<TABLE>
<CAPTION>
"A" "B" "C" "D"
--- --- --- ---
<S> <C> <C> <C> <C>
Minimum FICO Score................................................. 659 585 511 0
Maximum LTV........................................................ 75% 73% 72% 65%
Maximum debt-to-income ratio....................................... 40% 49% 59% 65%
</TABLE>
In addition to the above criteria, the Company requires higher interest
rates on loans with certain risk factors. These factors include, among others,
an unsubstantiated employment history, a recent foreclosure proceeding, a number
of recent delinquent payments on an existing mortgage, a recent bankruptcy
filing, non-owner occupied properties, rural properties or the presence of a
senior mortgage or zoning restrictions on the subject property.
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
six months ended June 30, 1997:
<TABLE>
<CAPTION>
TOTAL
(DOLLARS IN % OF INITIAL WEIGHTED
LOAN CLASSIFICATION THOUSANDS) TOTAL AVERAGE COUPON
- ------------------------------------------------------------ ----------- --------- -----------------
<S> <C> <C> <C> <C>
"A" Risk............................................. $ 100,308 45.6% 8.9%
"B" Risk............................................. 63,519 28.9 9.5
"C" Risk............................................. 42,336 19.2 10.1
"D" Risk............................................. 13,959 6.3 11.1
----------- --------- -----
Total..................................................... $ 220,122 100.0% 9.4%
----------- --------- -----
----------- --------- -----
</TABLE>
The preceding discussion does not apply to the Company's new High LTV Loan
Program. See "--General." The Company will originate High LTV loans in
accordance with underwriting guidelines supplied by Mego. The Company may enter
into similar arrangements with other originators.
41
<PAGE>
LOAN ORIGINATIONS AND PURCHASES
The following table highlights selected information relating to the
origination and purchase of loans by the Company for the periods indicated:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED DECEMBER 31,
ENDED JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Type of property securing loan:
Single family.................................... 92.4% 95.0% 95.1% 95.4% 93.6%
Multi-family..................................... 5.4 2.7 3.3 2.8 4.4
Planned unit development and other............... 2.2 2.3 1.6 1.8 2.0
--------- --------- --------- --------- ---------
Total.............................................. 100.0% 100.0% 100.0% 100.0% 100.0%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Type of mortgage securing loan:
First mortgage................................... 95.4% 94.5% 99.3% 98.9% 99.8%
Second mortgage.................................. 4.4 5.4 0.7 1.1 0.2
Third mortgage................................... 0.2 0.1 - - -
--------- --------- --------- --------- ---------
Total.............................................. 100.0% 100.0% 100.0% 100.0% 100.0%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Weighted average interest rate..................... 8.7% 10.3% 9.6% 9.5% 9.4%
Weighted average initial combined LTV (1).......... 56.2% 59.3% 62.2% 62.4% 63.5%
</TABLE>
- ------------------------
(1) The LTV 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 LTV 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 by the appraised value of the mortgaged
property at origination.
LOAN SALES
SECURITIZATION
In a Securitization, the Company exchanges loans for Regular Interests and a
Residual Interest in the REMIC Trust. The Regular Interests are immediately sold
by the Company to the public for cash. As the holder of the Residual Interest,
the Company is entitled to receive certain excess cash flows. These excess cash
flows are the difference between (a) principal and interest paid by borrowers
and (b) the sum of (i) scheduled 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 begins receiving these
excess cash flows after certain overcollaterization requirements, which are
specific to each Securitization and are used as a means of credit enhancement,
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 scheduled principal and
interest at the pass-through rate. 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
42
<PAGE>
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.
Generally, the Company sells loans at face value to a REMIC Trust, except
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
LTVs 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, which was initiated in 1994, has been 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.
43
<PAGE>
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. See "Risk Factors--Fluctuations in Interest Rates May
Adversely Affect Profitability." 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.
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
9,373 loans with an outstanding balance of $692.2 million as of June 30, 1997.
The Company receives management servicing fees ranging from 0.5% to 2.0% 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 a sophisticated computer-based loan servicing system that
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:
<TABLE>
<CAPTION>
TIME EVENT
- ---------------------------------------------- ---------------------------------------------
<S> <C>
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
19th 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 on 45th day
of delinquency
After notice of default or similar notice is Borrower informed of status and the Company's
recorded 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 third party or acquired on behalf of the
Company or a REMIC Trust
</TABLE>
44
<PAGE>
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 or repaid, 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 applicable 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 and the United Kingdom, the Company's collection procedures
described above may occur sooner or later depending upon applicable foreclosure
regulations.
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 regarding the liquidation of properties (I.E.,
foreclosure) and the rights of the mortgagor in default vary greatly from
jurisdiction to jurisdiction. 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 27 retail branch offices in 16 states
and the District of Columbia in the United States and four retail branch offices
in the United Kingdom. The Company
45
<PAGE>
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.
Although the Company is licensed to originate loans in 16 states, the
District of Columbia 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 22.5% of
the Company's total loan originations and purchases for the six months ended
June 30, 1997. 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 June 30, 1997.
The following table shows the geographic distribution of the Company's loan
originations and purchases for the periods indicated.
GEOGRAPHIC DISTRIBUTION OF LOAN ORIGINATIONS AND PURCHASES
<TABLE>
<CAPTION>
FOR THE
FOR THE YEAR SIX MONTHS ENDED
ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
United States
California........................................................... 94.3% 43.0% 37.9% 43.7% 22.5%
New York............................................................. - - 2.8 - 12.2
Illinois............................................................. - 14.1 14.2 15.2 11.2
New Jersey........................................................... - - 3.0 - 8.8
Washington........................................................... 3.4 14.9 10.9 12.6 7.7
Oregon............................................................... 0.2 5.9 5.6 6.0 6.5
Utah................................................................. - 2.5 3.0 3.6 4.8
Florida.............................................................. 0.1 8.1 6.7 7.8 4.6
Colorado............................................................. 0.4 6.7 4.2 4.7 4.4
Pennsylvania......................................................... - - 3.9 1.2 4.4
Other states......................................................... 1.6 4.8 6.9 5.2 9.9
United Kingdom......................................................... - - 0.9 - 3.0
--------- --------- --------- --------- ---------
Total.............................................................. 100.0% 100.0% 100.0% 100.0% 100.0%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
NATIONAL AND INTERNATIONAL 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'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 Homeowners whom 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. The Company then focuses its marketing efforts on these Homeowners
in the new market.
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 its retail branch offices from the
46
<PAGE>
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, savings 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.
REGULATION
The Company's business is subject to extensive regulation at both the
federal and state level and in the United Kingdom. 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
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refinance existing loans originated by the same lender or an affiliate of such
lender. The Company reported $1.7 million, $4.0 million, $3.2 million and $3.1
million in prepayment fee revenue in the six months ended June 30, 1997 and in
the 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. As a mortgage lender, the Company has been, and expects to continue
to be, subject to regulatory enforcement actions and private causes of action
from time to time with respect to its compliance with applicable laws and
regulations. The Company's lending practices have in the past been and currently
are under regulatory review by various state authorities. Although the Company
utilizes systems and procedures to facilitate compliance with these legal
requirements and believes that it is in compliance in all material respects with
applicable laws, rules and regulations, there can be no assurance that more
restrictive laws, rules and regulations will not be adopted in the future, or
that existing laws and regulations will not be interpreted in a more restrictive
manner, which could make compliance more difficult or expensive.
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
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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 L15,000 or less. Loans with principal balances in excess
of L15,000 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 re-opening "extortionate credit bargains." This cause of
action applies both to loans whose principal amount is less than or exceeds
L15,000. 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 United Kingdom Office of Fair Trade recently has expressed
regulatory concern with respect to certain mortgage loan products and practices,
which may include those utilized by the Company.
The Company's operations in the United Kingdom involve loans with principal
balances in excess of L15,000 and are therefore largely unregulated under the
CCA, but are subject to the provisions on the re-opening of extortionate credit
bargains. The Company's operations in the United Kingdom are also subject to the
Unfair Terms in Consumer Contracts Regulations 1994, which provide that "unfair"
terms in standard form contracts (which have not been individually negotiated)
are not binding on consumers.
REGULATION AND SUPERVISION--BANK
GENERAL. If the acquisition of the Bank is consummated, FACO will be a
savings and loan holding company and, as such, will be subject to OTS
regulation, examination, supervision and reporting requirements. The Bank is a
federally chartered savings bank, a member of the Federal Home Loan Bank
("FHLB") of San Francisco, and its deposits are insured by the Savings
Association Insurance Fund ("SAIF") to the maximum extent permitted by law. The
Bank is subject to extensive regulation by the OTS, as its chartering agency,
and by the FDIC, as its deposit insurer. In addition to the statutes and
regulations discussed above, the Bank must undergo at least one full scope,
on-site safety and soundness examination every year. The Director of the OTS is
authorized to impose assessments on the Bank to fund OTS operations, including
the cost of examinations. The FDIC has "back-up" authority to take enforcement
action against the Bank if the OTS fails to take such action after a
recommendation by the FDIC. The FDIC may also impose assessments on the Bank to
cover the cost of FDIC examinations. Finally, the Bank is subject to regulation
by the Board of Governors of the Federal Reserve System ("FRB") with respect to
certain aspects of its business.
Changes in legislation and regulatory policy and the interpretations thereof
have materially affected the business of the Bank and other financial
institutions in the past and are likely to do so in the future. There can be no
assurance that future changes in the regulations or their interpretation will
not adversely affect the business of the Bank. Future legislation and regulatory
policy could also alter the structures and
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competitive relationships among financial institutions. Regulatory authorities
also have the power, in certain circumstances, to prohibit or limit the payment
of dividends to holders of common stock of the Bank. In addition, certain
regulatory actions, including general increases in federal deposit insurance
premiums, additional insurance premium assessments to recapitalize the SAIF or
the application of the risk-based insurance premium system to the Bank, may
increase the Bank's operating expenses in future periods and may have a material
adverse impact on the Bank's capital levels and results of operations.
HOLDING COMPANY REGULATION. If the acquisition of the Bank is consummated,
FACO will be a "unitary" savings and loan holding company under the terms of the
Home Owners' Loan Act, as amended ("HOLA"). As such, FACO will be required to be
registered with the OTS and will be subject to OTS regulations, examinations,
supervision and reporting requirements. Among other things, the OTS has
enforcement authority which permits the OTS to restrict or prohibit activities
that are determined to be a serious risk to the subsidiary savings institution.
There are generally no restrictions on the activities of a unitary savings
and loan holding company. However, if the savings institution subsidiary of such
a holding company fails to meet the qualified thrift lender ("QTL") test, then
such holding company also will become subject to the activities restrictions
applicable to multiple savings and loan holding companies and, unless the
savings institution requalifies as a QTL within one year thereafter, will have
to register as, and become subject to, the restrictions applicable to a bank
holding company. See "--Qualified Thrift Lender Test."
FIRREA CAPITAL REQUIREMENT. The OTS capital regulations, as required by the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"),
include three separate minimum capital requirements for the savings institution
industry--a "tangible capital requirement," a "leverage limit" and a "risk-based
capital requirement." These capital standards must be no less stringent than the
capital standards applicable to national banks. The OTS also has the authority,
after giving the affected institution notice and an opportunity to respond, to
establish an individual minimum capital requirement for a savings institution
which is higher than the industry minimum requirements, upon a determination
that an individual minimum capital requirement is necessary or appropriate in
light of the institution's particular circumstances.
The industry minimum capital requirements are as follows:
Tangible capital of at least 1.5% of adjusted total assets. Tangible capital
consists of (1) common stockholders' equity, noncumulative perpetual preferred
stock and related earnings, nonwithdrawable accounts and pledged deposits
qualifying as core capital and minority interests in the equity accounts of
fully consolidated subsidiaries, after deducting (a) certain qualifying
intangible assets and certain mortgage servicing rights and (b) the amount by
which investments in subsidiaries engaged as principal in activities not
permissible for national banks exceeds the amount of such investments as of
April 12, 1989 and the lesser of the institution's investments in and extensions
of credit to such subsidiaries, net of any reserves established against such
investments, (i) as of April 12, 1989 and (ii) as of the date on which the
institution's tangible capital is being determined. In general, adjusted total
assets equal the institution's consolidated total assets, minus any assets that
are deducted in calculating capital.
Core capital of at least 3% of adjusted total assets (the "leverage limit").
Core capital consists of tangible capital plus goodwill resulting from pre-April
12, 1989 acquisitions of troubled savings institutions. Certain qualifying
intangible assets, mortgage servicing rights and deferred tax assets must be
deducted from core capital.
Total capital of at least 8% of risk-weighted assets (the "risk-based
capital requirement"). Total capital includes both core capital and
"supplementary" capital items deemed less permanent than core capital, such as
subordinated debt and general loan loss allowances (subject to certain limits).
Equity investments (with the exception of investments in subsidiaries and
investments permissible for national banks) and portions of certain high-risk
land loans and nonresidential construction loans must be deducted from total
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capital. If interest rate risk exceeds a certain threshold, total capital will
be reduced by a specified amount. At least half of total capital must consist of
core capital.
Risk-weighted assets are determined by multiplying each category of an
institution's assets, including off balance sheet asset equivalents, by an
assigned risk weight based on the credit risk associated with those assets, and
adding the resulting products. The four risk weight categories range from zero
percent for cash and government securities to 100% for assets (including
past-due loans and real estate owned) that do not qualify for preferential
risk-weighting.
FDICIA PCA REGULATIONS. FDICIA required the OTS to implement a system
requiring regulatory sanctions against institutions that are not adequately
capitalized, with the sanctions growing more severe the lower the institution's
capital. The OTS has established specific capital ratios under the PCA
Regulations for five separate capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized.
Under the OTS regulations implementing FDICIA, an institution is treated as
well capitalized if its ratio of total capital to risk-weighted assets is at
least 10.0%, its ratio of core capital to risk-weighted assets is at least 6.0%,
its ratio of core capital to adjusted total assets is at least 5.0%, and it is
not subject to any order or directive by the OTS to meet a specific capital
level. An institution is adequately capitalized if its ratio of total capital to
risk-weighted assets is at least 8.0%, its ratio of core capital to
risk-weighted assets is at least 4.0%, and its ratio of core capital to adjusted
total assets (leverage ratio) is at least 4.0% (3.0% if the institution receives
the highest rating on the OTS financial institutions rating system).
An institution whose capital does not meet the amounts required in order to
be adequately capitalized will be treated as undercapitalized. If an
undercapitalized institution's capital ratios are less than 6.0% total capital
to risk-weighted assets, 3.0% core capital to risk-weighted assets, or 3.0% core
capital to adjusted total assets, it will be treated as significantly
undercapitalized. Finally, an institution will be treated as critically
undercapitalized if its ratio of "tangible equity" (core capital plus cumulative
perpetual preferred stock minus intangible assets other than supervisory
goodwill and purchased mortgage servicing rights) to adjusted total assets is
equal to or less than 2.0%.
MANDATORY RESTRICTIONS ON UNDERCAPITALIZED INSTITUTIONS. There are numerous
mandatory restrictions on the activities of undercapitalized institutions. An
institution that is undercapitalized must submit a capital restoration plan to
the OTS that the OTS may approve only if it determines that the plan is likely
to succeed in restoring the institution's capital and will not appreciably
increase the risks to which the institution is exposed. In addition, the
institution's performance under the plan must be guaranteed by every company
that controls the institution, up to specified limits. An institution that is
undercapitalized may not acquire an interest in any company, open a new branch
office or engage in a new line of business without OTS or FDIC approval. An
undercapitalized institution also may not increase its average total assets
during any quarter except in accordance with an approved capital restoration
plan. An undercapitalized savings institution generally may not pay any
dividends or make other capital distributions. Undercapitalized institutions
also may not pay management fees to any company or individual that controls the
institution. An undercapitalized savings institution cannot accept, renew or
rollover deposits obtained through a deposit broker, and may not solicit
deposits by offering interest rates that are more than 75 basis points higher
than market rates. Savings institutions that are adequately capitalized but not
well capitalized must obtain a waiver from the FDIC in order to accept, renew or
rollover brokered deposits, and even if a waiver is granted may not solicit
deposits, through a broker or otherwise, by offering interest rates that exceed
market rates by more than 75 basis points.
RESTRICTIONS ON SIGNIFICANTLY AND CRITICALLY UNDERCAPITALIZED
INSTITUTIONS. In addition to the above mandatory restrictions which apply to
all undercapitalized savings institutions, institutions that are significantly
undercapitalized may not without the OTS' prior approval (a) pay a bonus to any
senior executive officer or (b) increase any senior executive officer's
compensation over the average rate of compensation (excluding bonuses, options
and profit-sharing) during the 12 months preceding the month
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in which the institution became undercapitalized. The same restriction applies
to undercapitalized institutions that fail to submit or implement an acceptable
capital restoration plan. If a savings institution is critically
undercapitalized, the institution is also generally prohibited from making
payments of principal or interest on subordinated debt beginning 60 days after
the institution becomes critically undercapitalized. In addition, the
institution cannot without prior FDIC approval enter into any material
transaction outside the ordinary course of business. Critically undercapitalized
savings institutions must be placed in receivership or conservatorship within 90
days of becoming critically undercapitalized unless the OTS, with the
concurrence of the FDIC, determines that some other action would better resolve
the problems of the institution at the least possible long-term loss to the
insurance fund, and documents the reasons for its determination.
DISCRETIONARY SANCTIONS. With respect to an undercapitalized institution,
the OTS, under certain circumstances, has the authority, among other things, to
order the institution to recapitalize by setting shares of capital stock or
other securities, order the institution to agree to be acquired by another
depository institution holding company or combine with another depository
institution, restrict transactions with affiliates, restrict the interest rates
paid by the institution on new deposits to the prevailing rates of interest in
the region where the institution is located, require the institution to divest
any subsidiary or the institution's holding company to divest the institution or
any other subsidiary or take any other action that the OTS determines will
better resolve the institution's problems at the least possible loss to the
deposit insurance fund. With respect to significantly undercapitalized
institutions and certain undercapitalized institutions, the OTS must take
certain of the above mentioned actions. In addition to the mandatory appointment
of a conservator or receiver for critically undercapitalized institutions,
described above, the OTS or FDIC may in certain circumstances appoint a receiver
or conservator for an undercapitalized institution.
