<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period and nine months ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from_________ to _________
COMMISSION FILE NUMBER 0-28706
-------
FIRST ALLIANCE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0721183
------------------------------- ---------------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
17305 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92614
-----------------------------------------------------------
(Address of principal executive offices including ZIP Code)
(949) 224-8500
------------------------------
(Registrant's telephone number
including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __
As of October 30, 1998 the registrant had outstanding, net of treasury
shares, 18,139,488 shares of Class A Common Stock.
================================================================================
<PAGE> 2
FIRST ALLIANCE CORPORATION
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition (Unaudited)
as of September 30, 1998 and December 31, 1997 .............. 1
Consolidated Statements of Income (Unaudited) for the
quarters and nine months ended September 30, 1998 and 1997... 2
Consolidated Statements of Comprehensive Income (Unaudited)
for the quarters and nine months ended September 30, 1998
and 1997..................................................... 3
Consolidated Statements of Cash Flows (Unaudited) for the
quarters and nine months ended September 30, 1998 and 1997... 4
Notes to Consolidated Financial Statements................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ("MD&A")........................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................ 19
Item 2. Changes in Securities........................................ 19
Item 3. Defaults Upon Senior Securities.............................. 19
Item 4. Submission of Matters to a Vote of Security Holders.......... 19
Item 5. Other Information............................................ 19
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits .......................................... 21
b. Reports on Form 8-K................................ 22
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
--------------- --------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents............................................................... $ 14,032 $ 1,841
Restricted cash......................................................................... 1,071
Receivable from trusts.................................................................. 3,085 4,810
Loans held for sale..................................................................... 54,872 79,918
Warehouse financing receivable.......................................................... 12,324 9,733
Loans receivable held for investment.................................................... 2,082 1,593
Residual interests in securities - at fair value........................................ 50,238 50,296
Mortgage servicing rights............................................................... 9,240 10,067
Property, net........................................................................... 8,587 10,496
Prepaid expenses and other assets....................................................... 3,687 1,829
============== ==============
Total assets......................................................................... $ 158,147 $ 171,654
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facilities.......................................................... $ 57,742 $ 83,889
Accounts payable and accrued liabilities................................................ 4,794 5,883
Deferred taxes/income taxes payable..................................................... 4,334 8,961
-------------- --------------
Total liabilities.................................................................... 66,870 98,733
-------------- --------------
Commitments and contingencies
Stockholders' equity:
Preferred Stock, $.01 per 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: 11,265,375 at December 31, 1997 and 22,186,288 at
September 30, 1998................................................................... 112 223
Class B Common Stock, $.01 par value; 15,000,000 shares authorized; shares issued
and outstanding: 10,956,270 at December 31, 1997.................................... 110
Additional paid in capital.............................................................. 65,321 65,298
Retained earnings....................................................................... 47,110 58,986
Treasury stock - at cost: 1,169,300 shares at December 31, 1997 and 4,046,800 shares at
September 30, 1998.................................................................. (20,544) (51,582)
Deferred stock compensation............................................................. (765)
Foreign currency translation............................................................ (67) (4)
-------------- --------------
Total stockholders' equity........................................................... 91,277 72,921
-------------- --------------
Total liabilities and stockholders' equity......................................... $ 158,147 $ 171,654
============== ==============
</TABLE>
See notes to consolidated financial statements.
1
<PAGE> 4
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Loan origination and sale................................. $ 15,758 $ 15,149 $ 47,544 $ 41,420
Loan servicing and other fees............................. 1,756 1,101 5,611 3,589
Interest and other........................................ 5,881 6,310 14,921 18,731
------------- ------------- ------------- -------------
Total revenue........................................... 23,395 22,560 68,076 63,740
------------- ------------- ------------- -------------
EXPENSE
Compensation and benefits................................. 5,052 6,072 13,958 17,835
Advertising............................................... 1,699 2,947 4,356 7,048
Professional services and other fees ..................... 881 1,194 2,329 3,237
Facilities and insurance.................................. 926 1,194 2,348 3,336
Supplies.................................................. 590 544 1,685 2,090
Depreciation and amortization............................. 275 503 651 1,401
Interest.................................................. 789 2,207 1,501 5,839
Legal..................................................... 374 969 1,153 1,844
Travel and training....................................... 501 339 1,300 1,134
Other..................................................... 202 379 661 841
------------- ------------- ------------- -------------
Total expense........................................... 11,289 16,348 29,942 44,605
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAX PROVISION........................... 12,106 6,212 38,134 19,135
INCOME TAX PROVISION......................................... 3,918 2,379 14,396 7,259
------------- ------------- ------------- -------------
NET INCOME................................................... $ 8,188 $ 3,833 $ 23,738 $ 11,876
============= ============= ============= =============
NET INCOME PER SHARE:
Basic..................................................... $ .38 $ .21 $ 1.08 $ .60
============= ============= ============= =============
Diluted................................................... $ .37 $ .21 $ 1.07 $ .60
============= ============= ============= =============
Weighted average number of common shares outstanding:
Basic..................................................... 21,749,564 18,534,938 21,957,707 19,798,208
Diluted................................................... 21,940,804 18,536,091 22,126,745 19,833,306
</TABLE>
See notes to consolidated financial statements.
2
<PAGE> 5
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
NET INCOME................................................... $ 8,188 $ 3,833 $ 23,738 $ 11,876
OTHER COMPREHENSIVE INCOME, NET OF TAX:
Foreign currency translation adjustment................... (96) 18 (61) 63
------------- ------------- ------------- -------------
COMPREHENSIVE INCOME......................................... $ 8,092 $ 3,851 $ 23,677 $ 11,939
============= ============= ============= =============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 6
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................. $ 8,188 $ 3,833 $ 23,738 $ 11,876
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Capitalized residual interests and mortgage
servicing rights........................................ (6,086) (4,539) (16,474) (18,242)
Deferred income taxes.................................... 166 2,961 2,356 9,490
Net accretion of residual interests in securities........ (660) 2,765 (876) 13,363
Amortization of mortgage servicing rights................ 747 1,277 2,045 3,994
Depreciation and amortization ........................... 275 503 651 1,401
Deferred stock compensation.............................. 205 - 307 42
Accretion of discounts on loans receivable
held for investment.................................... (24) (16) (122) (38)
Foreign currency transaction loss (gain)................. 191 (136) 272 (171)
Loss on sales of property................................ (3) - 36 5
Changes in assets and liabilities:
Restricted cash.......................................... - (445) - (1,071)
Receivable from trusts................................... 542 265 (380) (1,725)
Loans held for sale...................................... (24,817) (10,729) (32,174) (23,664)
Receivable from loan sales (15,388) - (15,388)
Prepaid expenses and other assets........................ (2,262) 816 (1,400) 1,869
Accounts payable and accrued liabilities................. (586) (4,891) 676 989
Income taxes payable..................................... (2,830) (887) (2,058) (4,551)
------------- ------------- ------------- -------------
Net cash provided by (used in) operating activities.... (42,342) (9,223) (38,791) (6,433)
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments (advances) on warehouse financing receivable..... (6,197) (3,281) (13,430) 2,591
Capital expenditures........................................ (3,859) (309) (6,074) (3,289)
Proceeds from sales of property............................. 62 - 423 50
Collections on loans receivable held for investment......... 195 291 710 601
------------- ------------- ------------- -------------
Net cash provided by (used in) investing activities.... (9,799) (3,299) (18,371) (47)
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings on warehouse financing
facilities................................................. 41,958 21,026 41,958 24,765
Purchase of treasury stock.................................. (2,098) (11,759) (7,710) (31,038)
Proceeds from issuance of stock............................. 304 - 628 521
------------- ------------- ------------- -------------
Net cash provided by (used in) financing activities... 40,164 9,267 34,876 (5,752)
------------- ------------- ------------- -------------
Effect of exchange rate changes on cash..................... (152) 23 (164) 41
------------- ------------- ------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS................... (12,129) (3,232) (22,450) (12,191)
CASH AND CASH EQUIVALENTS, beginning of period.............. 17,093 5,073 27,414 14,032
============= ============= ============= =============
CASH AND CASH EQUIVALENTS, end of period.................... $ 4,964 $ 1,841 $ 4,964 $ 1,841
============= ============= ============= =============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 7
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
(DOLLARS IN THOUSANDS)
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
SUPPLEMENTAL INFORMATION:
Interest paid............................................. $ 575 $ 2,123 $ 1,292 $ 5,760
============= ============= ============= =============
Income taxes paid......................................... $ 6,576 $ 117 $ 14,110 $ 2,172
============= ============= ============= =============
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 8
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
NOTE 1. GENERAL
The accompanying unaudited consolidated financial statements, which include
the accounts of First Alliance Corporation ("FACO") and its subsidiaries
(collectively the "Company"), have been prepared in accordance with the
instructions to Form 10-Q and include all information and footnotes required for
interim financial statement presentation. All adjustments (consisting only of
various normal accruals) necessary to present fairly the Company's consolidated
financial position, results of operations and cash flows have been made. All
significant intercompany transactions and balances have been eliminated and
certain reclassifications have been made to prior periods' consolidated
financial statements to conform to the current period presentation. The results
of operations for the nine months ended September 30, 1998 are not necessarily
indicative of the results of operations to be expected for the year ending
December 31, 1998.
The financial information provided herein, including the information under
the heading Item 2 "Management's Discussion and Analysis of Financial Condition
and Results of Operations" ("MD&A"), is written with the presumption that the
users of these interim consolidated financial statements have read, or have
access to, the Company's most recent filing on Form 10-K which contains the
latest available audited consolidated financial statements and notes thereto, as
of and for the period ended December 31, 1997, together with the MD&A for such
period.
HEDGING ACTIVITIES
The Company regularly securitizes and/or sells fixed and variable rate
mortgage loans. As part of its interest rate risk management strategy, the
Company hedges its interest rate risk related to its fixed rate loans held for
sale and origination commitments by selling short or selling forward United
States Treasury Securities. For accounting purposes, short sales of United
States Treasury Securities are not considered to be a hedge. Therefore, when
selling short United States Treasury Securities, the Company recognizes realized
and unrealized gains and losses on hedging activities in the period in which
they occur. The Company classifies forward sales of United States Treasury
Securities as hedges of specific loans held for sale and commitments to fund
loans to be held for sale. The gains and losses derived from these transactions
are deferred and included in the carrying amounts of loans held for sale and are
recognized in earnings upon sale of loans hedged. Gains (losses) recognized on
hedging activities were $(1,250,000) and $(1,270,000) for the quarter and nine
months ended September 30, 1998, respectively, as compared to $30,000 and
$(60,000) for the corresponding periods in 1997. The loss incurred during the
third quarter of 1998 is primarily attributable to a decreasing interest rate
environment experienced during the quarter. The notional amount of forward sales
of United States Treasury Securities was $21.1 million at September 30, 1998
with deferred losses of $313,000.
STOCK REPURCHASE PROGRAM
In April 1997 the Board of Directors approved a share repurchase program
under which the Company was authorized to purchase up to 1.5 million shares of
its Class A Common Stock. In January 1998 and July 1998, the Board of Directors
authorized the purchase of an additional 2.0 million shares and 4.0 million
shares of Class A Common Stock, respectively. Of the 7.5 million shares
authorized, the Company had repurchased approximately 4.0 million shares as of
October 30, 1998.