SAFETY AND SOUNDNESS STANDARDS. In addition to the PCA provisions discussed
above based on an institution's regulatory capital ratios, FDICIA contains
several measures intended to promote early identification of management problems
at depository institutions and to ensure that regulators intervene promptly to
require corrective action by institutions with inadequate operational and
managerial standards.
Pursuant to FDICIA, the OTS has prescribed minimum acceptable operational
and managerial standards, and standards for asset quality, earnings and
valuation of publicly traded shares, for savings institutions and their holding
companies. The operational standards cover internal controls, loan
documentation, credit underwriting, interest rate exposure, asset growth and
employee compensation. The asset quality and earnings standards specify a
maximum ratio of classified assets to capital, minimum earnings sufficient to
absorb losses and minimum ratio of market value to book value for publicly
traded shares.
QUALIFIED THRIFT LENDER TEST. The QTL test requires that, in at least nine
out of every twelve months on a rolling, "look back" basis, at least 65% of a
savings institution's "portfolio assets" must be invested in a limited list of
qualified thrift investments, primarily investments related to housing loans. If
the Bank fails to satisfy the QTL test and does not requalify as a QTL within
one year, any entity in control of the Bank must register and be regulated as a
bank holding company, and the Bank must either convert to a commercial bank
charter or become subject to restrictions on branching, business activities and
dividends as if it were a national bank. Portfolio assets consist of tangible
assets minus (a) assets used to satisfy liquidity requirements and (b) property
used by the institution to conduct its business. In 1996, the Economic Growth
and Regulatory Paperwork Reduction Act ("EGRPRA") was adopted, amending the QTL
requirements to allow educational loans, small business loans and credit card
loans to count as qualified thrift assets without limit and to allow loans for
personal, family or household purposes to count as qualified thrift assets in
the category limited to 20% of portfolio assets. Prior to EGRPRA, small business
loans were included in qualified thrift assets only if made in a credit-needy
area and educational and credit card loans were included subject to a 10% of
portfolio assets limit. The previous limit for loans for personal, family or
household purposes was also 10% of portfolio assets. Finally, EGRPRA provided
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that as an alternative to the QTL test, thrifts may choose to comply with the
Internal Revenue Service's domestic building and loan tax code test.
INVESTMENTS AND LOANS. In general, federal savings institutions such as the
Bank may not invest directly in equity securities, noninvestment grade debt
securities or real estate, other than real estate used for the institution's
offices and related facilities. Indirect equity investment in real estate
through a subsidiary is permissible, but subject to certain limitations and
deductions from regulatory capital. Loans by a savings institution to a single
borrower are generally limited to 15% of an institution's "unimpaired capital
and unimpaired surplus," which is similar but not identical to total capital.
Aggregate loans secured by nonresidential real property are generally limited to
400% of an institution's total capital. Commercial loans generally may not
exceed 20% of an institution's total assets, provided that commercial lending in
excess of 10% of total assets represents only small business loans. Consumer
loans may not exceed 35% of an institution's total assets.
REAL ESTATE LENDING STANDARDS. The OTS and the other federal banking
agencies have adopted regulations which require institutions to adopt and at
least annually review written real estate lending policies. The lending policies
must include diversification standards, underwriting standards (including
loan-to-value limits), loan administration procedures and procedures for
monitoring compliance with the policies. The policies must reflect consideration
of guidelines adopted by the banking agencies.
PAYMENT OF DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS. The payment of
dividends, stock repurchases and other capital distributions by the Bank to FACO
will be subject to regulation and certain limitations on amount. Currently, 30
days' prior notice to the OTS of any capital distribution is required.
REQUIRED LIQUIDITY. OTS regulations require savings institutions to
maintain, for each calendar month, an average daily balance of liquid assets
(including cash, certain time deposits, bankers' acceptances, specified United
States government, state and federal agency obligations and balances maintained
in satisfaction of the FRB reserve requirements described below) equal to at
least 5% of the average daily balance of its net withdrawable accounts plus
short-term borrowings during the preceding calendar month. The OTS may change
this liquidity requirement from time to time to an amount within a range of 4%
to 10% of such accounts and borrowings depending upon economic conditions and
the deposit flows of member institutions, and may exclude from the definition of
liquid assets any item other than cash and the balances maintained in
satisfaction of the FRB reserve requirements. OTS regulations also require each
member institution to maintain, for each calendar month, an average daily
balance of short-term liquid assets (generally those having maturities of 12
months or less) equal to at least 1% of the average daily balance of its net
withdrawable accounts plus short-term borrowings during the preceding calendar
month.
CLASSIFICATION OF ASSETS. Savings institutions are required to classify
their assets on a regular basis, to establish appropriate allowances for losses
and report the results of such classification quarterly to the OTS. A savings
institution is also required to set aside adequate valuation allowances, and to
establish liabilities for off-balance sheet items, such as letters of credit,
when a loss becomes probable and estimable. The OTS has the authority to review
the institution's classification of its assets and to determine whether
additional assets must be classified, or the institution's valuation allowances
must be increased.
DEPOSIT INSURANCE. The Bank's deposits are insured by the FDIC. Under
FIRREA, the FDIC administers two separate deposit insurance funds: the Bank
Insurance Fund ("BIF") which insures the deposits of institutions that were
insured by the FDIC prior to FIRREA, and the SAIF which maintains a fund to
insure the deposits of institutions, such as the Bank, that were insured by the
Federal Savings and Loan Insurance Corporation prior to FIRREA. FDICIA directed
the FDIC to establish a risk-based system for setting deposit insurance premium
assessments. The FDIC has implemented such a system, under which an
institution's insurance assessments will vary depending on the level of capital
the institution holds and the degree to which it is the subject of supervisory
concern to the FDIC. The FDIC may initiate a proceeding to terminate an
institution's deposit insurance if, among other things, the
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institution is in an unsafe or unsound condition to continue operations. It is
the policy of the FDIC to deem an insured institution to be in an unsafe or
unsound condition if its ratio of Tier 1 capital to total assets is less than
2%. Tier 1 capital is similar to core capital but includes certain investments
in and extensions of credit to subsidiaries engaged in activities not permitted
for national banks.
AFFILIATE AND INSIDER TRANSACTIONS. The ability of FACO and its
non-depository subsidiaries to deal with the Bank is limited by the affiliate
transaction rules, including Sections 23A and 23B of the Federal Reserve Act,
which also govern BIF-insured banks. With limited exceptions, these rules
require that all transactions between the Bank and an affiliate must be on arms'
length terms. The term "affiliate" covers any company that controls or is under
common control with the Bank, but does not include individuals and generally
does not include the Bank's subsidiaries.
Under Section 23A and Section 11 of the HOLA, specific restrictions apply to
transactions in which the Bank provides funding to its affiliates: the Bank may
not purchase the securities of an affiliate, make a loan to any affiliate that
is engaged in activities not permissible for a bank holding company or acquire
from an affiliate any asset that has been classified, a nonaccrual loan, a
restructured loan, or a loan that is more than 30 days past due. As to
affiliates engaged in bank holding company-permissible activities, the aggregate
of (a) loans, guarantees and letters of credit provided by the Bank for the
benefit of any one affiliate and (b) purchases of assets by the Bank from the
affiliate, may not exceed 10% of the Bank's capital stock and surplus (20% for
the aggregate of permissible transactions with all affiliates). All loans to
affiliates must be secured by collateral ranging from 100% to 130% of the amount
of the loan, depending on the type of collateral.
In addition, OTS regulations on affiliate transactions require, among other
things, that savings institutions retain records of their affiliate transactions
that reflect such transactions in reasonable detail. If a savings institution
has been the subject of a change of control application or notice within the
preceding two-year period, does not meet its minimum capital requirements, has
entered into a supervisory agreement, is subject to a formal enforcement
proceeding, or is determined by the OTS to be the subject of supervisory
concern, the institution may be required to provide the OTS with 30 days' prior
notice of any affiliate transaction.
Under these regulatory limitations, loans by the Bank to directors,
executive officers and 10% stockholders of the Bank, FACO and FACO's
subsidiaries (collectively, "insiders"), or to a corporation or partnership that
is at least 10% owned by an insider (a "related interest"), are subject to
limits separate from the affiliate transaction rules. However, a company that
controls a savings institution is excluded from the coverage of the insider
lending rules even if it owns 10% or more of the stock of the institution, and
is subject only to the affiliate transaction rules. All loans to insiders and
their related interests must be underwritten and made on non-preferential terms;
loans in excess of $500,000 must be approved in advance by the Bank's Board of
Directors; and the Bank's total of such loans may not exceed 100% of the Bank's
capital. Loans by the Bank to its executive officers are subject to additional
limits which are even more stringent.
ENFORCEMENT. Whenever the OTS has reasonable cause to believe that the
continuation by a savings and loan holding company of any activity or of
ownership or control of any non FDIC-insured subsidiary constitutes a serious
risk to the financial safety, soundness or stability of a savings and loan
holding company's subsidiary savings institution and is inconsistent with the
sound operation of the savings institution, the OTS may order the holding
company, after notice and opportunity for a hearing, to terminate such
activities or to divest such noninsured subsidiary. FIRREA also empowers the
OTS, in such a situation, to issue a directive without any notice or opportunity
for a hearing, which directive may (a) limit the payment of dividends by the
savings institution, (b) limit transactions between the savings institution and
its holding company or its affiliates and (c) limit any activity of the
association that creates a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution.
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In addition, FIRREA includes savings and loan holding companies within the
category of persons designated as "institution-affiliated parties." An
institution-affiliated party may be subject to significant penalties and/or loss
of voting rights in the event such party took any action for or toward causing,
bringing about, participating in, counseling or aiding and abetting a violation
of law or unsafe or unsound practice by a savings institution.
COMMUNITY REINVESTMENT ACT. The Community Reinvestment Act ("CRA") requires
each savings institution, as well as other lenders, to identify and delineate
the communities served through and by the institution's offices and to
affirmatively meet the credit needs of its delineated communities and to market
the types of credit the institution is prepared to extend within such
communities. The CRA also requires the OTS to assess the performance of the
institution in meeting the credit needs of its community and to take such
assessment into consideration in reviewing applications for mergers,
acquisitions and other transactions. An unsatisfactory CRA rating may be the
basis for denying such an application. Performance is assessed on the basis of
an institution's actual lending, service and investment performance rather than
the extent to which the institution conducts needs assessments, documents
community outreach or complies with other procedural requirements. In connection
with its assessment of CRA performance, the OTS assigns a rating of
"outstanding," "satisfactory," "needs improvement" or "substantial
noncompliance."
FEDERAL HOME LOAN BANK SYSTEM. The FHLBs provide a credit facility for
member institutions. As a member of the FHLB of San Francisco, the Bank is
required to own capital stock in the FHLB of San Francisco in an amount at least
equal to the greater of 1% of the aggregate principal amount of its unpaid home
loans, home purchase contracts and similar obligations at the end of each
calendar year, assuming for such purposes that at least 30% of its assets were
home mortgage loans, or 5% of its advances from the FHLB of San Francisco.
Long-term FHLB advances may be obtained only for the purpose of providing funds
for residential housing finance and all FHLB advances must be secured by
specific types of collateral.
FEDERAL RESERVE SYSTEM. The FRB requires savings institutions to maintain
noninterest-earning reserves against certain of their transaction accounts
(primarily deposit accounts that may be accessed by writing unlimited checks)
and non-personal time deposits. The balances maintained to meet the reserve
requirements imposed by the FRB may be used to satisfy the Bank's liquidity
requirements discussed above.
As a creditor and a financial institution, the Bank is subject to certain
regulations promulgated by the FRB, including, without limitation, Regulation B
(Equal Credit Opportunity Act), Regulation D (Reserves), Regulation E
(Electronic Funds Transfers Act), Regulation F (limits on exposure to any one
correspondent depository institution), Regulation Z (Truth in Lending Act),
Regulation CC (Expedited Funds Availability Act), and Regulation DD (Truth in
Savings Act). As creditors of loans secured by real property and as owners of
real property, financial institutions, including the Bank, may be subject to
potential liability under various statutes and regulations applicable to
property owners, generally including statutes and regulations relating to the
environmental condition of the property.
RECHARTERING LEGISLATION. Legislation enacted in 1996 provides that the BIF
and SAIF will merge on January 1, 1999, if there are no savings associations, as
defined, in existence on that date. Pursuant to that legislation, the Department
of Treasury in May 1997 recommended in a report to Congress that the separate
charters for thrifts and banks be abolished. Various proposals to eliminate the
federal thrift charter, create a uniform financial institutions charter, conform
holding company regulation and abolish the OTS have been introduced in Congress.
The House Committee on Banking and Financial Services has considered and
reported H.R. 10, the Financial Services Competition Act of 1997, including
Title III, the "Thrift Charter Transition Act of 1997" ("Title III"). Title III
will require federal savings associations to convert to national banks or some
type of state charter within two years of enactment or they would automatically
become national banks. On the earlier of January 1, 2000, or two years after the
date of
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enactment, the BIF and SAIF will merge. Two years after enactment, the HOLA will
be repealed and the OTS will be abolished. Within nine months of enactment, the
Secretary of the Treasury shall adopt a plan for the combination of the OTS and
the Office of the Comptroller of the Currency into a single agency. Converted
federal thrifts generally will be permitted to continue to engage in any
activity, including the holding of any asset, lawfully conducted on the date
prior to enactment. A federal savings association converted to a national bank
may retain all branches established or proposed in a pending application as of
enactment and establish new branches in any state in which it has a branch.
Otherwise it may establish new branches only under national bank rules. In
addition, beginning two years after enactment, national banks will be authorized
to exercise all powers formerly authorized for federal savings associations.
Under H.R. 10, holding companies for converted savings associations
generally will become subject to the same regulation as holding companies that
control commercial banks, with a grandfather provision for former unitary
savings and loan holding companies. Such grandfathered companies will be
permitted to maintain and establish affiliations with any type of company and to
acquire additional depository institutions, as long any acquired depository
institution is merged into its converted savings association and such
institution continues to comply with both the qualified thrift lender test and
certain asset and investment limitations to which it was subject as a federal
savings association. Such a converted holding company would be subject to the
same capital requirements (if any) applicable under OTS regulation if it were a
savings and loan holding company on June 19, 1997, and for three years would be
subject to substantially similar regulation, reporting and examination as
implemented by the OTS as of January 1, 1997.
Title III provides for the continuation of adjustable rate mortgage indices
used by converted savings associations, including cost-of-funds indices, if
calculation of the index could not be made by the terms of the governing
instrument as a result of changes made by H.R. 10. H.R. 10 also makes
significant changes in the operation of the FHLB System, including the types of
stock that may be issued by FHLBs to members and borrowers and FHLB
capitalization, management, investments and lending. Effective January 1, 1999,
the FHLB Act will be amended to permit federal savings associations to be
voluntary members and stockholders of an FHLB.
The Company is unable to predict whether H.R. 10 or any other such
legislation will be enacted, what the provisions of any such final legislation
may be, or the extent to which the legislation would restrict, disrupt or
otherwise have a material effect on its operations.
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.
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EMPLOYEES
As of August 31, 1997, the Company had a total of 482 employees. The Company
has 246 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.
PROPERTIES
The Company's corporate headquarters are located at 17305 Von Karman Avenue,
Irvine, California 92614-6203, where the Company leases from a partnership
beneficially owned by Brian and Sarah Chisick approximately 40,000 square feet
of office space. The lease expires on January 31, 2003, and the Company has an
option to renew the lease for five years. The Company also leases office space
for its 31 retail branch offices in 16 states and the United Kingdom. The
average size of these retail branch offices is approximately 1,700 square feet,
with an annual average base rent of approximately $32,000. The Company recently
purchased an office building in Irvine, California with approximately 40,000
square feet of office space. The Company intends to remodel this building
primarily for use as a telemarketing center. 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.
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 results of operations or financial condition of the Company.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Board of Directors of the Company is divided into three classes: Class
I, Class II and Class III. After his or her initial term, each director serves
for a term ending following the third annual meeting following the annual
meeting at which such director is elected and until his or her successor is
elected. The terms of office of directors in Class I, Class II and Class III end
after the annual meetings of stockholders of the Company in 2000, 1998 and 1999,
respectively. The following table sets forth the name, age and position with
FACO of each person who is an executive officer or director of FACO.
<TABLE>
<CAPTION>
NAME AGE POSITION CLASS
- ------------------------------------ --------- ------------------------------------------------------------ -----
<S> <C> <C> <C>
Brian Chisick....................... 58 President, Chief Executive Officer and Director II
Sarah Chisick....................... 57 Director II
Mark K. Mason....................... 38 Executive Vice President, Chief Financial Officer I
and Director
Jeffrey W. Smith.................... 35 Executive Vice President, Sales and Marketing and Director I
Merrill Butler...................... 72 Director III
George Gibbs, Jr.................... 67 Director III
Albert L. Lord...................... 51 Director III
Edwin C. Summers.................... 50 Vice President, General Counsel and Secretary
</TABLE>
The name and business experience during the past five years of each director
and executive officer are described below.
BRIAN CHISICK has been the Chairman of the Board, Chief Executive Officer
and President of the Company since its founding in 1971. Mr. Chisick has held a
real estate broker's license since 1971. In 1985, Mr. Chisick was Vice President
of the Mortgage Brokers Institute, a statewide trade association of over 120
mortgage brokers and served as a member of the legislative committee of the
Mortgage Brokers Institute.
SARAH CHISICK has been Vice President of FAMCO since 1971 and a director of
FACO since its founding. Her duties have in the past included projects in the
loan servicing, foreclosure, marketing and investment departments. She is not
currently involved in the day to day operations of the Company. Mrs. Chisick is
the spouse of Brian Chisick.
MARK K. MASON, a certified public accountant, has been Executive Vice
President and Chief Financial Officer of the Company since November 1995. From
1994 to 1995, Mr. Mason was Executive Vice President and Chief Financial Officer
of Fidelity, where he remains a member of the Board of Directors. From 1993 to
1994, Mr. Mason was a Senior Manager with the international accounting firm of
Deloitte & Touche LLP. From 1990 to 1993, Mr. Mason was Executive Vice President
and Chief Financial Officer of the Eadington Companies. Mr. Mason has been a
director of the Company since the Initial Public Offering.
JEFFREY W. SMITH has been Executive Vice President, Sales and Marketing, of
the Company since 1995 and Chief Operating Officer of FAMCO since September
1996. From 1984 to 1995, Mr. Smith held various positions in the Company
including, Assistant Director of Marketing, Director of Marketing and Vice
President of Marketing. Mr. Smith has been a director of the Company since the
Initial Public Offering.
MERRILL BUTLER has been a director of the Company since the Initial Public
Offering. Mr. Butler formed Merrill Butler, Inc., in 1983 to consult with
savings and loans on real estate matters. During 1995, Mr. Butler served on the
Volunteer Executive Team organized to advise Orange County, California after
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the County had declared bankruptcy. Mr. Butler was a co-creator of the Butler
Popejoy Group, a general partnership, which, from 1992 to 1994, capitalized home
builders with equity funds to develop entry level housing projects. Mr. Butler
served from 1986 to 1989 as the President, Chief Executive Officer, and, in
1988, as the Chairman of the American Real Estate Group. From 1955 to 1983, Mr.
Butler was President of his own home building and development companies, which
developed 12,500 homes, apartments, etc., in Southern California and Arizona.
Mr. Butler is also a past director of the Federal National Mortgage Association
(Fannie Mae) and a former member of both the Advisory Committee of the Federal
Home Loan Mortgage Corporation (Freddie Mac) and the Federal Savings & Loan
Advisory Council to the Federal Home Loan Bank Board. Mr. Butler was also a
United States delegate to the United Nations for the European Economic
Commission on Housing. Mr. Butler has previously served on the Boards of
Directors of American Savings and Loan, The Commodore Corporation, Far Western
Bank, National Association of Home Builders and the Building Industry
Association of Southern California.
GEORGE GIBBS, JR. has been a director of the Company since the Initial
Public Offering. Mr. Gibbs recently retired as Principal and Senior Vice
President of Johnson & Higgins, a position he held since 1987. Mr. Gibbs has
been a director of Fidelity since August 1994. Mr. Gibbs is a past Vice
President and Executive Committee member of the Los Angeles Chamber of Commerce.
ALBERT L. LORD has been a director of the Company since the Initial Public
Offering. Since January 1994, Mr. Lord has been the President of LCL, Ltd., a
financial consulting and equity investment management company. From October 1981
to January 1994, Mr. Lord was Chief Operating Officer and Executive Vice
President for the Student Loan Marketing Association (Sallie Mae). Mr. Lord is
the Chief Executive Officer and a director of Sallie Mae.
EDWIN C. SUMMERS has been Vice President, General Counsel and Secretary of
the Company since 1996. From 1991 to 1995, Mr. Summers served as Senior Counsel,
Finance and Senior Vice President, General Counsel and Secretary of Transamerica
Finance Group.
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth security ownership information regarding the
Company's Class A Common Stock and Class B Common Stock as of the date of this
Prospectus (except as otherwise noted), and as adjusted to reflect the sale of
shares offered by the Selling Stockholder hereby, by (i) each person who is
known by the Company to own beneficially more than 5% of either the Class A or
the Class B Common Stock, (ii) the Selling Stockholder, (iii) each director and
executive officer and (iv) all directors and executive officers of the Company
as a group. Unless otherwise indicated, all shares reflected below are shares of
Class A Common Stock.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
SHARES BENEFICIALLY OWNED
PRIOR TO PUBLIC OFFERING AFTER PUBLIC OFFERING(1)
-------------------------- -------------------------
NAME(2) NUMBER PERCENT NUMBER PERCENT
- ----------------------------------------------------------- ------------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
CLASS A COMMON STOCK
First Union Corporation (3)................................ 471,772 12.6% 471,772 7.0%
One First Union Center
Charlotte, NC 28288
Brian and Sarah Chisick (4)................................ 48,745 1.3% 48,745 *
Mark K. Mason (5).......................................... 17,367 * 17,367 *
Jeffrey W. Smith (6)....................................... 13,750 * 13,750 *
Albert L. Lord (6)......................................... 9,375 * 9,375 *
George Gibbs, Jr........................................... 100 * 100 *
Merrill Butler (6)......................................... 875 * 875 *
Edwin C. Summers........................................... 500 * 500 *
All directors and executive officers as a group
(7 persons).............................................. 90,712 2.4% 90,712 1.3%
CLASS B COMMON STOCK
Brian and Sarah Chisick (7)................................ 10,642,500 99.3% 7,692,500 99.0%
Mark K. Mason.............................................. 78,215 * 78,215 1.0%
All directors and executive officers as a group
(7 persons).............................................. 10,720,715 100.0% 7,770,715 100.0%
</TABLE>
- ------------------------
* Less than one percent.
(1) Assumes no exercise of the Underwriters' over-allotment option and gives no
effect to any purchases that may be made in the public offering.
(2) Unless otherwise indicated and subject to community property laws where
applicable, each of the stockholders named in this table has sole voting and
investment power with respect to the shares shown as beneficially owned by
him or her. A person is deemed to be the beneficial owner of securities that
can be acquired by such person within 60 days from the date of this
Prospectus upon the exercise of options and warrants. Each beneficial
owner's percentage ownership is determined by assuming that options that are
held by such person (but not those held by any other person) and that are
exercisable within 60 days from the date of this Prospectus have been
exercised.
(3) Owned through its subsidiary, Keystone Investment Management Company; number
of shares is as of December 31, 1996.
(4) Includes shares held by The Chisick Trust No. 1 U/D/T 3-30-96 and The
Chisick Trust No. 2 U/D/T 3-30-96, of which Brian Chisick is the sole
trustee, and the Brian and Sarah Chisick Revocable Trust U/A 3-7-79, of
which Brian and Sarah Chisick are the co-trustees. Also includes a total of
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3,745 shares held by grantor trusts established for the benefit of three of
Mr. and Mrs. Chisick's grandchildren, of which trusts Mr. Chisick is the
sole trustee.
(5) Includes 4,875 shares of Class A Common Stock with respect to which Mr.
Mason holds options exercisable within 60 days from the date of this
Prospectus, 140 shares held by a grantor trust established for the benefit
of Mr. Mason's daughter, of which trust Mr. Mason is the sole trustee, and
452 shares held in Mr. Mason's account by the Corporation's 401(k) Plan.
(6) Represents shares of Class A Common Stock issuable upon the exercise of
options that are exercisable within 60 days from the date of this
Prospectus.
(7) Includes shares held by the Brian and Sarah Chisick Revocable Trust U/A
3-7-79, of which Brian and Sarah Chisick are the co-trustees.
The Corporation's 401(k) Plan owned a total of 22,205 shares of the
Corporation's Class A Common Stock on June 30, 1997, or 0.6% of the Class A
Common Stock then outstanding. Although the Corporation is the Administrator of
the 401(k) Plan, the 401(k) Plan was established and is administered to achieve
the purposes for which it was created for the exclusive benefit of its
participants, and employees participating in the 401(k) Plan are entitled to
vote all shares allocated to their accounts. Accordingly, the 401(k) Plan does
not constitute a "group" within the meaning of Section 13(d) of the Securities
Exchange Act of 1934, as amended.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company consists of (i) 1,000,000 shares
of preferred stock, $.01 par value ("Preferred Stock"), (ii) 25,000,000 shares
of Class A common stock, $.01 par value (the "Class A Common Stock") and
15,000,000 shares of Class B common stock, $.01 par value (the "Class B Common
Stock" or, together with the Class A Common Stock, the "Common Stock").
COMMON STOCK
As of June 30, 1997, there were 4,044,024 shares of Class A Common Stock
outstanding and 10,750,000 shares of Class B Common Stock outstanding. All of
the outstanding Class B Common Stock is beneficially owned by the Chisick Trusts
and Mark K. Mason. Upon completion of the Public Offering, there will be
6,705,343 shares of Class A Common Stock and 7,770,715 shares of Class B Common
Stock outstanding (assumes no exercise of the Underwriters' over-allotment
option). The issued and outstanding shares of Class A Common Stock and Class B
Common Stock have been, and the shares of Class A Common Stock offered hereby
will be, duly authorized, validly issued, fully paid and nonassessable.
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. The Class A Common Stock and the Class B Common Stock
vote together as a single class on all matters submitted to a vote of
stockholders (including the election of directors which will be by proxy),
except that, (i) in the case of a proposed amendment to the Company's
Certificate of Incorporation that would alter the powers, preferences or special
rights of either the Class A Common Stock or the Class B Common Stock, the class
of Common Stock to be altered shall vote on the amendment as a separate class
and (ii) in the case of a proposed issuance of Class B Common Stock, such
issuance will require the affirmative vote of the holders of a majority of the
outstanding shares of Class B Common Stock. Shares of Common Stock do not have
cumulative voting rights with respect to the election of directors.
As a result of the Public Offering, the percentage of the voting power of
the outstanding Common Stock controlled by the Chisick Trusts will decline from
91% to 82% (assuming the Underwriters' over-allotment option is not exercised).
This will continue to allow the Chisick Trusts to control all actions to be
taken by the stockholders, including the election of all directors to the Board
of Directors. While the Chisick Trusts will have the voting power to control the
votes on any matter requiring stockholder approval, the Company intends to
submit all such matters to a vote of all stockholders. However, because the
Company's Certificate of Incorporation provides that any action that can be
taken at a meeting of the stockholders may be taken by written consent in lieu
of the meeting if the Board of Directors of the Company has approved the action
and the Company receives consents signed by stockholders having the minimum
number of votes that would be necessary to approve the action at a meeting at
which all shares entitled to vote on the matter were present, the Chisick
Trusts, assuming approval by the Board of Directors, may take all actions
required to be taken by the stockholders without providing the other
stockholders the opportunity to make nominations or raise other matters at a
meeting. See "Principal and Selling Stockholders" and "Risk
Factors--Anti-Takeover Effect of Capital Structure; Voting Control of Company."
Each share of Class A Common Stock and Class B Common Stock will be equal in
respect of dividends and other distributions in cash, stock or property
(including distributions upon liquidation of the Company and consideration to be
received upon a merger or consolidation of the Company or a sale of all or
substantially all of the Company's assets), except that in the case of dividends
or other distributions pursuant to stock splits or dividends, only shares of
Class A Common Stock will be distributed with respect to the Class A Common
Stock and only shares of Class B Common Stock will be distributed with respect
to Class B Common Stock, except if the Board of Directors determines that shares
of Class A Common Stock shall be distributed with respect to the Class B Common
Stock. In no event will either Class A Common Stock or Class B Common Stock be
split, divided or combined unless the other class is proportionately split,
divided or combined.
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Holders of Common Stock do not have any preemptive rights or rights to
subscribe for additional securities of the Company. Shares of Common Stock are
not redeemable and there are no sinking fund provisions.
While the shares of Class A Common Stock are not convertible into any other
series or class of the Company's securities, each share of Class B Common Stock
is freely convertible into one share of Class A Common Stock at the option of
the Class B stockholder. All shares of Class B Common Stock shall automatically
convert to an equal number of shares of Class A Common Stock on the earliest
record date for an annual meeting of the Company's stockholders on which the
number of shares of Class B Common Stock outstanding is less than 10% of the
total number of shares of Common Stock outstanding. Shares of Class B Common
Stock may not be transferred to third parties (except for transfers to certain
family members and in other limited circumstances). Any impermissible transfer
of shares of Class B Common Stock will result in the automatic conversion of
such shares. Subject to the preferences applicable to Preferred Stock
outstanding at the time, holders of shares of Common Stock are entitled to
dividends if, when and as declared by the Board of Directors from funds legally
available therefor, and are entitled, in the event of liquidation, to share
ratably in all assets remaining after payment of liabilities and Preferred Stock
preferences, if any.
The Class A Common Stock is listed for trading on Nasdaq under the symbol
"FACO."
PREFERRED STOCK
Pursuant to the Company's Certificate of Incorporation, the Board of
Directors has the authority to issue up to 1,000,000 shares of Preferred Stock
in one or more series with such designations, rights, preferences and voting
rights as may be determined from time to time by the Board of Directors.
Accordingly, the Board of Directors is empowered, without stockholder approval,
to issue Preferred Stock with dividend, liquidation, conversion, voting or other
rights that adversely affect the voting power or other rights of the holders of
the Company's Common Stock. In the event of issuance, the Preferred Stock could
be utilized, under certain circumstances, as a way of discouraging, delaying or
preventing an acquisition or change in control of the Company. There is
currently no Preferred Stock outstanding and the Company does not currently
intend to issue any shares of its Preferred Stock.
STOCK INCENTIVE PLAN
On July 24, 1996, the Company's stockholders approved a stock incentive
plan, which enables directors, officers and other key employees of the Company
to participate in the ownership of the Company. The stock incentive plan
provides for the award to eligible employees of the Company of a broad variety
of stock-based compensation alternatives such as non-qualified stock options,
incentive stock options, restricted stock and performance awards. Under the
stock incentive plan, 642,500 shares of Class A 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. Since July 25, 1996, the Company
has granted options to acquire an aggregate of 25,369 shares of Class A Common
Stock at an exercise price equal to the market price at the date of grant. 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 September 9, 1997,
34,793 options granted had been exercised and 17,352 options granted had been
forfeited. As of August 18, 1997, 502,289 shares remained subject to outstanding
options and 105,418 shares remained available for new option grants.
CERTAIN PROVISIONS OF DELAWARE LAW
The Company is a Delaware corporation and is subject to Section 203 of the
Delaware General Corporation Law. In general, Section 203 prevents an
"interested stockholder" (defined generally as a
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person owning 15% or more of the Company's outstanding voting stock) from
engaging in a "business combination" (as defined in Section 203) with the
Company for three years following the date that person became an interested
stockholder unless: (i) before that person became an interested stockholder, the
Board approved the transaction in which the interested stockholder became an
interested stockholder or approved the business combination; (ii) upon
completion of the transaction that resulted in the interested stockholders
becoming an interested stockholder, the interested stockholder owned at least
85% of the voting stock of the Company outstanding at the time the transaction
commenced (excluding stock held by directors who are also officers of the
Company and by employee stock plans that do not provide employees with the right
to determine confidentially whether shares held subject to the plan will be
tendered in a tender or exchange offer); or (iii) on or following the date on
which that person became an interested stockholder, the business combination is
approved by the Company's Board and authorized at a meeting of stockholders by
the affirmative vote of the holders of at least 66 2/3% of the outstanding
voting stock of the Company not owned by the interested stockholder.
Under Section 203, these restrictions also do not apply to certain business
combinations proposed by an interested stockholder following the announcement or
notification of one of certain extraordinary transactions involving the Company
and a person who was not an interested stockholder during the previous three
years or who became an interested stockholder with the approval of a majority of
the Company's directors, if that extraordinary transaction is approved or not
opposed by a majority of the directors (but not less than one) who were
directors before any person became an interested stockholder in the previous
three years or who were recommended for election or elected to succeed such
directors by a majority of such directors then in office.
Pursuant to Section 162 of the Delaware General Corporation Law, the Board
of Directors of the Company can, without stockholder approval, issue shares of
capital stock, which may have the effect of delaying, deferring or preventing a
change of control of the Company. The Company has no plan or arrangement for the
issuance of any shares of capital stock other than in the ordinary course
pursuant to the Stock Incentive Plan.
CERTAIN CHARTER AND BYLAW PROVISIONS
The Company's Certificate of Incorporation provides that the stockholders
may act only in a meeting that has been duly called and noticed, except that
stockholders may approve by written consent any proposal that has already been
approved by the Board of Directors.
The Company's Bylaws require stockholders to provide advance notice of any
stockholder nominations for director and of any business to be brought before
any meeting of stockholders. Stockholders are not entitled to cumulative voting
in connection with the election of directors. As a result, a person or a group
controlling the majority of shares of Common Stock can elect all of the
directors. Following the Public Offering, the Chisick Trusts will beneficially
own shares of Common Stock constituting 82% of the voting power of the issued
and outstanding Common Stock. See "Principal and Selling Stockholders" and "Risk
Factors--Anti-Takeover Effect of Capital Structure; Voting Control of Company."
The Certificate of Incorporation of the Company contains certain provisions
permitted under the Delaware General Corporation Law relating to the liability
of directors. These provisions eliminate the directors' liability for monetary
damages for a breach of fiduciary duty, except in certain circumstances
involving wrongful acts, including the breach of a director's duty of loyalty or
acts or omissions which involve intentional misconduct or a knowing violation of
a law. The Company's Certificate of Incorporation also contains provisions to
indemnify its directors and officers to the fullest extent permitted by the
Delaware General Corporation Law.
TRANSFER AGENT
The transfer agent and registrar for the Class A Common Stock is American
Stock Transfer and Trust Company.
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SHARES ELIGIBLE FOR FUTURE SALE
The Company's Certificate of Incorporation authorizes the issuance of
25,000,000 shares of Class A Common Stock and 15,000,000 shares of Class B
Common Stock. Upon completion of the Public Offering, there will be outstanding
6,705,343 shares of Class A Common Stock and 7,770,715 shares of Class B Common
Stock (assuming no exercise of the Underwriters' over-allotment option).
The 2,950,000 shares of Class A Common Stock to be sold in the Public
Offering (3,392,500 shares if the Underwriters' over-allotment option is
exercised in full) will be available for resale to the public without
restriction or further registration under the Securities Act, except for shares
purchased by affiliates of the Company (in general, any person who has a control
relationship with the Company), which shares will be subject to the resale
limitations of Rule 144 promulgated under the Securities Act ("Rule 144"). All
outstanding shares of Class B Common Stock are deemed to be "restricted
securities," as that term is defined in Rule 144, and are eligible for sale to
the public in compliance with Rule 144. The Chisick Trusts have agreed, subject
to certain exceptions, that they will not offer, sell or otherwise dispose of
any of the shares of Class B Common Stock owned by them for a period of 120 days
after the date of this Prospectus without the prior written consent of the
Representative of the Underwriters. The Company has agreed, subject to certain
limited exceptions, not to offer, sell or otherwise dispose of any shares of
Class A Common Stock for a period of 120 days after the date of this Prospectus
without the prior written consent of the Representatives of the Underwriters.