6
<PAGE> 9
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
NET INCOME PER SHARE
A reconciliation of the numerators and denominators used in basic and
diluted net income per share are as follows for the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income: Basic and diluted (dollars in thousands)........ $ 8,188 $ 3,833 $ 23,738 $ 11,876
============= ============= ============= =============
Weighted average number of common shares:
Basic...................................................... 21,749,564 18,534,938 21,957,707 19,798,208
Effect of dilutive securities - stock options.............. 191,240 1,153 169,038 35,098
============= ============= ============= =============
Diluted.................................................... 21,940,804 18,536,091 22,126,745 19,833,306
============= ============= ============= =============
Net income per share:
Basic .................................................... $ .38 $ .21 $ 1.08 $ .60
Effect of dilutive securities - stock options.............. (.01) - (.01) -
------------- ------------- ------------- -------------
Diluted.................................................... $ .37 $ .21 $ 1.07 $ .60
============= ============= ============= =============
</TABLE>
RECENT DEVELOPMENTS; RISK FACTORS
As a fundamental part of its business and financial strategy, the Company
securitizes the majority of its loans, whereby the Company deposits into a trust
certain loans originated or acquired by the Company in exchange for (i) debt
instruments backed by the loans in the trust and (ii) a residual interest in the
trust. The Company then sells the debt instruments to the public. A significant
portion of the Company's revenues, income and cash flow is generated through
these securitizations. Conditions in the securitization market have deteriorated
in recent months as lenders in the sub-prime sector have suffered a significant
loss of liquidity. As a result, there can be no assurance that the Company will
be able to continue to access the securitization market on the same terms as
previously experienced. Any substantial reduction in the availability of the
securitization market for the Company's loans, or any substantial deterioration
in the terms to the Company of any securitizations, would be likely to have a
material adverse effect on the Company's results of operations and financial
condition.
In November 1998, one of the Company's warehouse lines, a $175 million
facility, expired and was not renewed (see Liquidity and Capital Resources). The
Company, however, has in place a $125 million facility and a 50 UKP million
facility with another warehouse lender, both of which expire in December 1998.
Although management expects that the Company will be able to maintain this
warehouse financing facility, there can be no assurance that the Company will be
able to do so. The Company is therefore continuing to pursue other warehouse
financing facility arrangements. To the extent that the Company is not
successful in maintaining or replacing the existing financing arrangements, the
Company may be forced to curtail its loan production activity which may lead to
significantly reduced loan sales, thereby having a material adverse effect on
the Company's results of operations and financial condition.
In September 1998, the Company was informed by the United States Department
of Justice that it and the Attorneys General of Arizona, Florida, Illinois,
Massachusetts, Minnesota, New York and Washington have initiated a joint
investigation into the lending practices of the Company. That investigation and
any negative findings that may result therefrom could have a significant adverse
effect on the Company's ability to obtain new and renew existing state lending
licenses, which, in turn, could have a significant adverse effect on the
Company's ability to maintain or expand its retail branch network of offices and
on the Company's results of operations and financial condition.
7
<PAGE> 10
The Company is also party to various legal proceedings arising out of the
ordinary course of its business (see Item 1. Legal Proceedings). Any substantial
judgment against the Company in any of these legal proceedings, or the related
legal fees that may be incurred to defend the Company in connection therewith,
could have a material adverse effect on the Company's results of operations and
financial condition.
RECENT ACCOUNTING PRONOUNCEMENTS
Beginning with the first quarter of 1998, the Company adopted Financial
Accounting Standards Board ("FASB") Statement of Financial Accounting Standards
("SFAS") No. 130 "Reporting Comprehensive Income". 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.
In June of 1997, the FASB issued SFAS No. 131 "Disclosures about Segments
of an Enterprise and Related Information" which is effective for annual periods
beginning after December 15, 1997. This statement established standards for the
method that public entities use to 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 products and services, geographical areas, and major customers.
In February 1998, FASB issued SFAS No. 132 "Employers' Disclosure about
Pensions and Other Postretirement Benefits," which is effective for annual and
interim periods beginning after December 15, 1997. This statement standardizes
the disclosure requirements for pensions and other postretirement benefits to
the extent practicable, requires additional information on changes in the
benefit obligations and fair values of plan assets that will facilitate
financial analysis and eliminates certain disclosures that are no longer useful
as they were under previous statements. The adoption of this standard had no
impact on the Company's current presentation of financial statements.
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which is effective for annual and interim
periods beginning after June 15, 1999. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. The
adoption of this standard is not expected to have a material effect on the
Company's financial condition, results of operations and cash flows.
In October 1998, the FASB issued SFAS 134, "Accounting for Mortgage-Backed
Securities Retained After the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise," which will become effective for the first fiscal
quarter beginning after December 15, 1998. This statement requires that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities
based on its ability and intent to sell or hold those investments. The Company
has not yet completed its analysis of the effect this standard will have on the
Company's financial reporting.
8
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
OVERVIEW
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, as of September 30, 1998, was comprised
of 31 offices in the United States (eight of which are located in California,
three of which are located in New Jersey and New York, two of which are located
in each of Illinois, Maryland, and Ohio and one of which is located in each of
Arizona, Colorado, Florida, Georgia, Massachusetts, Minnesota, Oregon,
Pennsylvania, Utah, Virginia and Washington) and three 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 trusts. A significant portion of the Company's loan production is securitized
with the Company retaining the right to service the loans.
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 historically allowed the Company to
generate positive operating cash flow (see Liquidity and Capital Resources).
There can be no assurance, however, that the Company's operating cash flow will
continue to be positive in the future.
In a securitization, the Company exchanges loans for regular interests and
residual interests in trusts. 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 overcollateralization requirements, which are
specific to each securitization and are used as a means of credit enhancement,
have been met.