In general, under Rule 144 as currently in effect, any person (or persons
whose shares are aggregated) who has beneficially owned shares for at least one
year is entitled to sell, within any three-month period, a number of shares
which does not exceed the greater of 1% of the then-outstanding shares of the
Company's Class A Common Stock (67,053 shares immediately after the Public
Offering, assuming no exercise of the Underwriters' over-allotment option) or
the average weekly trading volume of the Company's Class A Common Stock during
the four calendar weeks preceding the date on which notice of the sale is filed
with the Commission. Sales under Rule 144 may also be subject to certain manner
of sale provisions, notice requirements and the availability of current public
information about the Company. Any person (or persons whose shares are
aggregated) who is not deemed to have been an affiliate of the Company at any
time during the three months preceding a sale, and who has beneficially owned
shares within the definition of "restricted securities" under Rule 144 for at
least two years, is entitled to sell such shares under Rule 144(k) without
regard to the volume limitation, manner of sale provisions, public information
requirements or notice requirements.
65
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below (the "Underwriters"), through their Representatives,
have severally agreed to purchase from the Selling Stockholder the following
respective number of shares of Class A Common Stock at the Public Offering price
less the underwriting discounts and commissions set forth on the cover page of
this Prospectus:
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
- ------------------------------------------------------------------------------------------- ----------
<S> <C>
Friedman, Billings, Ramsey & Co., Inc...................................................... 834,000
Bear, Stearns & Co. Inc.................................................................... 833,000
Montgomery Securities...................................................................... 833,000
Lehman Brothers Inc........................................................................ 100,000
PaineWebber Incorporated................................................................... 100,000
Advest, Inc................................................................................ 50,000
Everen Securities, Inc..................................................................... 50,000
McDonald & Company Securities, Inc......................................................... 50,000
Piper Jaffray Inc.......................................................................... 50,000
Sutro & Co. Incorporated................................................................... 50,000
----------
Total Underwriters................................................................. 2,950,000
----------
----------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all of the shares of the Class A Common Stock offered hereby if any of
such shares are purchased.
The Selling Stockholder has been advised by the Underwriters that the
Underwriters propose to offer the shares of Class A Common Stock to the public
at the Public Offering price set forth on the cover page of this Prospectus and
to certain dealers at such price less a concession not in excess of $0.84 per
share. The Underwriters may allow, and such dealers may reallow, a concession
not in excess of $0.10 per share to certain other dealers. After the Public
Offering, the Public Offering price and other selling terms may be changed by
the Representatives of the Underwriters.
The Selling Stockholder has granted to the Underwriters an option,
exercisable not later than 30 days after the date of this Prospectus, to
purchase up to 442,500 additional shares of Class A Common Stock at the Public
Offering price less the underwriting discounts and commissions set forth on the
cover page of this Prospectus. To the extent that the Underwriters exercise such
option, each of the Underwriters will have a firm commitment to purchase
approximately the same percentage thereof that the number of shares of Class A
Common Stock to be purchased by it shown in the above table bears to 2,950,000
and the Selling Stockholder will be obligated, pursuant to the option, to sell
such shares to the Underwriters. The Underwriters may exercise such option only
to cover over-allotments made in connection with the sale of Class A Common
Stock offered hereby. If purchased, the Underwriters will offer such additional
shares on the same terms as those on which the 2,950,000 shares are being
offered.
As described in the Underwriting Agreement, the Company and the Selling
Stockholder have agreed to indemnify the Underwriters against certain
liabilities including liabilities under the Securities Act of 1933, as amended
(the "Securities Act"). The Company has been advised that in the opinion of the
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities is asserted by the Underwriters in
connection with the shares of Class A Common Stock offered hereby, the Company
will, unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of competent jurisdiction the question
whether such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The Chisick Trusts have agreed, subject to certain exceptions, that they
will not offer, sell or otherwise dispose of any of the shares of Class B Common
Stock owned by them for a period of 120 days after the
66
<PAGE>
date of this Prospectus without the prior written consent of the Representatives
of the Underwriters. See "Shares Eligible for Future Sale."
The Representatives of the Underwriters have advised the Company that the
Underwriters do not intend to confirm sales to any account over which they
exercise discretionary authority.
In connection with the Public Offering, the Underwriters and their
respective affiliates may engage in transactions that stabilize, maintain or
otherwise affect the market price of the Class A Common Stock. Such transactions
may include stabilization transactions effected in accordance with Rule 104 of
Regulation M, pursuant to which such persons may bid for or purchase Class A
Common Stock for the purpose of stabilizing its market price. Any Underwriter
also may create a short position for the account of such Underwriter by selling
more Class A Common Stock in connection with the Public Offering than it is
committed to purchase from the Company, and in such case may purchase Class A
Common Stock in the open market following completion of the Public Offering to
cover all or a portion of such short position. An Underwriter may also cover all
or any portion of such short position, up to 442,500 shares of Class A Common
Stock, by exercising the Underwriters' over-allotment option referred to above.
In connection with the Public Offering, the Underwriters, their respective
affiliates who are qualified registered market makers on Nasdaq and the Selling
Stockholder may engage in passive market making transactions in the Class A
Common Stock on Nasdaq in accordance with Rule 103 of Regulation M, during a
specified period before commencement of offers or sales of the Class A Common
Stock. The passive market making transactions must comply with applicable volume
and price limits and be identified as such. In general, a passive market maker
may display its bid at a price not in excess of the highest independent bid for
such security; if all independent bids are lowered below the passive market
maker's bid, however, such bid must then be lowered when certain purchase limits
are exceeded.
Any of the transactions described in the preceding paragraph may result in
the maintenance of the price of the Class A Common Stock at a level above that
which might otherwise prevail in the open market. None of the transactions
described in the preceding paragraph is required, and if any such transactions
are undertaken, they may be discontinued at any time.
LEGAL MATTERS
Certain legal matters will be passed upon for the Company and the Selling
Stockholder by Gibson, Dunn & Crutcher LLP, Los Angeles, California. Certain
legal matters will be passed upon for the Underwriters by Manatt, Phelps &
Phillips, LLP, Los Angeles, California.
EXPERTS
The consolidated financial statements of First Alliance Corporation as of
December 31, 1996 and 1995 and for each of the three years in the period ended
December 31, 1996 included in this Prospectus, have been audited by Deloitte &
Touche LLP, independent auditors, as stated in their report appearing herein,
and are included in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.
The consolidated financial statements of Standard Pacific Savings, F.A. as
of December 31, 1996 and 1995 and for each of the three years in the period
ended December 31, 1996 included in this Prospectus, have been audited by Arthur
Andersen LLP, independent auditors, as stated in their report appearing herein,
and are included in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, and the rules and regulations promulgated
thereunder (the "Exchange Act"), and in accordance therewith files reports,
proxy and information statements and other information with the Securities and
Exchange Commission (the "Commission"). Such reports, proxy and information
statements and other information filed by the Company with the Commission can be
inspected and copied at the public
67
<PAGE>
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Room 1024, Washington, D.C. 20549; and at the Commission's Northeast Regional
Office, 7 World Trade Center, Suite 1300, New York, New York 10048, and Midwest
Regional Office, Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511. Copies of such material can also be obtained at prescribed
rates from the Public Reference Section of the Commission at 450 Fifth Street,
N.W., Washington D.C. 20549. The Commission maintains a Web site that contains
reports, proxy and information statements and other information regarding
registrants such as the Company that file electronically with the Commission.
The address of such site is http://www.sec.gov.
The Company has filed a Registration Statement on Form S-3 (the
"Registration Statement") with the Commission pursuant to the Securities Act of
1933, as amended, with respect to the Class A Common Stock offered hereby. This
Prospectus does not contain all the information set forth in the Registration
Statement and the exhibits and schedules filed as a part thereof, as permitted
by the rules and regulations of the Commission. For further information with
respect to the Company and the Class A Common Stock, reference is hereby made to
the Registration Statement, including the exhibits and schedules filed as a part
thereof. Statements contained in this Prospectus as to the contents of any
contract or other document referred to herein are not necessarily complete, and
where such contract or other document is an exhibit to the Registration
Statement, each such statement is qualified in all respects by the provisions of
such exhibit, to which reference is hereby made for a full statement of the
provisions thereof. The Registration Statement, including the exhibits and
schedules filed as a part thereof, may be inspected without charge at the public
reference facilities maintained by the Commission as set forth in the preceding
paragraph. Copies of these documents may be obtained at prescribed rates from
the Public Reference Section of the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents have been filed by the Company (File No. 0-28706)
with the Commission pursuant to the Exchange Act, and are incorporated herein by
reference:
1. The Company's Annual Report on Form 10-K for the year ended December 31,
1996;
2. The Company's Quarterly Report on Form 10-Q for the quarter ended March
31, 1997;
3. The Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 1997; and
4. The Company's Proxy Statement on Schedule 14A as filed with the
Commission on April 3, 1997; and
5. The description of the Class A Common Stock set forth in the Company's
registration statement filed with the Commission pursuant to Section 12 of the
Exchange Act, and any amendment or report filed for the purpose of updating any
such description.
In addition, all documents filed by the Company pursuant to Sections 13(a),
13(c), 14 or 15(d) of the Exchange Act after the date hereof and prior to the
termination of the Public Offering hereunder shall be deemed to be incorporated
by reference in this Prospectus and to be a part hereof from the date of filing
of such documents. Any statement contained in a document incorporated by
reference herein shall be deemed to be modified or superseded for all purposes
to the extent that a statement contained herein or in any other subsequently
filed document which is deemed to be incorporated by reference herein modifies
or supersedes such statement. Any statement so modified or superseded shall not
be deemed, except as modified or superseded, to constitute a part of this
Prospectus.
The Company will provide, without charge, to each person to whom a copy of
this Prospectus is delivered, upon the written or oral request of such person, a
copy of any and all of the documents incorporated by reference (not including
the exhibits to such documents, unless such exhibits are specifically
incorporated by reference in such documents). Requests for such copies should be
directed to Edwin C. Summers, Secretary, First Alliance Corporation, 17305 Von
Karman Avenue, Irvine, California 92614-6203, or by telephone at (714) 224-8500.
68
<PAGE>
<TABLE>
<S> <C>
Unaudited Pro Forma Condensed Consolidated Financial Information..................... F-2
</TABLE>
FIRST ALLIANCE CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report......................................................... F-5
Consolidated Statements of Financial Condition
As of June 30, 1997 (unaudited) and December 31, 1996 and 1995..................... F-6
Consolidated Statements of Income
For the six months ended June 30, 1997 and 1996 (unaudited) and for each of the
three years in the period ended December 31, 1996.................................. F-7
Consolidated Statements of Stockholders' Equity
For the six months ended June 30, 1997 (unaudited) and for each of the three years
in the period ended December 31, 1996.............................................. F-8
Consolidated Statements of Cash Flows
For the six months ended June 30, 1997 and 1996 (unaudited) and for each of the
three years in the period ended December 31, 1996.................................. F-9
Notes to Consolidated Financial Statements
For the six months ended June 30, 1997 and 1996 (unaudited) and for each of the
three years in the period ended December 31, 1996.................................. F-11
</TABLE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants............................................. F-25
Consolidated Statements of Financial Condition
As of June 30, 1997 (unaudited) and December 31, 1996 and 1995..................... F-26
Consolidated Statements of Operations
For the six months ended June 30, 1997 and 1996 (unaudited) and for each of the
three years in the period ended December 31, 1996.................................. F-27
Consolidated Statements of Changes in Stockholder's Equity
For the six months ended June 30, 1997 (unaudited) and for each of the three years
in the period ended December 31, 1996.............................................. F-28
Consolidated Statements of Cash Flows
For the six months ended June 30, 1997 and 1996 (unaudited) and for each of the
three years in the period ended December 31, 1996.................................. F-29
Notes to Consolidated Financial Statements
For the six months ended June 30, 1997 and 1996 (unaudited) and for each of the
three years in the period ended December 31, 1996.................................. F-31
</TABLE>
F-1
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
In June 1997, the Company entered into a definitive agreement to acquire
Standard Pacific Savings, F.A. (the "Bank"), a federally chartered savings
association based in Newport Beach, California (the "Definitive Agreement"). The
following unaudited pro forma financial information presents information as if
the acquisition had occurred at the beginning of the year ended December 31,
1996 as to the statements of income and as of June 30, 1997 as to the statement
of financial condition. The unaudited pro forma statements of income do not
include anticipated economic benefits from the consolidation of administrative
operations or other anticipated opportunities provided by the acquisition. The
unaudited pro forma financial information is intended for informational purposes
only and is not necessarily indicative of the future financial condition or
results of operations of the Company, or the financial condition or the results
of operations that would have actually occurred had the acquisition been
consummated as of the dates indicated. The unaudited pro forma financial
information should be read together with the financial statements of the Company
and Standard Pacific Savings, F.A., and related notes included elsewhere in the
Prospectus.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
JUNE 30, 1997
<TABLE>
<CAPTION>
FIRST STANDARD
ALLIANCE PACIFIC
CORPORATION SAVINGS ADJUSTMENTS PRO FORMA
----------- ---------- ----------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents.................................. $ 17,093 $ 101,384 $ (9,032)(5) $ 109,445
Receivable from trusts..................................... 3,593 - - 3,593
Loans held for sale........................................ 18,075 12,183 (12,183)(1) 18,075
Warehouse financing receivable............................. 7,233 - - 7,233
Loans receivable held for investment....................... 2,205 - - 2,205
Residual interests in securities........................... 37,377 - - 37,377
Mortgage servicing rights.................................. 7,207 - - 7,207
Investment securities -- available for sale................ - 38,314 (2,283)(3) 36,031
Investment in FHLB stock................................... - 8,205 (7,305)(2) 900
Other assets............................................... 7,191 5,969 (4,793) (5) 8,367
----------- ---------- ----------- ----------
Total assets........................................... $ 99,974 $ 166,055 $ (35,596) $ 230,433
----------- ---------- ----------- ----------
----------- ---------- ----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits................................................... $ - $ 111,328 $ - $ 111,328
FHLB advances and other borrowings......................... - 27,938 (9,938)(4) 18,000
Other liabilities.......................................... 11,523 5,490 (4,359) (5) 12,654
----------- ---------- ----------- ----------
Total liabilities...................................... 11,523 144,756 (14,297) 141,982
----------- ---------- ----------- ----------
Total stockholders' equity................................. 88,451 21,299 (21,299) (6) 88,451
----------- ---------- ----------- ----------
Total liabilities and stockholders' equity................. $ 99,974 $ 166,055 $ (35,596) $ 230,433
----------- ---------- ----------- ----------
----------- ---------- ----------- ----------
</TABLE>
F-2
<PAGE>
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
FIRST STANDARD
ALLIANCE PACIFIC
CORPORATION SAVINGS ADJUSTMENTS PRO FORMA
----------- ----------- --------------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest income................................................. $ 9,034 $ 8,633 $ - $ 17,667
Interest expense................................................ 712 7,286 52(7) 8,050
----------- ----------- --- -----------
Net interest income............................................. 8,322 1,347 (52) 9,617
Provision for estimated loan losses............................. - (3) - (3)
----------- ----------- --- -----------
Net interest income after provision for estimated loan losses... 8,322 1,344 (52) 9,614
Non-interest income............................................. 35,647 2,686 - 38,333
Operating expense............................................... 17,941 3,845 (11)(8) 21,775
----------- ----------- --- -----------
Income before income tax provision.............................. 26,028 185 (41) 26,172
Income tax provision............................................ 10,478 77 (17)(9) 10,538
----------- ----------- --- -----------
Net income...................................................... $ 15,550 $ 108 $ (24) $ 15,634
----------- ----------- --- -----------
----------- ----------- --- -----------
</TABLE>
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
FIRST STANDARD
ALLIANCE PACIFIC
CORPORATION SAVINGS ADJUSTMENTS PRO FORMA
----------- --------- --------------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest income................................................. $ 13,562 $ 20,072 $ - $ 33,634
Interest expense................................................ 2,655 17,450 104(7) 20,209
----------- --------- --- -----------
Net interest income............................................. 10,907 2,622 (104) 13,425
Provision for estimated loan losses............................. - (465) - (465)
----------- --------- --- -----------
Net interest income after provision for estimated loan losses... 10,907 2,157 (104) 12,960
Non-interest income (expense)................................... 57,309 836 - 58,145
Operating expense............................................... 29,977 4,029 (23)(8) 33,983
----------- --------- --- -----------
Income (loss) before income tax provision (benefit)............. 38,239 (1,036) (81) 37,122
Income tax provision (benefit).................................. 6,100 (429) (34)(9) 5,637
----------- --------- --- -----------
Net income (loss)............................................... $ 32,139 $ (607) $ (47) $ 31,485
----------- --------- --- -----------
----------- --------- --- -----------
</TABLE>
F-3
<PAGE>
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED STATEMENTS
(1) Reflects the sale or transfer of the Bank's loan portfolio, including any
real estate owned and related other assets and liabilities, as provided for
in the Definitive Agreement, prior to the closing date of the acquisition.
(2) Reflects the reduction of the Bank's investment in FHLB Stock to
approximately $0.9 million, as provided for in the Definitive Agreement,
prior to the closing date of the acquisition.
(3) In order to fund the reduction of FHLB Advances and other borrowings under
the agreement, it has been assumed that the Bank sold $2.3 million of
investment securities.
(4) Reflects the reduction of the Bank's FHLB Advances and other borrowings to
$18.0 million, as provided for in the Definitive Agreement, prior to the
closing date of the acquisition.
(5) Reflects the acquisition of the Bank by the Company after the completion of
the transactions discussed above for $9.0 million which is equal to the
Bank's stockholder's equity plus $0.6 million. Other assets have been
increased by $0.7 million to reflect the value of the acquired core deposit
intangible and other liabilities have been increased by $0.1 million to
reflect the excess of current lease commitments over the fair value of the
current lease agreement for the Bank's branch office ("Lease Adjustment").
(6) Reflects the elimination of the Bank's stockholder's equity upon
acquisition.
(7) Reflects the amortization of the acquired core deposit intangible, based on
an expected life of seven years, as if the acquisition had occurred as of
the beginning of the period presented in the statements of income.
(8) Reflects the amortization of the Lease Adjustment, based on the remaining
term of the lease of 80 months, as if the acquisition had occurred as of the
beginning of the period presented in the statements of income.