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 securitized and the residual interests and the 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
securitization and is included in loan origination and sale revenue.
RECENT DEVELOPMENTS
During 1997, the Company entered into an agreement with Fidelity Federal
Bank F.S.B. ("Fidelity"), under which Fidelity issues real estate secured credit
cards ("Credit Cards") that bear the Company's name and that the Company markets
and services. The Company believes that the terms of the Credit Cards, including
the tax deductibility of interest paid on outstanding balances for most
customers, may be attractive to potential borrowers.
The Company markets the Credit Cards using procedures similar to those used
by the Company in originating its mortgage loan products. Many of the
individuals solicited for mortgage loan products are also solicited for the
Credit Cards, thereby resulting in relatively lower marketing expenditures for
the Credit Cards than would otherwise be expected. As of September 30, 1998, the
Company's servicing portfolio of Credit Cards totaled $18.6 million.
9
<PAGE> 12
During the first two quarters of 1998, the Company began securitizing its
loans in the form of owner's trusts. By utilizing this securitization structure,
the Company's securitization of loans were treated as a borrowing for state and
federal tax purposes rather than as a sale. In the third quarter of 1998,
however, the Company decided to securitize its loans in the form of a real
estate mortgage investment conduit trust ("REMIC"), under which the
securitization of loans will be treated as a sale for state and federal tax
purposes.
In April 1998, the Company discontinued its high loan-to-value ("LTV") loan
program because adverse changes in the secondary market for these loans
significantly reduced the profitability of this program. Since the inception of
the program in July 1997, less than $4.0 million of high LTV loans were
originated by the Company.
In June 1998, the Company discontinued its low LTV program. The Company's
decision to discontinue this program is attributable to lower than expected
results in marketing, including lower than expected additional borrowings by
such homeowners. The Company purchased $25.0 million in low LTV loans for the
nine months ended September 30, 1998.
In November 1998, the Company anticipates refinancing its 40,000 square
foot office building in Irvine, and expects to receive proceeds of approximately
$3.7 million, but there can be no assurance that this refinancing will be
achieved.
In November 1998, one of the Company's warehouse lines, a $175 million
facility, expired and was not renewed (see Liquidity and Capital Resources).
LOAN ORIGINATIONS AND PURCHASES
<TABLE>
<CAPTION>
AT OR FOR THE QUARTER AT OR FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loan originations and purchases:
Retail originations........................................ $ 101,467 $ 118,082 $ 283,148 $ 338,850
Wholesale purchases........................................ 45,711 15,955 84,152 63,833
============= ============= ============= =============
Total.................................................... $ 147,178 $ 134,037 $ 367,300 $ 402,683
============= ============= ============= =============
Number of retail branches as of the end of the period:
United States:
California............................................... 7 8
Other states............................................. 20 23
United Kingdom............................................. 4 3
============= =============
Total.................................................... 31 34
============= =============
Weighted average initial interest rate....................... 9.4% 9.3% 9.4% 9.4%
Weighted average initial combined loan-to-value ratio........ 60.9% 67.2% 62.5% 64.9%
Average loan size............................................ $ 85 $ 101 $ 87 $ 92
</TABLE>
Originations and purchases decreased 9% and increased 10% for the quarter
and nine months ended September 30, 1998, respectively, as compared with the
corresponding periods in the prior year. Retail originations increased 16% and
20% for the quarter and nine months ended September 30, 1998, respectively, as
compared with the corresponding periods in the prior year primarily as a result
of the Company's ongoing retail branch expansion. This increase was offset by a
65% and 24% decrease in wholesale purchases for the quarter and nine months
ended September 30, 1998, respectively, primarily due to the discontinuance of
the Company's wholesale low LTV program in the second quarter of 1998.
10
<PAGE> 13
LOAN SALES
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Securitizations.............................................. $ 85,002 $ 100,000 $ 233,005 $ 310,002
Whole loan sales............................................. 37,280 46,009 103,799 110,912
============= ============= ============= =============
Total................................................... $ 122,282 $ 146,009 $ 336,804 $ 420,914
============= ============= ============= =============
</TABLE>
Loan sales, including securitization of loans, increased 19% for the
current quarter as compared to the prior year quarter despite a decrease of 9%
in originations and purchases when compared to the 1997 quarter. This increase
was primarily the result of significant purchases of low LTV loans during the
1997 quarter, which were not included in the securitization for the quarter.
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 QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUE:
Loan origination and sale:
Gain on sale of loans.................................... 21.5% 12.2% 22.7% 12.2%
Net loan origination and other fees...................... 45.8 55.0 47.1 52.8
Loan servicing and other fees.............................. 7.5 4.9 8.2 5.6
Interest and other ........................................ 25.2 27.9 22.0 29.4
------------- ------------- ------------- -------------
Total revenue............................................ 100.0 100.0 100.0 100.0
------------- ------------- ------------- -------------
EXPENSE:
Compensation and benefits.................................. 21.6 26.9 20.5 28.0
Advertising................................................ 7.3 13.1 6.4 11.1
Professional services and other fees ...................... 3.8 5.3 3.4 5.1
Facilities and insurance................................... 3.9 5.3 3.4 5.2
Supplies................................................... 2.5 2.4 2.5 3.3
Depreciation and amortization.............................. 1.2 2.2 1.0 2.2
Interest................................................... 3.4 9.8 2.2 9.2
Legal...................................................... 1.6 4.3 1.7 2.9
Travel and training........................................ 2.1 1.5 1.9 1.8
Other...................................................... .9 1.7 1.0 1.2
------------- ------------- ------------- -------------
Total expense............................................ 48.3 72.5 44.0 70.0
------------- ------------- ------------- -------------
Income before income tax provision......................... 51.7 27.5 56.0 30.0
Income tax provision....................................... 16.7 10.5 21.1 11.4
------------- ------------- ------------- -------------
Net income................................................. 35.0% 17.0% 34.9% 18.6%
============= ============= ============= =============
</TABLE>
11
<PAGE> 14
RESULTS OF OPERATIONS
REVENUE
The following table sets forth the components of the Company's revenue for
the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loan origination and sale:
Gain on sale of loans (1).................................. $ 5,035 $ 2,745 $ 15,471 $ 7,786
Net loan origination and other fees........................ 10,723 12,404 32,073 33,634
Loan servicing and other fees................................ 1,756 1,101 5,611 3,589
Interest and other........................................... 5,881 6,310 14,921 18,731
============= ============= ============= =============
Total revenue............................................ $ 23,395 $ 22,560 $ 68,076 $ 63,740
============= ============= ============= =============
</TABLE>
(1) Excludes net loan origination and other fees.