(9) Reflects the impact on the income tax provision of the reduction in earnings
related to the pro forma adjustments to income before tax provision.
F-4
<PAGE>
INDEPENDENT AUDITORS' 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-5
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- --------- JUNE 30,
1997
-----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents...................................................... $ 4,019 $ 27,414 $ 17,093
Receivable from trusts......................................................... 4,664 2,671 3,593
Loans held for sale............................................................ 24,744 11,023 18,075
Warehouse financing receivable................................................. - - 7,233
Loans receivable held for investment........................................... 2,261 2,432 2,205
Residual interests in securities--at fair value................................ 19,705 29,253 37,377
Mortgage servicing rights...................................................... 4,021 6,025 7,207
Real estate owned, net......................................................... 1,474 312 242
Property, net.................................................................. 2,141 3,098 4,775
Deferred taxes................................................................. 73 3,101 911
Prepaid expenses and other assets.............................................. 3,809 2,128 1,263
--------- --------- -----------
Total assets................................................................. $ 66,911 $ 87,457 $ 99,974
--------- --------- -----------
--------- --------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facilities................................................. $ 18,233 $ - $ -
Accounts payable and accrued liabilities....................................... 5,234 3,952 5,320
Income taxes payable........................................................... - 5,396 6,094
Notes payable.................................................................. 1,123 131 109
--------- --------- -----------
Total liabilities............................................................ 24,590 9,479 11,523
--------- --------- -----------
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: 4,044,024 at June 30, 1997, 4,025,000 at December 31,
1996, no shares at December 31, 1995......................................... - 40 40
Class B Common Stock, $.01 par value; 15,000,000 shares authorized; shares
issued and outstanding: 10,750,000 at June 30, 1997 and December 31, 1996,
10,642,500 at December 31, 1995.............................................. 42 108 108
Additional paid in capital..................................................... - 64,643 65,041
Retained earnings.............................................................. 42,279 14,338 29,888
Treasury stock--at cost: 259,500 shares at June 30, 1997....................... - - (5,612)
Deferred stock compensation.................................................... - (1,113) (1,011)
Foreign currency translation................................................... - (38) (3)
--------- --------- -----------
Total stockholders' equity................................................... 42,321 77,978 88,451
--------- --------- -----------
Total liabilities and stockholders' equity................................... $ 66,911 $ 87,457 $ 99,974
--------- --------- -----------
--------- --------- -----------
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------------------- ----------------------------
1994 1995 1996 1996 1997
------------- ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUE:
Loan origination and sale.......... $ 27,902 $ 35,466 $ 48,171 $ 21,251 $ 31,786
Loan servicing and other fees...... 9,106 8,614 8,854 4,487 3,855
Interest and other................. 8,794 14,800 13,846 6,096 9,040
------------- ------------- ------------- ------------- -------------
Total revenue.................... 45,802 58,880 70,871 31,834 44,681
------------- ------------- ------------- ------------- -------------
EXPENSE:
Compensation and benefits.......... 9,559 10,416 15,488 6,727 8,906
Professional services and
other fees....................... 2,540 1,999 1,946 927 1,448
Advertising........................ 3,316 4,345 4,191 1,758 2,657
Rent............................... 974 1,278 1,530 742 833
Supplies........................... 831 1,214 1,575 641 1,095
Depreciation and amortization...... 514 907 838 317 376
Interest........................... 3,744 4,167 2,655 1,787 712
Legal.............................. 7,162 1,491 917 452 779
Travel and training................ 351 788 1,103 409 710
Other.............................. 1,577 1,255 2,389 908 1,137
------------- ------------- ------------- ------------- -------------
Total expense.................... 30,568 27,860 32,632 14,668 18,653
------------- ------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAX PROVISION... 15,234 31,020 38,239 17,166 26,028
INCOME TAX PROVISION................. 363 478 6,100 257 10,478
------------- ------------- ------------- ------------- -------------
NET INCOME........................... $ 14,871 $ 30,542 $ 32,139 $ 16,909 $ 15,550
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
NET INCOME PER SHARE................. $ 1.40 $ 2.87 $ 2.59 $ 1.59 $ 1.05
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
Weighted average number of common
shares outstanding................. 10,650,407 10,650,407 12,420,295 10,650,407 14,790,339
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
CLASS A CLASS B TREASURY
COMMON STOCK COMMON STOCK ADDITIONAL STOCK
---------------------- ----------------------- PAID IN RETAINED ---------
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SHARES
--------- ----------- ---------- ----------- ----------- ----------- ---------
<S> <C> <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 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 -
Net income (unaudited).............. - - - - - 15,550 -
Amortization of deferred stock
compensation (unaudited).......... - - - - - - -
Foreign currency translation
adjustment (unaudited)............ - - - - - - -
Proceeds and tax benefit from
exercise of stock options
(unaudited)....................... 19,024 - - - 398 - -
Stock repurchased (unaudited)....... - - - - - - 259,500
--------- --- ---------- ----- ----------- ----------- ---------
Balance June 30, 1997 (unaudited)... 4,044,024 $ 40 10,750,000 $ 108 $ 65,041 $ 29,888 259,500
--------- --- ---------- ----- ----------- ----------- ---------
--------- --- ---------- ----- ----------- ----------- ---------
<CAPTION>
FOREIGN
DEFERRED CURRENCY TOTAL
STOCK TRANSLATION STOCKHOLDERS'
AMOUNT COMPENSATION ADJUSTMENT EQUITY
----------- ------------- --------------- ------------
<S> <C> <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
Net income (unaudited).............. - - - 15,550
Amortization of deferred stock
compensation (unaudited).......... - 102 - 102
Foreign currency translation
adjustment (unaudited)............ - - 35 35
Proceeds and tax benefit from
exercise of stock options
(unaudited)....................... - - - 398
Stock repurchased (unaudited)....... (5,612) - - (5,612)
----------- ------------- ----- ------------
Balance June 30, 1997 (unaudited)... $ (5,612) $ (1,011) $ (3) $ 88,451
----------- ------------- ----- ------------
----------- ------------- ----- ------------
</TABLE>
See notes to consolidated financial statements.
F-8
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 14,871 $ 30,542 $ 32,139 $ 16,909 $ 15,550
Adjustments to reconcile net income to net cash provided
by operating activities:
Capitalized residual interests and mortgage servicing
rights................................................ (3,638) (9,908) (12,515) (4,530) (10,388)
Loan origination and sale revenue-other................. (23,145) (24,464) (35,356) (16,422) (22,049)
Deferred income taxes................................... (63) 73 (3,028) - 2,190
Net accretion of residual interests in securities....... (1,128) (2,048) (850) 183 (216)
Deferred stock compensation............................. - - 487 - 102
Accretion of discounts on loan receivable............... - (1,022) (268) (136) (98)
Amortization of mortgage servicing rights............... 683 638 1,813 789 1,298
Depreciation and amortization........................... 514 907 838 317 376
Foreign currency transaction (gains) losses............. - - (188) - 81
Loss (gain) on sales of real estate owned and
property.............................................. (78) 46 414 136 39
Loans originated or purchased for sale, net of loan
fees.................................................. (289,338) (213,903) (290,773) (140,638) (201,497)
Sales of regular interests in securities................ 347,500 167,899 267,370 127,391 148,000
Proceeds from sales of loans............................ 20,503 64,400 70,605 41,410 67,919
Changes in assets and liabilities:
Receivable from trusts................................ 163 (758) 1,993 (2,319) (922)
Prepaid expenses and other assets..................... 802 (2,253) 1,681 905 865
Accounts payable and accrued liabilities.............. 4,775 (4,169) (1,282) (117) 1,364
Income taxes payable.................................. - - 5,396 - 772
--------- --------- --------- --------- ---------
Net cash provided by operating activities........... 72,421 5,980 38,476 23,878 3,386
--------- --------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (851) (978) (2,286) (896) (2,051)
Loans receivable issued................................... (1,949) (1,579) - - -
Collections on loans receivable........................... 1,341 2,880 1,784 757 781
Additions to real estate owned............................ - (355) - - (166)
Net repayments (advances) on warehouse financing
receivable.............................................. - - - - (7,233)
Proceeds from sales of real estate owned and property..... 3,566 552 1,748 794 361
--------- --------- --------- --------- ---------
Net cash (used in) provided by investing
activities........................................ 2,107 520 1,246 655 (8,308)
--------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings on warehouse financing
facilities.............................................. (53,445) 4,843 (18,233) (7,740) -
Payments on notes payable................................. (2,831) (417) (1,163) (522) (104)
Cash dividends............................................ (17,341) (12,205) (15,085) (11,432) -
Proceeds from issuance of notes payable to stockholders... 3,000 4,500 1,000 1,000 -
Payments on notes payable to stockholders................. (3,000) (4,500) (1,000) (1,000) -
Purchase of treasury stock................................ - - - - (5,612)
Proceeds from issuance of stock (net of issuance costs)... - - 63,149 - -
Payments on S distribution notes.......................... - - (44,995) - -
Proceeds from exercise of stock options................... - - - - 324
--------- --------- --------- --------- ---------
Net cash used in financing activities............... (73,617) (7,779) (16,327) (19,694) (5,392)
--------- --------- --------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH................... - - - - (7)
--------- --------- --------- --------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS...... 911 (1,279) 23,395 4,839 (10,321)
CASH AND CASH EQUIVALENTS, beginning of period............ 4,387 5,298 4,019 4,019 27,414
--------- --------- --------- --------- ---------
CASH AND CASH EQUIVALENTS, end of period.................. $ 5,298 $ 4,019 $ 27,414 $ 8,858 $ 17,093
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
F-9
<PAGE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
SUPPLEMENTAL INFORMATION:
Interest paid................................................. $ 3,605 $ 4,114 $ 2,735 $ 1,842 $ 717
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income taxes paid............................................. $ 100 $ 486 $ 3,686 $ 326 $ 7,534
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
SUPPLEMENTAL INFORMATION ON NONCASH INVESTING AND FINANCING
ACTIVITIES:
Exchange of loans for regular and residual interests in
securities.................................................. $ 350,331 $ 167,974 $ 267,661 $ 127,675 $ 148,003
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Distribution of S distribution notes.......................... $ 44,995 $ 44,020
--------- ---------
--------- ---------
Dividends declared and unpaid................................. $ 3,669
---------
---------
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................................................. $ 2,342 $ 91 $ 171
--------- --------- ---------
--------- --------- ---------
Loans issued to facilitate sales of real estate owned......... $ 290 $ 19
--------- ---------
--------- ---------
</TABLE>
See notes to consolidated financial statements.
F-10
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
INTERIM UNAUDITED FINANCIAL INFORMATION--In the opinion of management, the
accompanying unaudited consolidated financial statements contain all adjustments
(consisting only of various normal accruals) necessary to present fairly the
Company's consolidated financial condition, results of operations and cash
flows. The financial condition at June 30, 1997 is not necessarily indicative of
the financial condition to be expected at December 31, 1997 and results of
operations for the six months ended June 30, 1997 are not necessarily indicative
of the results of operations to be expected for the year ending December 31,
1997.
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'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 (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 condition 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 REMIC
trusts 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
F-11
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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
15% for the six months ended June 30, 1997 and of 18.0%, 18.0% and 23.6% for the
years ended December 31, 1996, 1995, and 1994,
F-12
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
The Company capitalized $2,481,000, $3,817,000 and $3,896,000 of mortgage
servicing rights for the six months ended June 30, 1997 and the years ended
December 31, 1996 and 1995, respectively. During the same periods, related
amortization of such mortgage servicing rights was $1,298,000, $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 borrowers whose borrowing needs
may not be met by traditional financial institutions. The Company has found that
these 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 securitizations
and other loan sales. Revenue from loans pooled and securitized or sold in
F-13
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 securities issued by the 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 the Company's then-current
estimate of future cash flows. This yield is then used to accrue interest income
on the Residual Interest in the subsequent quarter.
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.
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 six months ended June 30, 1997 and 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
F-14
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, the subsidiary's
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" 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 condition or
results of operations.
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share" which is
effective for annual and interim periods ending after December 15, 1997. It
supersedes the presentation of primary earnings per share with a presentation of
basic earnings per share which does not consider the effect of common stock
equivalents. The computation of diluted earnings per share, which gives effect
to all dilutive potential common shares that were outstanding during the period,
is consistent with the computation of fully diluted earnings per share per
Accounting Principles Board Opinion No. 15. The adoption of this standard is not
expected to have a material effect on the Company's reported earnings per share.
In June 1997, FASB issued SFAS No. 130 "Reporting Comprehensive Income"
which is effective for annual and interim periods ending after December 15,
1997. This statement requires that all items that are required to be recognized
under accounting standards as comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements.
F-15
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 1997, FASB issued SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" which is effective for annual and interim
periods ending after December 15, 1997. This statement establishes standards for
the method by which public entities report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about product and services, geographical areas, and major customers. The
adoption of this standard is not expected to have a material effect on the
Company's financial reporting.
RECLASSIFICATIONS. Certain reclassifications have been made to conform the
1995 and 1994 consolidated financial statements to the 1996 presentation.
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:
<TABLE>
<CAPTION>
1995 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Office equipment....................................................... $ 4,245 $ 4,218
Vehicles............................................................... 388 396
Leasehold improvements................................................. 160 78
Computer software...................................................... 1,119 647
Building............................................................... 406 141
Land................................................................... 98 -
--------- ---------
Property, gross........................................................ 6,416 5,480
Less accumulated depreciation and amortization......................... (4,275) (2,382)
--------- ---------
Property, net.......................................................... $ 2,141 $ 3,098
--------- ---------
--------- ---------
</TABLE>
NOTE 4. SERVICING PORTFOLIO
Trust and other custodial funds, relating to loans serviced for others,
amounted to approximately $15.8 million, $14.5 million, $5.8 million and $2.4
million at June 30, 1997 and 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 $692,243,000, $641,191,000 and $613,791,000
at June 30, 1997 and December 31, 1996 and 1995, respectively.
F-16
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
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 June
30, 1998. The second line of credit expires on March 5, 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.
The following table presents data on the lines of credit for the periods
indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
--------------------------------- ENDED
1994 1995 1996 JUNE 30, 1997
---------- ---------- --------- -------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C>
Weighted average interest rate for the
period.................................... 5.96% 7.10% 6.30% 6.40%
Interest rate at the end of the period...... 7.38% 6.56% 6.30% 6.49%
Average amount outstanding for the period... $58,139 $52,610 $30,507 $ 22,066
Maximum amount outstanding at any
month-end................................. $ 110,551 $ 108,217 $ 65,262 $ 41,057
</TABLE>
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 per year 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 $86,000, $120,000, $97,000 and $45,000 for the six months ended June 30,
1997 and years ended December 31, 1996, 1995 and 1994, respectively.
F-17
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
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 is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
-------------- SIX MONTHS
ENDED
JUNE 30, 1997
--------------
(UNAUDITED)
<S> <C> <C>
Tax at federal statutory rate.................................... 35.0% 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 5.3
----- ------
Effective rate................................................... 16.0% 40.3%
----- ------
----- ------
</TABLE>
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
------------------------------- ENDED
1994 1995 1996 JUNE 30, 1997
--------- --------- --------- -------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal.................................... $ - $ - $7,204 $ 6,609
State...................................... 426 405 1,924 1,679
--------- --------- --------- -------------
Total current.................................. 426 405 9,128 8,288
--------- --------- --------- -------------
Deferred:
Federal.................................... - - (3,289) 1,784
State...................................... (63) 73 261 406
--------- --------- --------- -------------
Total deferred................................. (63) 73 (3,028) 2,190
--------- --------- --------- -------------
Total...................................... $ 363 $ 478 $6,100 $ 10,478
--------- --------- --------- -------------
--------- --------- --------- -------------
</TABLE>
F-18
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 8. INCOME TAXES (CONTINUED)
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:
<TABLE>
<CAPTION>
(DOLLARS IN
THOUSANDS)
<S> <C>
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
------
------
</TABLE>
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:
<TABLE>
<CAPTION>
(DOLLARS IN
YEAR ENDING DECEMBER 31: THOUSANDS)
<S> <C>
1997.................................................................... $ 1,384
1998.................................................................... 1,110
1999.................................................................... 904
2000.................................................................... 812
2001.................................................................... 686
Thereafter.............................................................. 565
</TABLE>
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.
F-19
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 9. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK (CONTINUED)
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 June 30, 1997 and December 31, 1996, loans related to property located in
the state of California comprised approximately 59% and 67%, respectively, 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-20
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
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 Stock 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.
STOCK REPURCHASE PROGRAM. In April 1997, the Board of Directors approved a
stock repurchase program under which the Company is authorized to purchase up to
1,000,000 shares of its Class A Common Stock. During the quarter ended June 30,
1997, the Company repurchased 259,500 shares of its common stock at a cost of
$5.6 million.
F-21
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
------------------------------- ENDED
1994 1995 1996 JUNE 30, 1997
--------- --------- --------- -------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C>
Loans sold to principal stockholder of the Company................ $ 6,783 $ 3,188 $ 515 $ -
Loans purchased from an entity in which the Company's principal
stockholder has a controlling interest.......................... 91,501 15,126 - -
Loans purchased from companies owned by related parties:
Loans purchased........................................... - 9,841 31,033 35,570
Premiums paid............................................. - 193 1,208 1,328
Other fees received from an entity in which the Company's
principal stockholder has a controlling interest and companies
owned by related parties........................................ - 715 186 -
Payments to companies owned by the Company's principal
stockholder:
Rent payments................................................. 18 18 464 260
Consulting fees............................................... 161 76 - -
Interest paid to stockholders on notes payable to stockholder and
S distribution notes............................................ 10 223 612 -
Interest received from companies owned by related parties......... - - - 209
</TABLE>
The following amounts represent related party balances:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996 JUNE 30, 1997
---------- ---------- -------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C>
Loans serviced for related parties......................................... $ 12,909 $ 7,044 $ 4,959
Receivable from officers of the Company.................................... - 319 358
Balance outstanding on warehouse lines to companies owned by related
parties.................................................................. 525 - 7,233
</TABLE>
F-22
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
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
($91,000), $434,000, ($255,000) and $800,000 for the six months ended June 30,
1997 and years ended December 31, 1996, 1995 and 1994, respectively.
The following disclosures of the estimated fair value of financial
instruments as of June 30, 1997 and 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.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
1995 1996 JUNE 30, 1997
---------------------- ---------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE AMOUNT FAIR VALUE
--------- ----------- --------- ----------- --------- -----------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Assets:
Cash and cash equivalents................ $ 4,019 $ 4,019 $ 27,414 $ 27,414 $ 17,093 $ 17,093
Loans held for sale...................... 24,744 25,610 11,023 12,912 18,075 20,490
Loans receivable held for investment..... 2,261 2,340 2,432 2,771 2,205 2,465
Residual interests....................... 19,705 19,705 29,253 29,253 37,377 37,377
Liabilities:
Warehouse financing facilities........... 18,233 18,233 - - - -
Notes payable............................ 1,123 1,174 131 131 109 109
</TABLE>
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 June 30, 1997 and December 31, 1996 and 1995.
Although management is not aware of any factors that would significantly affect
the estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these consolidated financial statements since that date
and, therefore, current estimates of fair value may differ significantly from
the amounts presented herein.
F-23
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 12. FINANCIAL INSTRUMENTS (CONTINUED)
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.
As of June 30, 1997 and December 31, 1996, the Company had outstanding
commitments to extend credit or purchase loans in the amounts of $6,085,000 and
$7,524,000, respectively.
NOTE 13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C> <C>
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
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
</TABLE>
NOTE 14. SUBSEQUENT EVENT (UNAUDITED)
In June 1997, the Company entered into a definitive agreement to acquire
Standard Pacific Savings, F.A., a federally chartered savings association based
in Newport Beach, California ("Bank"). The cost of the acquisition, which will
be $0.6 million in excess of the Bank's stockholders' equity at the date of
acquisition, is currently estimated to be $9.0 million. The acquisition is
subject to the approval of the Office of Thrift Supervision.
F-24
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Standard Pacific Savings, F.A.:
We have audited the accompanying consolidated statements of financial
condition of Standard Pacific Savings, F.A. (a Federally chartered savings and
loan association and wholly owned subsidiary of Standard Pacific Corp.) and
subsidiary as of December 31, 1996 and 1995 and the related consolidated
statements of operations, changes in stockholder's 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 Association'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, the financial statements referred to above present fairly,
in all material respects, the financial position of Standard Pacific Savings,
F.A. and subsidiary 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.
ARTHUR ANDERSEN LLP
Orange County, California
January 21, 1997
F-25
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996
---------- ---------- JUNE 30,
1997
-----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and interest earning deposits.......................................... $ 1,912 $ 1,800 $ 2,084
Federal funds sold and overnight deposits................................... 34,790 7,969 99,300
---------- ---------- -----------
Total cash and cash equivalents........................................... 36,702 9,769 101,384
Investment in certificates of deposit....................................... - 490 -
Investment securities available for sale.................................... 28,635 42,401 38,314
Loans available for sale, net............................................... 14,081 4,360 12,183
Loans receivable, net....................................................... 253,158 193,192 -
Accrued interest and dividends receivable................................... 1,889 1,583 711
Real estate owned........................................................... 2,704 2,079 1,028
Federal Home Loan Bank stock................................................ 7,500 7,958 8,205
Premises and equipment, net................................................. 266 227 164
Deferred taxes.............................................................. 1,183 253 43
Other assets................................................................ 2,882 2,961 4,023
---------- ---------- -----------
Total assets.............................................................. $ 349,000 $ 265,273 $ 166,055
---------- ---------- -----------
---------- ---------- -----------
LIABILITIES AND STOCKHOLDER'S EQUITY
Deposits.................................................................... $ 157,542 $ 132,812 $ 111,328
Advances from Federal Home Loan Bank........................................ 150,000 109,000 18,000
Securities sold under agreements to repurchase.............................. 15,016 - 9,938
Accounts payable and other liabilities...................................... 4,873 2,458 5,490
---------- ---------- -----------
Total liabilities......................................................... 327,431 244,270 144,756
---------- ---------- -----------
Commitments and contingencies
Stockholder's equity:
Common stock, $20.00 par value, 100,000 shares authorized, issued and
outstanding at June 30, 1997 and December 31, 1996 and 1995............... 2,000 2,000 2,000
Additional paid-in capital.................................................. 14,377 14,377 14,377
Unrealized gains (losses) on investment securities available for sale, net
of deferred taxes......................................................... (80) (39) 149
Retained earnings........................................................... 5,272 4,665 4,773
---------- ---------- -----------
Total stockholder's equity................................................ 21,569 21,003 21,299
---------- ---------- -----------
Total liabilities and stockholder's equity................................ $ 349,000 $ 265,273 $ 166,055
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-26
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Interest income:
Loans receivable......................................... $ 20,537 $ 20,066 $ 16,548 $ 8,778 $ 6,434
Investment securities available for sale and other....... 3,172 3,360 3,524 1,604 2,199
Investment securities held to maturity................... 2,158 2,383 - - -
--------- --------- --------- --------- ---------
Total interest income.................................. 25,867 25,809 20,072 10,382 8,633
--------- --------- --------- --------- ---------
Interest expense:
Deposits................................................. 10,816 12,913 9,258 4,796 4,391
Advances from Federal Home Loan Bank..................... 7,369 9,651 7,797 4,278 2,786
Securities sold under agreements to repurchase........... 1,801 1,541 395 131 109
--------- --------- --------- --------- ---------
Total interest expense................................. 19,986 24,105 17,450 9,205 7,286
--------- --------- --------- --------- ---------
Net interest income........................................ 5,881 1,704 2,622 1,177 1,347
Provision for loan losses.................................. 2,475 3,354 465 465 3
--------- --------- --------- --------- ---------
Net interest income(expense) after provision for loan
losses............................................... 3,406 (1,650) 2,157 712 1,344
--------- --------- --------- --------- ---------
Other income(expense):
Loan and other fees...................................... 359 (3) - (3) (187)
Gain(loss) on sale of loans, net......................... 337 (181) 34 - 2,642
Loss on sale of investments.............................. (668) (1,841) (21) - (166)
Loan servicing........................................... 208 255 235 122 112
Prepayment penalty on FHLB advances...................... - (1,233) - - (241)
Other income(expense).................................... (127) (64) 92 458 (1,716)
--------- --------- --------- --------- ---------
Total other............................................ 109 (3,067) 340 577 444
--------- --------- --------- --------- ---------
General and administrative expenses:
Personnel................................................ 2,699 1,316 1,016 447 536
Office occupancy, net.................................... 737 562 438 230 158
Other general and administrative......................... 1,772 1,538 412 370 845
SAIF assessments......................................... 482 463 382 215 64
SAIF special assessment.................................. - - 1,285 - -
--------- --------- --------- --------- ---------
Total other expenses................................... 5,690 3,879 3,533 1,262 1,603
--------- --------- --------- --------- ---------
Income (loss) before income tax provision (benefit)........ (2,175) (8,596) (1,036) 27 185
Income tax provision (benefit)............................. (890) (3,620) (429) 11 77
--------- --------- --------- --------- ---------
Net income (loss).......................................... $ (1,285) $ (4,976) $ (607) $ 16 $ 108
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-27
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
SIX MONTHS
ENDED
JUNE 30,
-----------
1997
-----------
(UNAUDITED)
Common stock:
<S> <C> <C> <C> <C>
Balance at beginning of year........................ $ 2,000 $ 2,000 $ 2,000 $ 2,000
--------- --------- --------- -----------
Balance at end of period............................ 2,000 2,000 2,000 2,000
--------- --------- --------- -----------
Additional paid-in capital:
Balance at beginning of year........................ 14,377 14,377 14,377 14,377
--------- --------- --------- -----------
Balance at end of period............................ 14,377 14,377 14,377 14,377
--------- --------- --------- -----------
Unrealized losses on investment securities available
for sale, net of deferred taxes:
Balance at beginning of year........................ - (1,617) (80) (39)
Decrease (increase) in unrealized loss............ (1,617) 1,537 41 188
--------- --------- --------- -----------
Balance at end of period............................ (1,617) (80) (39) 149
--------- --------- --------- -----------
Retained earnings:
Balance at beginning of year........................ 11,533 10,248 5,272 4,665
Net income (loss)................................. (1,285) (4,976) (607) 108
--------- --------- --------- -----------
Balance at end of period............................ 10,248 5,272 4,665 4,773
--------- --------- --------- -----------
Total Stockholder's Equity............................ $ 25,008 $ 21,569 $ 21,003 $ 21,299
--------- --------- --------- -----------
--------- --------- --------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-28
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................. $ (1,285) $ (4,976) $ (607) $ 16 $ 108
--------- --------- --------- --------- ---------
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization................................... 201 153 126 65 55
Provision for loan losses....................................... 2,475 3,354 465 465 3
Unrealized (recovery) loss on loans held for sale............... 100 126 (225) - -
Amortization of deferred cost and premiums--loans............... 189 222 26 60 (8)
Amortization of premiums (discounts)--investment securities
available for sale............................................ 67 29 (29) 19 72
Amortization of premiums--investment securities held to
maturity...................................................... 321 169 - - -
(Gain) loss on sale of real estate owned........................ 177 (244) (685) (535) (308)
(Gain) loss on sale of loans.................................... (337) 181 (34) - (2,457)
Loss on sale of investment securities available for sale........ 668 1,841 21 - 166
Loss (gain) on sale of fixed assets............................. 3 11 (8) - 2
Federal Home Loan Bank stock dividends.......................... (359) (462) (458) (218) (247)
Decrease (increase) in accrued interest and dividends
receivable.................................................... (362) 318 306 147 872
(Increase) decrease in other assets............................. 160 (1,762) (79) (1,418) (1,062)
Decrease (increase) in deferred taxes........................... (23) (522) 901 79 75
Increase (decrease) in accounts payable and other liabilities... (882) 1,558 (2,415) 647 3,033
--------- --------- --------- --------- ---------
Total adjustments............................................. 2,398 4,972 (2,088) (689) 196
--------- --------- --------- --------- ---------
Net cash provided by (used in) operating activities........... 1,113 (4) (2,695) (673) 304
--------- --------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
New loan fundings and purchases................................... (186,079) (18,112) (2,592) (457) 28
Proceeds from loan sales and principal repayments from loans...... 131,009 48,100 68,269 24,338 186,786
Proceeds from sale of real estate owned........................... 2,704 3,511 5,177 3,075 2,377
Payments from REO related activities.............................. (1,075) (152) (89) (10) -
Net increase (decrease) in certificates of deposit................ - - (490) - 490
Purchase of investment securities available for sale.............. (12,590) (9,715) (46,734) (12,962) (26,957)
Purchase of investment securities held to maturity................ (40,843) - - - -
Principal repayment from investment securities available for
sale............................................................ 4,661 1,860 14,553 2,460 2,175
Proceeds from sale of investment securities available for sale.... 30,619 63,351 18,493 4,500 28,954
Principal repayment from investment securities held to maturity... 2,786 3,923 - - -
Proceeds from redemption of Federal Home Loan Bank stock.......... - 1,975 - - -
Purchase of Federal Home Loan Bank stock.......................... (1,776) - - - -
Proceeds from sale of fixed assets................................ 22 10 22 - 6
Purchase of fixed assets.......................................... (50) (33) (101) (13) (1)
--------- --------- --------- --------- ---------
Net cash provided by (used in) Investing activities........... (70,612) 94,718 56,508 20,931 193,858
--------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Federal Home Loan Bank advances..................... 365,000 111,000 18,000 - 77,000
Principal payments on Federal Home Loan Bank advances............. (305,750) (121,300) (59,000) (14,000) (168,000)
Net change in securities sold under agreements to repurchase...... 26,736 (31,758) (15,016) (7,557) 9,938
Proceeds from deposits............................................ 566,688 305,466 274,382 118,478 120,339
Payments for maturing deposit accounts............................ (584,521) (340,144) (303,509) (147,721) (143,494)
Interest credited to deposit accounts............................. 3,765 4,057 4,397 2,718 1,670
--------- --------- --------- --------- ---------
Net cash (used in) provided by financing activities............. 71,918 (72,679) (80,746) (48,082) (102,547)
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents............ 2,419 22,035 (26,933) (27,824) 91,615
Cash and cash equivalents: beginning of period.................. 12,248 14,667 36,702 36,702 9,769
--------- --------- --------- --------- ---------
Cash and cash equivalents: end of period........................ $ 14,667 $ 36,702 $ 9,769 $ 8,878 $ 101,384
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-29
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL SCHEDULE OF
INVESTING AND FINANCING ACTIVITIES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash paid (received) during the year for:
Interest................................................ $ 19,378 $ 23,354 $ 19,394 $ 13,233 $ 9,159
Income taxes............................................ 583 (2,237) (991) - -
Non-cash transactions included:
Acquisition of real estate in settlement of loans......... 4,616 4,106 3,778 2,723 1,228
Reclassification of mortgage backed certificates held to
maturity to investment securities available for sale.... - 48,880 - - -
Change in unrealized losses on investment securities
available for sale, net of deferred taxes............... (1,617) 1,537 41 (461) 564
Reclassification of allowance for loss from loans to real
estate owned............................................ 626 - - 220 200
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-30
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
INTERIM UNAUDITED FINANCIAL INFORMATION--In the opinion of management, the
accompanying unaudited consolidated financial statements contain all adjustments
(consisting only of various normal accruals) necessary to present fairly the
consolidated financial condition, results of operations and cash flows of
Standard Pacific Savings, F.A. (Savings). The financial condition at June 30,
1997 is not necessarily indicative of the financial condition to be expected at
December 31, 1997 and results of operations for the six months ended June 30,
1997 are not necessarily indicative of the results of operations to be expected
for the year ending December 31, 1997.
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. ORGANIZATION AND OPERATIONS
Savings is a federally chartered savings and loan association which was
formed on March 6, 1987 by the Federal Savings and Loan Insurance Corporation
(the FSLIC) for the purpose of receiving substantially all of the assets and
assuming substantially all of the liabilities of South Bay Savings and Loan
Association (South Bay), an unaffiliated California chartered institution which
was placed into receivership. The acquisition of Savings was accounted for as a
purchase and the assets received and liabilities assumed from the FSLIC were
recorded at their fair values after giving effect to certain FSLIC assistance
(see Note 13). On March 6, 1987 Savings became a wholly owned subsidiary of
Standard Pacific Corp. (SPC).
Savings' principal business was the mortgage banking business, which
included acting as a loan origination agent for SPC and other unaffiliated
parties. In June 1995, Savings discontinued the mortgage banking operations.
b. NATURE OF OPERATIONS
Savings operates one savings branch in Southern California. Its primary
source of revenue is interest income from its portfolio of mortgage loans and
investment securities. Savings also receives income for servicing loans for
others.
c. 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 period. Actual results could differ from those estimates.
d. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Savings and
SPS Affiliates, Inc. (SPSA), a wholly-owned subsidiary of Savings. SPSA is an
active corporation that was formed for the purpose of acting as the trustee on
Savings' deeds of trust. SPSA's total assets consist of approximately $11,000
and $85,000 in cash as of December 31, 1996 and 1995, respectively. All
significant intercompany balances and transactions have been eliminated in
consolidation.
F-31
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
e. REVENUE RECOGNITION
Interest income is recognized as earned. The amortization of discounts on
loans receivable and net deferred loan fees are recognized over the contractual
lives of the related individual loans using methods which approximate the
effective interest method and adjusted for actual prepayments. Interest is
accrued only so long as it is deemed collectible (generally not more than 90
days past due).
f. INTEREST RATE SWAP AND CAP AGREEMENTS
The interest differential on swaps to be paid or received is accrued and
recognized over the life of the agreements as an adjustment to interest expense
on savings accounts.
Premiums paid for interest rate caps are amortized over the life of the
agreement. Interest is accrued based upon expected settlement payments and
recorded as an adjustment to interest expense on savings accounts.
g. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash
on hand, amounts due from banks, federal funds sold, overnight deposits, and all
highly liquid short-term investments, including interest bearing securities
purchased with a remaining maturity of three months or less.
h. INVESTMENT IN CERTIFICATES OF DEPOSIT
Investment in certificates of deposit have remaining maturities greater than
three months.
i. INVESTMENT SECURITIES
Savings accounts for their investment securities using Financial Accounting
Standards Board Statement No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." This statement requires Savings to carry the portion of
their investments in debt and equity securities they do not intend to hold to
maturity at their market values. Under these rules, securities classified as
available for sale are carried at their market values and changes in the
securities market values are recorded as a separate component of stockholder's
equity, net of income tax effect.
During 1995, and resulting from regulatory agency clarification of the
ruling regarding the unrealized loss effects on regulatory capital, all of
Savings' investment securities classified as held to maturity were transferred
to available for sale.
j. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable are recorded at cost net of unamortized deferred credits.
Loans held for sale are carried at the lower of their cost or market value.
Savings provides for loan losses on the allowance method. The allowance for loan
losses is increased by charges to income and decreased by charge-offs (net of
recoveries). Management's periodic evaluation of the adequacy of the allowance
is based on Savings' past loan loss experience, known and inherent risks in the
portfolio, adverse situations that may affect the borrower's ability to repay,
the estimated value of any underlying collateral, and current economic
F-32
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
conditions. In providing such allowance, consideration is given to all elements
of fair value, including costs of recovery, holding, and disposition of the
underlying collateral. While management uses currently available information to
evaluate the adequacy of allowances, ultimate losses may vary from current
estimates. Adjustments to estimates are charged to earnings in the period in
which they become known.
In May 1995, the Financial Accounting Standards Board issued Statement No.
122, "Accounting for Mortgage Servicing Rights" which is effective for years
beginning after December 15, 1995. SFAS No. 122 amended SFAS No. 65, "Accounting
for Certain Mortgage Banking Activities." SFAS No. 122 requires the recognition
of originated mortgage servicing rights, as well as purchased mortgage servicing
rights, as assets by allocating total costs incurred between the loan and the
servicing rights based on their relative fair values. SFAS No. 122 had no
significant impact on results of operations for the year ended December 31,
1996.
In May 1993, the Financial Accounting Standards Board issued Statement No.