Total revenues decreased 4% or $0.8 million and 6% or $4.3 million for the
quarter and nine months ended September 30, 1998, respectively, as compared to
the corresponding periods in 1997.
Loan origination and sale revenue decreased $0.6 million and $6.1 million
for the quarter and nine months ended September 30, 1998, respectively, from
$15.8 million and $47.5 million during the corresponding periods in 1997.
Gain on sale of loans decreased $2.3 million and $7.7 million for the
quarter and nine months ended September 30, 1998, respectively, as compared to
the corresponding prior year period. Gain on sale as percent of loans sold
decreased to 1.9% and 1.8% for the quarter and nine months ended September 30,
1998, respectively, as compared to 4.1% and 4.6% during the corresponding prior
year periods. The decrease in gain on sale of loans during the quarter is
primarily related to a reduction in the value of residual interest and mortgage
servicing rights, and increase in losses on hedging activity, which was
partially offset by a decrease in premiums paid on wholesale purchases. The
decrease in the value of residual interest and mortgage servicing rights is
attributable to the widening of the spreads required by investors which purchase
asset-backed securities, and an increase in the Company's constant repayment
rate ("CPR") assumptions, which are based on experienced empirical data (see
Liquidity and Capital Resources). The decrease in gain on sale for the nine
months ended September 30, 1998 is primarily related to a $4.5 million write
down of residual interest in the second quarter of 1998, coupled with a
decreased value of residual interest in the current quarter. The second quarter
write down was a result of an increase in the Company's prepayment rates
primarily related to its adjustable rate loans.
Net loan origination and other fees increased 16% or $1.7 million and 5% or
$1.6 million for the quarter and nine months ended September 30, 1998 as
compared to the same periods in 1997. This increase is attributable to a 35% and
16% increase in retail loans sold for the quarter and nine months ended
September 30, 1998, respectively, as compared to the corresponding prior year
periods. This increase was offset by a decrease in the average gross fees to
13.4% and 13.7% for the quarter and nine months ended September 30, 1998,
respectively, as compared to 14.8% and 14.9% for the corresponding prior year
periods.
Loan servicing and other fees decreased 37% or $0.7 million and 36% or $2.0
million during the quarter and nine months ended September 30, 1998,
respectively, when compared to the corresponding periods in 1997. This decrease
was primarily due to an increase in amortization of mortgage servicing rights.
Amortization of mortgage servicing rights increased $0.5 million and $1.9
million for the quarter and nine months ended September 30, 1998, respectively,
as compared to the corresponding periods in 1997. This increase is primarily the
result of an increase in the average balance of mortgage servicing rights in
1998 as compared to 1997. The increase for the nine months ended September 30,
1998 also included a $0.8 million increase in accelerated amortization caused by
increases in the prepayments of adjustable rate loans.
12
<PAGE> 15
Interest and other income increased 7% or $.04 million and 26% or $3.8
million for the quarter and nine months ended September 30, 1998, respectively,
as compared to the corresponding prior year periods.
Interest income derived from loans held for sale increased 40% or $0.7
million and 88% or $3.6 million for the quarter and nine months ended September
30, 1998, respectively, as compared with the corresponding prior year periods.
This increase in interest was a direct result of an increase in the average
balance of loans held for sale, due primarily to a growing United Kingdom
portfolio when compared to the prior year periods.
Interest income and other income, excluding interest earned on loans held
for sale, decreased $0.2 million and increased $0.3 million for the quarter and
nine months ended September 30, 1998, respectively, as compared to the
corresponding prior year periods. The decrease for the quarter and the increase
for the nine months ended September 30, 1998 is due to a $1.2 million and $2.2
million increase, respectively, in other income, primarily due to the Company's
credit card operations, which commenced activity in the fourth quarter of 1997.
This was offset by a $1.4 million and $1.9 million decrease in recognition of
interest income from residual interest for the quarter and nine months ended
September 30, 1998, respectively.
EXPENSE
The following table sets forth the components of the Company's expense for
the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Compensation and benefits.................................... $ 5,052 $ 6,072 $ 13,958 $ 17,835
Advertising.................................................. 1,699 2,947 4,356 7,048
Professional services and other fees......................... 881 1,194 2,329 3,237
Facilities and insurance..................................... 926 1,194 2,348 3,336
Supplies..................................................... 590 544 1,685 2,090
Depreciation and amortization................................ 275 503 651 1,401
Interest..................................................... 789 2,207 1,501 5,839
Legal........................................................ 374 969 1,153 1,844
Travel and training.......................................... 501 339 1,300 1,134
Other........................................................ 202 379 661 841
============= ============= ============= =============
Total expense.............................................. $ 11,289 $ 16,348 $ 29,942 $ 44,605
============= ============= ============= =============
</TABLE>
Total expense increased 45% or $5.1 million and 49% or $14.7 million for
the quarter and nine months ended September 30, 1998, respectively, as compared
with the corresponding periods in 1997.