114, "Accounting by Creditors for Impairment of a Loan" which was amended in
1994 by Financial Accounting Standards Board No. 118. These statements require
that impaired loans be measured based on the present value of expected future
cash flows, the loan's observable market price, or the fair value of the
collateral if the loan is collateral dependent. Savings adopted the above
statements for the fiscal year beginning January 1, 1995. A loan is impaired
when, based on current information and events, it is probable that a creditor
will be unable to collect all amounts due according to the contractual terms of
the loan agreement. The adoption of these statements had no material impact on
Savings consolidated statement of financial condition or consolidated statement
of operations at December 31, 1995 or December 31, 1996.
k. REAL ESTATE OWNED
Real estate owned is recorded at the lower of the recorded investment in the
loan satisfied or the fair value of the assets received, adjusted for estimated
carrying and selling costs. Estimated losses are subsequently charged off when
the carrying value of the real estate acquired exceeds the fair value.
l. PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation
computed on the straight-line method over the estimated useful lives of the
assets which approximates five years. Generally, leasehold improvements are
amortized using the straight-line method over the lives of the respective
leases. Maintenance and repairs on premises and equipment are charged to expense
in the year incurred.
m. INCOME TAXES
Savings has executed a tax allocation agreement (the "Agreement") with
Standard Pacific Corp. (SPC). The Agreement states Savings will file a
consolidated federal income tax return and a combined California franchise tax
return with SPC. The Agreement requires the parties to allocate their total tax
liability based on each party's separate return tax liability. Moreover, the
parties agree to reimburse any party which has tax losses or credits in an
amount equal to 100% of the tax benefits realized by the consolidated group.
Savings makes payments to SPC at the time that such tax amounts are actually
paid to
F-33
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the respective taxing authority by SPC. Any tax related funds paid by Savings to
SPC prior to the estimated tax due dates or filing dates are to be held in
trust.
The financial statement benefit from utilization of net operating loss
carryovers will vary depending on the holding period of the acquired assets and
tax return realization meeting certain time criteria. Based on the criteria met,
the benefits would be recognized as a reduction of income tax expense.
Savings accounts for income taxes using Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." SFAS No. 109 mandates
the liability method of accounting for income taxes. Under the liability method,
deferred tax assets and liabilities are recognized for the expected future tax
consequences of existing differences between financial reporting and tax
reporting bases of assets and liabilities, as well as for operating losses and
tax credit carryforwards, using enacted tax laws and rates.
Under SFAS No. 109, deferred tax expense represents the net change in the
deferred tax asset or liability balance for the period. This amount, together
with income taxes currently payable or refundable in the current period,
represents the total tax expense for the period.
NOTE 2: REGULATORY MATTERS
In April 1990, and as a result of the passage of the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 (FIRREA) and laws governing
transactions between savings associations and their affiliates, Savings prepared
and mailed a written request to the General Counsel of the Board of Governors of
the Federal Reserve System (FRB) for interpretations of those laws as it related
to the operations of Savings. Specifically, Savings interpreted and their
counsel concurred that those laws allowed it to directly originate and hold home
loans made to SPC's homebuyers in the ordinary course of business, so long as
the terms and pricing of such loans were no more favorable to SPC than what
could be obtained in a non-affiliated transaction. Savings continued to follow
up on the requested interpretation.
In January 1995, and in conjunction with an annual regulatory examination
the Office of Thrift Supervision (OTS) decided to review this matter to
determine its permissibility. Additionally, the OTS reviewed the limits of
affiliated loans in Savings' portfolio as specified in Sections 23A and 23B of
the Federal Reserve Act. In October 1995 Savings received the OTS' response
regarding this matter. The OTS determined that loans made by Savings to SPC
homebuyers are to be considered affiliated transactions. Therefore, Savings is
limited to holding such loans in its portfolio to an amount not to exceed 10% of
capital. At December 31, 1996 Savings had approximately $4.4 million of these
loans in its portfolio. The OTS has given Savings until September 1997 to meet
the 10% of capital limitation. All of the loans made to SPC homebuyers have been
classified as held for sale and carried at the lower of cost or market value.
Since June 1994 Savings has not originated loans on behalf of SPC homebuyers. As
of June 30, 1997, Savings had reduced affiliated loans to an amount below the
10% limitation.
Congress passed legislation to recapitalize the Federal Deposit Insurance
Corporation's (FDIC) Savings Association Insurance Fund (SAIF). The legislation
required all SAIF insured institutions to pay a one time special assessment in
1996 of .66% of their outstanding deposits as of March 31, 1995. The special
assessment was approximately $1.3 million which was charged to expense in
September 1996.
F-34
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 3: INVESTMENT SECURITIES AVAILABLE FOR SALE
Shown below are the amortized costs and market values of investment
securities with related maturity data:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------------------------------
1995 1996
---------------------------------------------------- -----------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES VALUE COST GAINS LOSSES
----------- ------------- ------------- --------- ----------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Agency securities:
Maturing less than 1
year................. $ - $ - $ - $ - $ 1,255 $ - $ -
Maturing after 1 year
but within 5 years... 7,781 1 - 7,782 12,078 3 11
Maturing after 5 years
but within 10
years................ - - - - 3,900 7 -
Maturing after 10
years................ - - - - 5,023 - 4
----------- ----- ----- --------- ----------- ----- -----
Subtotal U.S. Agency
securities......... 7,781 1 - 7,782 22,256 10 15
----------- ----- ----- --------- ----------- ----- -----
Mortgage-backed
securities:
Maturing after 10
years................ 20,990 - 137 20,853 20,211 146 207
----------- ----- ----- --------- ----------- ----- -----
TOTAL................ $ 28,771 $ 1 $ 137 $ 28,635 $ 42,467 $ 156 $ 222
----------- ----- ----- --------- ----------- ----- -----
----------- ----- ----- --------- ----------- ----- -----
<CAPTION>
JUNE 30, 1997
----------------------------------------------------
GROSS GROSS
MARKET AMORTIZED UNREALIZED UNREALIZED MARKET
VALUE COST GAINS LOSSES VALUE
--------- ----------- ------------- ------------- ---------
<S> <C> <C> <C> <C> <C>
U.S. Agency securities:
Maturing less than 1
year................. $ 1,255 $ 3,256 $ 3 $ 1 $ 3,258
Maturing after 1 year
but within 5 years... 12,070 13,000 23 - 13,023
Maturing after 5 years
but within 10
years................ 3,907 3,612 3 6 3,609
Maturing after 10
years................ 5,019 5,000 5 - 5,005
--------- ----------- ----- ----- ---------
Subtotal U.S. Agency
securities......... 22,251 24,868 34 7 24,895
--------- ----------- ----- ----- ---------
Mortgage-backed
securities:
Maturing after 10
years................ 20,150 13,190 232 3 13,419
--------- ----------- ----- ----- ---------
TOTAL................ $ 42,401 $ 38,058 $ 266 $ 10 $ 38,314
--------- ----------- ----- ----- ---------
--------- ----------- ----- ----- ---------
</TABLE>
Proceeds from sales of investment securities and the related gross gains and
gross losses realized are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
SIX MONTHS
ENDED
JUNE 30, 1997
-------------
(DOLLARS IN THOUSANDS)(UNAUDITED)
<S> <C> <C> <C> <C>
Proceeds from sales.................................. $ 30,619 $ 63,351 $ 28,494 $ 31,954
Gross gains realized................................. 108 - 43 69
Gross losses realized................................ (776) (1,841) (64) (235)
</TABLE>
NOTE 4: INVESTMENT SECURITIES HELD TO MATURITY
During 1995, and resulting from regulatory agency clarification of the
ruling regarding the unrealized loss effects on regulatory capital, all of
Savings' investment securities classified as held to maturity were transferred
to available for sale. No investment securities were classified as held to
maturity as of June 30, 1997 and December 31, 1996 or 1995.
F-35
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 5: LOANS RECEIVABLE
Loans Receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1995 1996
------------- -------------
JUNE 30, 1997
-------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C>
Real Estate:
Residential 1-4.............................. $ 264,295 $ 191,408 $ 6,683
Residential 5 or more........................ 4,235 5,790 5,736
Non-residential.............................. 2,279 2,448 1,541
------------- ------------- -------------
Total Real Estate.......................... 270,809 199,646 13,960
Other.......................................... 43 57 28
Less:
Discount on acquired loans................... 135 213 91
Deferred loan fees (costs)................... (222) (97) 29
Allowance for loan losses.................... 3,496 1,899 1,676
Other deferrals.............................. 204 136 9
------------- ------------- -------------
Total Loans, net............................... $ 267,239 $ 197,552 $ 12,183
------------- ------------- -------------
------------- ------------- -------------
Weighted Average Interest Rate................. 7.09% 7.33% 8.60%
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
Included in the above amounts are loans classified as held for sale of
$12,183,000, $4,360,000 and $14,081,000, at June 30, 1997 and December 31, 1996
and 1995, respectively, net of market value allowance of $225,000, at December
31, 1995.
Savings had no loans to directors or officers as of June 30, 1997 and
December 31, 1996 or 1995.
Activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
SIX MONTHS
ENDED
JUNE 30, 1997
-------------
(DOLLARS IN (UNAUDITED)
THOUSANDS)
<S> <C> <C> <C> <C>
Balance at beginning of period........... $ 1,183 $ 1,906 $ 3,496 $ 1,899
Provision for losses..................... 2,475 3,354 465 3
Net charge-offs.......................... (1,752) (1,764) (2,062) (226)
--------- --------- --------- ------
Balance at end of period................. $ 1,906 $ 3,496 $ 1,899 $ 1,676
--------- --------- --------- ------
--------- --------- --------- ------
</TABLE>
F-36
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 5: LOANS RECEIVABLE (CONTINUED)
For the years ended December 31, 1996 and 1995, interest income of
approximately $275,000 and $395,000, respectively, (all of which has been fully
reserved) related to non-accrual loans that would have been recorded had the
loans been performing in accordance with their original terms. The total balance
of non-accrual loans at December 31, 1996 and 1995 were $691,000 and $3,220,000,
respectively.
The amount of impaired loans as defined by SFAS 114 was $3,194,000 and
$2,609,000 which required loss allowances of $229,000 and $353,000 as of
December 31, 1996 and 1995, respectively. The amount of impaired loans for which
no loss allowance was required was $2,227,000 and $1,603,000 as of December 31,
1996 and 1995, respectively. The average balance of impaired loans for the years
ending December 31, 1996 and 1995 was $4,099,000 and $5,222,000, respectively.
Interest income recognized for those loans was $151,000 and $253,000, for the
years ending December 31, 1996 and 1995, respectively.
Savings was servicing loans for others with principal amounts of
approximately $37,314,000, $40,493,000 and $43,099,000, of which approximately
$1,642,000, $2,363,000 and $2,805,000 was serviced for SPC at June 30, 1997 and
December 31, 1996 and 1995, respectively. Savings received loan servicing income
of $4,700, $12,000, $13,000 and $14,000 from SPC for loans serviced on their
behalf for the 6 months ended June 30, 1997 and the years ended 1996, 1995 and
1994, respectively.
Substantially all of Savings' loans are in California residential real
estate. This does not expose Savings to undue credit risk; however, economic
conditions and real estate markets in California may affect Savings, loan
portfolio and underlying collateral values.
NOTE 6: ACCRUED INTEREST AND DIVIDENDS RECEIVABLE
Accrued interest and dividends receivable is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
JUNE 30,
1997
-------------
(DOLLARS IN (UNAUDITED)
THOUSANDS)
<S> <C> <C> <C>
Loans.................................................. $ 1,427 $ 1,042 $ 84
Investments............................................ 462 541 627
--------- --------- -----
$ 1,889 $ 1,583 $ 711
--------- --------- -----
--------- --------- -----
</TABLE>
NOTE 7: PREMISES AND EQUIPMENT
Premises and equipment, stated at cost, consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Leasehold improvements................................................ $ 108 $ 144
Furniture and equipment............................................... 1,134 951
--------- ---------
1,242 1,095
Less accumulated depreciation and amortization........................ 976 868
--------- ---------
$ 266 $ 227
--------- ---------
--------- ---------
</TABLE>
F-37
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 8: DEPOSIT ACCOUNTS
Deposit accounts consist of the following:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE RATE
-----------------------------------------
DECEMBER 31, DECEMBER 31, 1995 DECEMBER 31, 1996
------------------------ ---------------------- ----------------------
1995 1996 AMOUNT PERCENT AMOUNT PERCENT
----------- ----------- --------- ----------- --------- -----------
JUNE 30,
1997
---------------
(UNAUDITED) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
No minimum term--checking:
NOW.......................... 1.78% 1.39% 1.43% $ 769 .49% $ 627 .48%
Money Market................. 3.77 4.62 2.75 2,722 1.73 980 .74
Non-interest bearing
commercial................. - - - 1,024 .65 964 .73
No minimum term--savings:
Passbook..................... 2.72 2.90 2.90 908 .58 509 .38
Money market savings......... 3.89 2.71 3.66 1,620 1.03 1,219 .92
Certificates of Deposit:
Less than 6 months........... 6.26 5.82 5.79 89,181 56.59 77,917 58.66
6 months to 1 Year........... 6.29 5.95 6.04 30,099 19.12 28,308 21.31
1 Year to 3 Years............ 6.65 6.21 6.28 28,535 18.11 16,547 12.46
3 Years to 5 Years........... 6.94 6.66 6.32 2,684 1.70 5,433 4.09
Over 5 Years................. - 6.28 6.16 - - 308 .23
--- ----- --- --------- ----------- --------- -----------
Total...................... 6.20% 5.82% 5.66% $ 157,542 100.00% $ 132,812 100.00%
--- ----- --- --------- ----------- --------- -----------
--- ----- --- --------- ----------- --------- -----------
<CAPTION>
JUNE 30, 1997
----------------------
AMOUNT PERCENT
--------- -----------
<S> <C> <C>
No minimum term--checking:
NOW.......................... $ 719 .65%
Money Market................. 1,007 .90
Non-interest bearing
commercial................. 3,055 2.74
No minimum term--savings:
Passbook..................... 344 .31
Money market savings......... 1,567 1.41
Certificates of Deposit:
Less than 6 months........... 66,435 59.68
6 months to 1 Year........... 22,305 20.04
1 Year to 3 Years............ 10,935 9.82
3 Years to 5 Years........... 4,719 4.24
Over 5 Years................. 242 .21
--------- -----------
Total...................... $ 111,328 100.00%
--------- -----------
--------- -----------
</TABLE>
Included in certificates of deposit are jumbo certificates ($95,000 or
greater) totaling $80,724,000, $96,780,000 and $97,915,000 in June 30, 1997 and
December 31, 1996 and 1995, respectively. Brokered deposits in the above
certificates of deposit equal 99,000 and $99,000 at June 30, 1997 and December
31, 1996 and 1995.
A summary of certificate accounts by maturity as of June 30, 1997 is as
follows:
<TABLE>
<CAPTION>
MATURITY (DOLLARS IN
- ------------------------------------------------------------------------------------- THOUSANDS)
(UNAUDITED)
<S> <C>
1997................................................................................. $ 71,655
1998................................................................................. 23,309
1999................................................................................. 2,772
2000................................................................................. 2,375
2001................................................................................. 3,541
Thereafter........................................................................... 984
--------
Total.............................................................................. $ 104,636
--------
--------
</TABLE>
F-38
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 8: DEPOSIT ACCOUNTS (CONTINUED)
Interest expense related to deposit accounts consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS
------------------------------- ENDED
1994 1995 1996 JUNE 30, 1997
--------- --------- --------- -------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C>
Passbook........................................................... $ 69 $ 47 $ 84 $ 39
Money Market and NOW Accounts...................................... 262 199 68 13
Other Certificates................................................. 601 1,026 966 513
Jumbo Certificates (over $95,000).................................. 9,884 11,641 8,140 3,826
--------- --------- --------- ------
$ 10,816 $ 12,913 $ 9,258 $ 4,391
--------- --------- --------- ------
--------- --------- --------- ------
</TABLE>
NOTE 9: ADVANCES FROM FEDERAL HOME LOAN BANK
During 1995 and as a part of a balance sheet restructure, Savings prepaid
$45,000,000 of FHLB advances with a weighted average interest rate of 7.78%. The
weighted average days to maturity was 693 days, for a prepayment penalty of
$1,233,000. No prepayments of advances occurred in 1996.
FHLB advances of $18,000,000, $109,000,000 and $150,000,000 with interest
rates ranging from 4.87% to 5.57%, $4.87% to 6.88% and 4.32% to 6.88%, are
secured by the investment in stock of the Federal Home Loan Banks and certain
mortgage loans and investment securities aggregating approximately $24,802,000,
$155,406,000 and $221,994,000 at June 30, 1997 and December 31, 1996 and 1995,
respectively. The weighted average interest rate on these advances was 5.38%,
6.10% and 6.07% at June 30, 1997 and December 31, 1996 and 1995, respectively.
The FHLB advances outstanding at June 30, 1997 mature in 1998.
NOTE 10: SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
There were no securities sold under agreements to repurchase as of December
31, 1996. The securities sold under agreements to repurchase, amortized costs
and market values as of December 31, 1995 are 15,016,000, 16,163,000 and
16,030,000, respectively.
The weighted average interest rate of these borrowings was 5.81% and the
weighted average maturity was 22 days at December 31, 1995. The maximum amounts
of outstanding agreements at any month-end were $18,099,000 and $33,480,000 for
the years ended December 31, 1996 and 1995, respectively. The average amounts of
outstanding agreements for the years ended December 31, 1996 and 1995 were
$7,041,000 and $24,943,000, respectively. The weighted average interest rates
for the years ended December 31, 1996 and 1995 were 5.61% and 6.18%,
respectively. The securities underlying the agreements are held by the
securities dealers until the maturities of the agreements. For all the
agreements, the dealers agreed to resell the same securities to Savings.
F-39
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 11: INCOME TAXES
The income tax provision (benefit) consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
SIX MONTHS
ENDED
JUNE 30, 1997
---------------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal...................................... $ (677) $ (2,285) $ (929) $ 35
State........................................ (190) (813) (401) (33)
--------- --------- --------- ---
(867) (3,098) (1,330) 2
--------- --------- --------- ---
Deferred
Federal...................................... 36 (346) 618 21
State........................................ (59) (176) 283 54
--------- --------- --------- ---
(23) (522) 901 75
--------- --------- --------- ---
Total............................................ $ (890) $ (3,620) $ (429) $ 77
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
A reconciliation of the statutory federal income tax rate and the effective
tax rate as a percentage of pre-tax income (loss) for the periods indicated is
as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------
1994 1995 1996
------------ ------------ ------------ SIX MONTHS
ENDED
JUNE 30, 1997
--------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Statutory rate.............................. 34.00% 34.00% 34.00% 34.00%
State and local income taxes, net of U.S.
Federal income tax benefit................. 7.57 7.46 7.46 7.46
Other....................................... (.66) .66 (.05) .23
----- ----- ----- -----
Effective Tax Rate...................... 40.91% 42.12% 41.41% 41.69%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
F-40
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 11: INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax assets are as follows at December 31:
<TABLE>
<CAPTION>
1995 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Loan loss allowances deferred for tax purposes........................ $ 2,203 $ 1,245
Net loan costs deferred for financial statement purposes, previously
recognized for tax purposes.......................................... (560) (376)
FHLB stock dividends deferred for tax purposes........................ (371) (582)
State taxes........................................................... (399) (163)
Other................................................................. 253 101
--------- ---------
1,126 225
Unrealized loss on investment securities available for sale........... 57 28
--------- ---------
$ 1,183 $ 253
--------- ---------
--------- ---------
</TABLE>
Based upon management's assessments, it is more likely than not that the net
deferred tax assets will be realized through future consolidated taxable
earnings or alternative tax strategies.
For the years ended December 31, 1996 and 1995 the components of the change
in deferred income taxes represent the effect of changes in the amounts of
temporary differences and changes in the tax rates. The sources of these
temporary differences and their related tax effects are as follows:
<TABLE>
<CAPTION>
1995 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Benefit of financial statement loan valuation allowances............... $ (696) $ 957
Loan fees (costs) recognized for tax purposes.......................... (93) (184)
Long term capital loss deferred for tax purposes....................... 308 -
FHLB stock dividends deferred.......................................... (225) 212
State taxes............................................................ 266 (236)
Other.................................................................. (82) 152
--------- ---------
$ (522) $ 901
--------- ---------
--------- ---------
</TABLE>
NOTE 12: DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate.
CASH AND CASH EQUIVALENTS AND CERTIFICATES OF DEPOSIT
The carrying amount is a reasonable estimate of fair value. These assets
primarily consist of amounts due from banks, federal funds sold, overnight
deposits, and certificates of deposit.
F-41
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 12: DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
INVESTMENT SECURITIES AVAILABLE FOR SALE
Investment securities available for sale consist of U.S. Treasury, U.S.
Federal Agency, corporate debt securities, mortgage-backed certificates, and
other securities. Fair value equals quoted market price, if available. If a
quoted market price is not available, fair value is estimated using quoted
market prices for similar securities.
LOANS RECEIVABLE
The fair values for loans receivable are estimated using discounted cash
flow analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality.
FEDERAL HOME LOAN BANK STOCK
The carrying amount of Federal Home Loan Bank stock is a reasonable estimate
of fair value since shares are redeemable at par value.
DEPOSIT ACCOUNTS
The fair values disclosed for deposit accounts (e.g., interest and
non-interest checking, passbook savings, and certain types of money market
accounts) are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying amounts). The carrying amounts for
variable-rate, fixed-term money market accounts and certificates of deposits
approximate their fair values at the reporting date. Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow calculation
that applies interest rates currently being offered on certificates to a
schedule of aggregated expected monthly maturities on time deposits.
ADVANCES FROM FEDERAL HOME LOAN BANK
Federal Home Loan Bank advances are composed of both variable and fixed rate
borrowings. For variable rate borrowings the carrying amounts approximate their
fair value. Fixed rate borrowings are estimated using a discounted cash flow
analysis, based upon the current incremental borrowing rates.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The carrying amounts of securities sold under agreements to repurchase
approximate their fair values.
INTEREST RATE SWAP AGREEMENT
The fair value of the interest rate swaps (used for hedging purposes) is the
estimated amount that Savings would receive or pay to terminate the swap
agreements at the reporting date, taking into account current interest rates and
the current credit worthiness of the swap counterparty.
F-42
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 12: DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
INTEREST RATE CAP AGREEMENTS
The fair value of the interest rate caps (also used for hedging purposes)
are based on quoted market prices, where available. If quoted market prices are
not available, fair values are based on quoted market prices of comparable
instruments.
The estimated fair values of Savings financial instruments are as follows:
<TABLE>
<CAPTION>
AT DECEMBER 31, 1995 AT DECEMBER 31, 1996 AT JUNE 30, 1997
---------------------- ---------------------- ----------------------
CARRYING CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash and cash equivalents............. $ 36,702 $ 36,702 $ 9,769 $ 9,769 $ 101,384 $ 101,384
Investment in certificates of
deposit............................. - - 490 490 - -
Investment securities available for
sale................................ 28,635 28,635 42,401 42,401 38,314 38,314
Loans receivable...................... 270,735 272,462 199,451 201,417 13,859 13,859
Less: Allowance for loan losses....... (3,496) (3,496) (1,899) (1,899) (1,676) (1,676)
Federal Home Loan Bank stock.......... 7,500 7,500 7,958 7,958 8,205 8,205
FINANCIAL LIABILITIES:
DEPOSIT ACCOUNTS
Non-interest bearing checking......... 1,024 1,024 964 964 3,055 3,055
Interest bearing checking............. 769 769 627 627 719 719
Passbook.............................. 908 908 508 508 344 344
Money Market Accounts................. 4,342 4,342 2,200 2,200 2,574 2,574
Certificates of Deposit............... 150,499 151,386 128,513 128,771 104,636 104,636
---------- ---------- ---------- ---------- ---------- ----------
Total Deposits...................... 157,542 158,429 132,812 133,070 111,328 111,328
ADVANCES FROM FEDERAL HOME LOAN BANK
Variable rate......................... - - 13,000 13,000 13,000 13,000
Fixed rate............................ 150,000 151,542 96,000 96,351 5,000 5,000
SECURITIES SOLD UNDER AGREEMENTS TO
REPURCHASE.......................... 15,016 15,016 - - 9,937 9,937
OTHER FINANCIAL INSTRUMENTS:
Interest rate swaps................... - (3,490) - (1,874) (2,300) (2,300)
Interest rate caps.................... 64 - 138 - 1 -
Commitments to fund mortgage loans.... 400 400 - - - -
</TABLE>
F-43
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 13: COMMITMENTS AND CONTINGENCIES
Savings leases office space for its operations, as well as some office
equipment, under operating lease agreements. Net rent expense for noncancelable
operating leases and sub-leases for the years ended December 31, 1996 and 1995
was approximately $260,000 and $357,000, respectively. As of December 31, 1996
the future lease rentals payable under noncancelable operating commitments for
premises and equipment were as follows:
<TABLE>
<S> <C>
1997.............................................................. $ 148,000
1998.............................................................. 148,000
1999.............................................................. 148,000
2000.............................................................. 148,000
2001.............................................................. 148,000
Thereafter........................................................ 235,000
---------
$ 975,000
---------
---------
</TABLE>
The ability of Savings to maintain a positive interest rate spread in a
changing economic environment is dependent primarily on the matching of the
repricing characteristics of its interest earning assets and its interest paying
liabilities. One indication of interest rate sensitivity is the gap between
assets that reprice within one year and liabilities that reprice within one year
as a percentage of total interest earning assets (the "one year gap").
Management's goal is to keep its one year gap as a percentage of total interest
earning assets in a range of approximately (10)% to 10%.
Savings has entered into interest rate exchange agreements ("Swaps") as a
means to manage interest rate risk. Swaps generally involve the exchange of
fixed and floating rate interest payment obligations without the exchange of the
underlying notional principal amounts. All of the Swaps listed below are
designated as hedging certain savings accounts.
In October 1995 Savings restructured the terms of the interest rate swap
with a $50 million notional amount by buying down the fixed interest rate of
8.78%. The new terms reflect a fixed rate of 6.78% to October 1996, 7.78% from
October 1996 to October 1997, and 8.78% to October 1998. The buydown fee of
$1,430,000 is amortized over the remaining term of the swap agreement.
Swaps contain the risk of default by counterparties. The amounts potentially
subject to credit risk are much smaller than the notional principal amounts used
to express these transactions. At December 31, 1996 Savings exposure to credit
loss in the event of non-performance by the counterparties was not material to
the consolidated financial statements.
F-44
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 13: COMMITMENTS AND CONTINGENCIES (CONTINUED)
Swaps outstanding are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995
---------------------------------------------------
NOTIONAL WEIGHTED AVERAGE
AMOUNT INTEREST RATE
--------- ----------------------
TYPE PAID RECEIVED MATURITY DATE(S)
- ------------------------------------------------------------- --------- ----------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Pay fixed/receive variable (payable swap).................... $ 50,000 6.78% 5.43% October 1998
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------------
NOTIONAL WEIGHTED AVERAGE
AMOUNT INTEREST RATE
--------- ----------------------
TYPE PAID RECEIVED MATURITY DATE(S)
- ------------------------------------------------------------- --------- ----------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Pay fixed/receive variable (payable swap).................... $ 50,000 7.78% 5.11% October 1998
</TABLE>
The net spread (expense) on interest rate swaps of approximately ($916,000),
($1,355,000) and ($1,892,000) in 1996, 1995 and 1994, respectively, is included
in interest expense on savings accounts in the accompanying Consolidated
Statements of Operations. Savings pledged mortgage-backed certificates as
collateral on the swap agreements. The pledged securities had an amortized cost
of $3,264,000 and a market value of $3,265,000 at December 31, 1996.
At December 31, 1996, Savings was a participant in interest rate cap
programs ("Caps") as another means to manage interest rate risk. The aggregate
notional principal amount is $100 million with a remaining term of 19 months,
which provides for payments of interest to Savings if the indices upon which the
Caps are based exceed a weighted average rate of 8.00%. Amortization of the fees
Savings was required to pay in order to participate in the Caps was $106,000,
$171,000 and $122,000 for the years ended December 31, 1996, 1995 and 1994,
respectively, and is included in interest expense on savings accounts in the
accompanying Consolidated Statements of Operations. The remaining unamortized
amount of such fees was $138,000 at December 31, 1996. During 1995 and 1994,
Savings received payments of $87,000 and $103,000, respectively, and recognized
$87,000 and $365,000 as a reduction to interest expense under the Caps. Savings
had no risk of loss due to caps as of December 31, 1996.
Savings and its subsidiary are involved in litigation arising in the normal
course of business. Although the legal responsibility and financial impact with
respect to such litigation cannot be ascertained, Savings does not anticipate
that these matters will result in payment by Savings of monetary damages that in
the aggregate would be material in relation to the consolidated statements of
operations of Savings.
Pursuant to the assistance agreement dated March 6, 1987, the FSLIC agreed
to indemnify Savings against certain losses attributable to assets and
liabilities acquired from South Bay. Certain of those losses resulted in a tax
benefit to the institution which, under the terms of the assistance agreement,
may require the institution to reimburse FDIC (as successor in interest to the
FSLIC) for a portion of the tax benefits. The estimated amounts of such benefits
due FDIC have been accrued and are not material to the consolidated financial
statements.
F-45
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 14: STOCKHOLDER'S EQUITY
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
(FIRREA) included dividend restrictions for savings associations. The dividend
restrictions require savings associations to give the Office of Thrift
Supervision (OTS) thirty days written notice prior to the declaration of a
dividend. In addition, savings associations are required to meet certain
regulatory capital requirements and net income requirements prior to the
declaration of a dividend.
Savings is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material effect on
Savings' financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, Savings must meet specific
capital guidelines that involve quantitative measures of Saving's assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. Savings' capital amounts and classifications are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Savings to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1996, that Savings
meets all capital adequacy requirements to which it is subject.
As of December 31, 1996, the most recent notification from OTS categorized
the Bank as WELL CAPITALIZED under the regulatory framework for prompt
corrective action. To be categorized as WELL CAPITALIZED Savings must maintain
minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed the institution's category.
F-46
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 14: STOCKHOLDER'S EQUITY (CONTINUED)
The Bank's actual capital amounts and ratios are also presented in the
table. No amount was deducted from capital for interest rate risk.
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------------------------------------------
TO BE
WELL
CAPITALIZED
FOR
PROMPT
MINIMUM FOR CAPITAL CORRECTIVE
ACTION
ACTUAL ADEQUACY PURPOSES PROVISIONS
-------------------- -------------------- ---------
RATIO AMOUNT RATIO AMOUNT RATIO
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Stockholder's equity, and ratio to total assets.................... 7.9% $ 21,003
---------
Intangible assets.................................................. 39
---------
Tangible capital and ratio to adjusted total assets................ 7.9% $ 21,042 1.5% $ 3,980
--------- --------- --------- ---------
--------- ---------
Tier 1 (core) capital and ratio to adjusted total assets........... 7.9% $ 21,042 4.0% $ 10,611 5.0%
--------- --------- --------- --------- ---------
--------- ---------
Tier 1 capital and ratio to risk-weighted assets................... 16.9% $ 21,042 6.0%
--------- --------- ---------
---------
Allowance for loan and lease losses................................ $ 1,642
---------
---------
Subordinated debentures............................................ -
---------
---------
Tier 2 capital..................................................... $ 1,642
---------
---------
Total risk-based capital and ratio to risk-weighted assets......... 18.2% $ 22,684 8.0% $ 9,952 10.0%
--------- --------- --------- --------- ---------
--------- ---------
Total assets....................................................... $ 265,273
---------
---------
Adjusted total assets.............................................. $ 265,312
---------
---------
Risk-weighted assets............................................... $ 124,406
---------
---------
<CAPTION>
AMOUNT
---------
<S> <C>
Stockholder's equity, and ratio to total assets....................
Intangible assets..................................................
Tangible capital and ratio to adjusted total assets................
Tier 1 (core) capital and ratio to adjusted total assets........... $ 13,266
---------
---------
Tier 1 capital and ratio to risk-weighted assets................... $ 7,464
---------
---------
Allowance for loan and lease losses................................
Subordinated debentures............................................
Tier 2 capital.....................................................
Total risk-based capital and ratio to risk-weighted assets......... $ 12,441
---------
---------
Total assets.......................................................
Adjusted total assets..............................................
Risk-weighted assets...............................................
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1997
------------------------------------------------------
TO BE
WELL
CAPITALIZED
FOR
PROMPT
MINIMUM FOR CAPITAL CORRECTIVE
ACTION
ACTUAL ADEQUACY PURPOSES PROVISIONS
--------------------- -------------------- ---------
RATIO AMOUNT RATIO AMOUNT RATIO
--------- ---------- --------- --------- ---------
(DOLLARS IN THOUSANDS, UNAUDITED)
<S> <C> <C> <C> <C> <C>
Stockholder's equity, and ratio to total assets................... 12.8% $ 21,298
---------
Intangible assets................................................. (149)
----------
Tangible capital and ratio to adjusted total assets............... 12.8% $ 21,149 1.5% $ 2,489
--------- ---------- --------- ---------
---------- ---------
Tier 1 (core) capital and ratio to adjusted total assets.......... 12.8% $ 21,149 4.0% $ 6,624 5.0%
--------- ---------- --------- --------- ---------
---------- ---------
Tier 1 capital and ratio to risk-weighted assets.................. 28.0% $ 21,149 6.0%
--------- ---------- ---------
----------
Allowance for loan and lease losses............................... $ 950
----------
----------
Subordinated debentures........................................... -
----------
----------
Tier 2 capital.................................................... $ 950
----------
----------
Total risk-based capital and ratio to risk-weighted assets........ 29.3% $ 22,099 8.0% $ 6,043 10.0%
--------- ---------- --------- --------- ---------
---------- ---------
Total assets...................................................... $ 166,102
----------
----------
Adjusted total assets............................................. $ 165,593
----------
----------
Risk-weighted assets.............................................. $ 75,533
----------
----------
<CAPTION>
AMOUNT
---------
<S> <C>
Stockholder's equity, and ratio to total assets...................
Intangible assets.................................................
Tangible capital and ratio to adjusted total assets...............
Tier 1 (core) capital and ratio to adjusted total assets.......... $ 8,280
---------
---------
Tier 1 capital and ratio to risk-weighted assets.................. $ 4,532
---------
---------
Allowance for loan and lease losses...............................
Subordinated debentures...........................................
Tier 2 capital....................................................
Total risk-based capital and ratio to risk-weighted assets........ $ 7,553
---------
---------
Total assets......................................................
Adjusted total assets.............................................
Risk-weighted assets..............................................
</TABLE>
F-47
<PAGE>
STANDARD PACIFIC SAVINGS, F.A. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996 (UNAUDITED) AND
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
NOTE 15: SUBSEQUENT EVENT
In June 1997, SPC entered into a definitive agreement (the "Agreement") to
sell its ownership in Savings. Under the Agreement, among other things, the SPC
is required to cause Savings to sell or distribute all investment securities not
designated for retention, any and all derivative instruments, all loan
receivables, including accrued interest thereon and rights to service loans for
others and amounts receivable therewith as well as any real estate owned prior
to the closing of the transaction. Additionally, with the exception of those
designated for retention, Federal Home Loan Bank ("FHLB") advances shall be
repaid and investments in FHLB stock shall be reduced to the minimum required by
the FHLB.
F-48
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE PUBLIC OFFERING MADE
HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN
ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN
IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
-----------------
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 9
Price Range of Class A Common Stock and Dividend Policy................... 17
Capitalization............................................................ 18
Selected Consolidated Financial Data...................................... 19
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 21
Business.................................................................. 35
Management................................................................ 58
Principal and Selling Stockholders........................................ 60
Description of Capital Stock.............................................. 62
Shares Eligible for Future Sale........................................... 65
Underwriting.............................................................. 66
Legal Matters............................................................. 67
Experts................................................................... 67
Available Information..................................................... 67
Incorporation of Certain Documents by Reference........................... 68
Index to Financial Statements............................................. F-1
</TABLE>
2,950,000 SHARES
FIRST ALLIANCE
CORPORATION
CLASS A COMMON STOCK
----------------
PROSPECTUS
----------------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
BEAR, STEARNS & CO. INC.
MONTGOMERY SECURITIES
September 12, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