The increase in compensation and benefits of 20% or $1.0 million and 28% or
$3.9 million for the quarter and nine months ended September 30, 1998,
respectively, as compared to the corresponding periods in 1997, is the result of
an increase in personnel to support the Company's retail branch expansion and
the Company's credit card operations.
Advertising expense increased 74% or $1.2 million and 62% or $2.7 million
for the quarter and nine months ended September 30, 1998, respectively, as
compared to the corresponding periods in 1997. This increase is primarily
related to an increase in marketing activity, including purchases of marketing
databases associated with the Company's retail branch expansion and credit card
operations.
Professional services and other fees increased 36% or $0.3 million and 39%
or $0.9 million for the quarter and nine months ended September 30, 1998,
respectively, as compared to the corresponding periods in 1997, primarily due to
costs incurred under the Company's credit card program.
13
<PAGE> 16
Combined, facilities and insurance, supplies and depreciation and
amortization increased 25% or $0.5 million and 46% or $2.1 million for the
quarter and nine months ended September 30 1998, respectively, as compared to
corresponding prior year periods. This increase is primarily attributable to the
increase in the number of retail branches and the Company's new centralized
telemarketing facility. The Company increased its number of retail branches from
31 at September 30, 1997 to 34 at September 30, 1998.
Interest expense increased 180% or $1.4 million and 289% or $4.3 million
for the quarter and nine months ended September 30, 1998, respectively, as
compared to the corresponding periods in 1997. This is primarily due to an
increase in interest expense on the warehouse financing facilities. The increase
in interest expense related to the Company's warehouse financing facility is
primarily the result of an increase in the average warehouse financing balance
over 1997, due to an increase in the balance of loans held for sale.
Additionally, the weighted average interest rate on the warehouse financing
facility increased in 1998 when compared to 1997. The increase in the weighted
average interest rate is due to an increase in the proportion of United Kingdom
loans, which carry a higher cost of funds, included in the loans held for sale
balance during 1998 as compared to 1997. The September 30, 1998 loans held for
sale balance consisted of approximately 64% in United Kingdom originated loans
compared to approximately 35% at September 30, 1997.
INCOME TAXES
The Company's estimated tax rate for the nine months ended September 30,
1998 and September 30, 1997 were 38.30% and 37.75%, respectively.
During the first two quarters of 1998, the Company's securitization was in
the form of owner's trusts. Under this securitization structure, the
securitization of loans will be treated as a borrowing for state and federal tax
purposes rather than as a sale. In the third quarter of 1998, however, the
Company decided to securitize its loans in the form of a REMIC, under which the
securitization of loans will be treated as a sale for state and federal tax
purposes.
14
<PAGE> 17
SERVICING
The following tables provide data on loan delinquency, real estate owned
(REO) and net losses for the Company's servicing portfolio:
<TABLE>
<CAPTION>
UNITED STATES AS OF
----------------------------------------------------------------------------------
SEPTEMBER 30, 1997 DECEMBER 31, 1997 SEPTEMBER 30, 1998
--------------------------- --------------------------- --------------------------
% of % of % of
(Dollars in Servicing (Dollars in Servicing (Dollars in Servicing
Thousands) Portfolio Thousands) Portfolio Thousands) Portfolio
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Servicing portfolio................... $ 728,623 $ 769,733 $ 800,282
============ ============ ============
30-59 days delinquent................. $ 8,429 1.2% 7,718 1.0% 6,802 0.9%
60-89 days delinquent................. 5,644 0.8% 7,521 1.0% 3,685 0.5%
90 days or more delinquent............ 16,852 2.3% 16,935 2.2% 19,478 2.4%
------------ ------------ ------------ ------------ ------------ ------------
Total delinquencies................ $ 30,925 4.2% $ 32,174 4.2% $ 29,965 3.7%
============ ============ ============ ============ ============ ============
UNITED KINGDOM AS OF
----------------------------------------------------------------------------------
SEPTEMBER 30, 1997 DECEMBER 31, 1997 SEPTEMBER 30, 1998
--------------------------- --------------------------- --------------------------
% of % of % of
(Dollars in Servicing (Dollars in Servicing (Dollars in Servicing
Thousands) Portfolio Thousands) Portfolio Thousands) Portfolio
------------ ------------ ------------ ------------ ------------ ------------
Servicing portfolio................... $ 16,550 $ 29,352 $ 57,202
============ ============ ============
30-59 days delinquent................. - 0.0% $ 276 0.9% $ 1,726 3.0%
60-89 days delinquent................. - 0.0% 133 0.5% 719 1.3%
90 days or more delinquent............ 773 4.7% 443 1.5% 4,134 7.2%
------------ ------------ ------------ ------------ ------------ ------------
Total delinquencies................ $ 773 4.7% $ 852 2.9% $ 6,579 11.5%
============ ============ ============ ============ ============ ============
COMBINED AS OF
----------------------------------------------------------------------------------
SEPTEMBER 30, 1997 DECEMBER 31, 1997 SEPTEMBER 30, 1998
--------------------------- --------------------------- --------------------------
% of % of % of
(Dollars in Servicing (Dollars in Servicing (Dollars in Servicing
Thousands) Portfolio Thousands) Portfolio Thousands) Portfolio
------------ ------------ ------------ ------------ ------------ ------------
Servicing portfolio................... $ 745,173 $ 799,085 $ 857,484
============ ============ ============
30-59 days delinquent................. $ 8,429 1.1% $ 7,994 1.0% $ 8,528 1.0%
60-89 days delinquent................. 5,644 0.8% 7,654 0.9% 4,404 0.5%
90 days or more delinquent............ 17,625 2.4% 17,378 2.2% 23,612 2.8%
------------ ------------ ------------ ------------ ------------ ------------
Total delinquencies................ $ 31,698 4.3% $ 33,026 4.1% $ 36,544 4.3%
============ ============ ============ ============ ============ ============
REO (1) ............................. $ 2,652 0.4% $ 1,688 0.2% $ 1,921 0.2%
============ ============ ============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------------------------------------------
1997 1998 1997 1998
------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Average servicing portfolio balance outstanding (2).......... $ 718,708 $ 854,757 $ 683,861 $ 840,284
Net losses................................................... $ 531 $ 273 $ 1,531 $ 673
Percentage of average servicing portfolio - annualized....... 0.30% 0.13% 0.30% 0.11%
</TABLE>
(1) Includes REO of the Company as well as REO of the securitization 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 balances at the
beginning and end of each quarter.
15
<PAGE> 18
LIQUIDITY AND CAPITAL RESOURCES
Increased competition in the sub-prime mortgage industry has driven down
the interest rates charged to sub-prime borrowers, thereby decreasing the value
of such loans. Recent volatility in the capital markets has had a material
adverse effect on the credit available to the sub-prime lending and investment
industries. In order to generate additional cash resources for further lending
and investment, and in order to meet their own debt obligations, companies in
these industries have been forced to dispose of their portfolios of loans and
mortgage-backed securities that were intended for longer term investment. These
factors have contributed to a significant decline in the value of
mortgage-backed securities and underlying loans.
The declining value of sub-prime mortgage loans has also led warehouse
lenders, who hold such loans as collateral for their lines of credit, to place
margin calls (a cash demand reducing the outstanding line balance based on the
current market value of the security). Consequently, this tightening of credit
and lack of liquidity has forced sub-prime lenders to incur significant losses
and, in some instances, to ultimately file bankruptcy.
The Company's ability to continue to originate and purchase loans is
dependent upon adequate credit facilities and upon its ability to sell 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. The current market environment described above has
adversely affected the Company's ability to maintain its current sources of
financing or to obtain new sources of financing. These factors have also
adversely affected the Company's ability to complete securitizations on the same
terms as previously experienced in recent periods. The Company's inability to
complete a securitization in a calendar quarter will have a material adverse
effect on the Company's results of operations for that quarter. A prolonged
duration of the current market environment is likely to adversely affect the
Company's ability to make or purchase loans and its ability to sell loans in the
secondary market, with a consequent adverse impact on the Company's results of
operations and financial condition.
Although the Company has thus far been able to meet its margin call
requirements without materially compromising its cash position, one of the
Company's warehouse lenders has decided not to renew the warehouse financing
facility which expired in November. The Company, however, has in place a $125
million facility and a (pound)50 million facility with another warehouse lender,
both of which expire in December 1998. Although management expects that the
Company will be able to maintain this warehouse financing facility, there can be
no assurance that the Company will be able to do so. The Company is
therefore continuing to pursue other warehouse financing facility arrangements.
To the extent that the Company is not successful in maintaining or replacing the
existing financing arrangements, the Company may be forced to curtail its loan
production activity which may lead to significantly reduced loan sales, thereby
having a material adverse effect on the Company's results of operations and
financial condition.
Historically, the Company has generated positive cash flow. The Company's
sources of cash include loan sales, sales of regular interests, borrowings under
its warehouse financing facilities, distributions received from residual
interests, interest income and loan servicing income. The Company's uses of cash
include the funding of loan originations and purchases, payments of interest,
repayment of its warehouse financing facilities, capital expenditures, operating
and administrative expenses and payment of income taxes.
16
<PAGE> 19
The Company generated operating cash flow of $5.8 million and $17.2 million
in the quarter and nine months ended September 30, 1998, respectively, and $0.2
million and $9.9 million for the corresponding 1997 period. The following table
shows the computation of operating cash flow and provides a reconciliation of
operating cash flow to net cash provided by operating activities as it is
included in the consolidated statements of cash flows for the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1997 1998 1997 1998
------------- ----------------------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Net income................................................... $ 8,188 $ 3,833 $ 23,738 $ 11,876
Non-cash adjustments to reconcile net income to operating
cash flow:
Capitalized residual interests and mortgage
Servicing rights........................................... (6,086) (4,539) (16,474) (18,242)
Net accretion of residual interests in securities.......... (660) 2,765 (876) 13,363
Amortization of mortgage servicing rights.................. 747 1,277 2,045 3,994
Deferred income taxes/income taxes payable................. (2,664) 2,074 298 4,939
Depreciation and amortization.............................. 275 503 651 1,401
Other...................................................... 369 (152) 492 (162)
------------- ------------- ------------- -------------
Operating cash flow.......................................... $ 169 $ 5,761 $ 9,874 $ 17,169
============= ============= ============= =============
Reconciliation to consolidated statements of cash flows:
Operating cash flow........................................ $ 169 $ 5,761 $ 9,874 $ 17,169
Increase in loans held for sale.......................... (24,817) (10,729) (32,174) (23,664)
Changes in other assets and liabilities.................... (17,694) (4,255) (16,491) 62
------------- ------------- ------------- -------------
Net cash used by operating activities........................ $ (42,342) $ (9,223) $ (38,791) $ (6,433)
============= ============= ============= =============
</TABLE>
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 substantially
all of the loan origination and processing fees in cash at the time of the
warehouse financing facility borrowing.
As of September 30, 1998, the Company's warehouse financing facilities
consisted of three separate agreements: a $175 million facility, a $125 million
facility and a (pound)50 million facility. The Company's $175 million master
repurchase agreement, which was secured by loans originated or purchased by the
Company and bore interest at a rate ranging from 0.25% to 0.50% over 30 day US
dollar denominated London Interbank Offered Rate ("LIBOR"), expired in November
1998, and was not renewed. The Company's $125 million warehouse financing
facility is secured by loans originated or purchased by the Company and
currently bears interest at a rate of 0.80% over the 30 day US dollar
denominated LIBOR, and expires December 1998. The Company's (pound)50 million
credit facility 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, and expires December 1998.
In February 1997, the Company entered into master repurchase agreements to
provide warehouse financing facilities to two mortgage banking companies
("Borrowers") that are controlled by related parties. These facilities were
secured by loans originated by the Borrowers and by personal guarantees provided
by stockholders of the Borrowers, bore interest at 10% per annum, and had a
combined borrowing limit of $20 million. As of September 30, 1998, an aggregate
of $9.7 million was outstanding on these lines. In November 1998, subsequent to
receiving full repayment on the outstanding warehouse line balance, the Company
terminated these arrangements with the Borrowers.
As a part of the Company's credit card program, the Company is required to
maintain a cash balance restricted for the purpose of reserving for credit
losses. The Company had a cash balance of $1.1 million related to this at
September 30, 1998.
17
<PAGE> 20
As of September 30, 1998 the Company had commitments to fund loans of $18.1
million. Historically, approximately 55% of such commitments have ultimately
been funded.
Capital expenditures totaled $0.3 million and $3.3 million for the quarter
and nine months ended September 30, 1998, respectively, as compared to $3.9
million and $6.1 million for the corresponding periods in 1997. In the first
quarter of 1998, the Company's new telemarketing center was opened in a 40,000
square foot office building in Irvine, California which the Company purchased in
July 1997.
YEAR 2000
The Year 2000 issue is the result of computer programs written using two
digits rather than four digits to define the applicable year. Any of the
Company's internal use computer programs and hardware, as well as its software,
that are date sensitive may recognize a date using the two digits "00" as the
year 1900 rather than the year 2000. Failure to correct the Year 2000 problem
could result in miscalculation of data, causing a disruption of operations
including, among other things, an inability to process transactions or engage in
normal business. Such failure could materially and adversely affect the
Company's results of operations and financial condition.
The Company has implemented a formal five-step plan in order to address the
Year 2000 issue: (1) Awareness, (2) Inventory, (3) Assessment, (4) Renovation,
and (5) Testing and Implementation. The plan addresses hardware and software
purchased or leased from outside vendors, in-house developed software,
telecommunication equipment and facilities. The first three steps of the plan
have been completed and, thus far, the Company has been required to replace or
renovate only a small amount of older computer equipment to comply with the Year
2000 issue. The Company expects to complete the last two steps of the plan by
the second quarter of 1999. Because the majority of the Company's computer
software and hardware has been purchased or developed recently and was designed
to be Year 2000 compliant, the Company does not expect its costs to be material
in addressing the Year 2000 issue.
The Company has initiated formal communications with its significant
outside vendors to determine the extent to which the Company may be vulnerable
in the event that those parties fail to properly address their own Year 2000
issue. While the Company is not presently aware of any significant exposure,
there can be no assurance that the systems of third parties on which the Company
relies will be converted in a timely manner. Currently, the Company does not
have a formal contingency plan in place, but is in the process of completing a
plan.
18
<PAGE> 21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June 1998, Leon Rasachack and Philip A. Ettedgui filed a class action
suit on behalf of all purchasers of the Company's Class A common stock between
April 24, 1997 through May 15, 1998. The suit was filed in the Superior Court of
California in the County of Orange against the Company, Brian Chisick, Sarah
Chisick and Mark Mason. The complaint alleges that the Company conspired against
the purchasers of the stock during the class period by failing to disclose known
material adverse conditions in making certain public statements about the
Company's growth prospects for the future. The plaintiffs in this class action
suit are seeking an unspecified amount for damages.
In September 1998, the Company was informed by the United States Department
of Justice that it and the Attorneys General of Arizona, Florida, Illinois,
Massachusetts, Minnesota, New York and Washington have initiated a joint
investigation into the lending practices of the Company. The investigation seeks
to determine whether the Company has engaged in any violation of fair housing,
fair lending, or any other consumer protection laws. The investigation is in its
very early stages, and negotiations are currently underway to determine the
scope of the inquiry.
In October 1998, the Attorney General of Massachusetts filed an action on
behalf of the Commonwealth against the Company in the Superior Court of
Massachusetts, in the County of Suffolk. The suit seeks to enjoin the Company
from charging rates, points and other terms which significantly deviate from
industry-wide standards or which are otherwise unconscionable or unlawful. The
Attorney General seeks injunctive relief and also seeks restitution for all
consumers, civil penalties, and the costs of investigating and prosecuting the
action, including attorneys' fees.
The Company is also a party to various legal proceedings arising out of the
ordinary course of its business including 18 lawsuits alleging misleading
lending practices, some of which have been filed either as a class action or
under private attorney general statutes. In one of these cases there is a motion
pending filed by the American Association of Retired Persons to join as a party
plaintiff and to amend the complaint seeking damages including revocation of
business licenses and disgorgement of profits.
ITEM 2. CHANGES IN SECURITIES
In July, the Company announced that Brian Chisick, Chairman and Chief
Executive Officer, converted all of his Class B Common Stock to which four votes
per share applies in matters requiring a stockholder vote, into Class A Common
Stock, which carries one vote per share.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
Effective June 30, 1998 Edwin Summers resigned as Vice President, General
Counsel and Corporate Secretary of the Company.
Effective June 30, 1998 the Company appointed Richard Taylor as General
Counsel and Corporate Secretary of the Company.
19
<PAGE> 22
Effective July 20, 1998 the Company appointed Francisco Nebot as
Executive Vice President and Chief Financial Officer of the Company.
Effective August 4, 1998 George Gibbs, Jr. resigned as a member of the
Board of Directors of the Company.
Effective October 26, 1998 the Company appointed Wendy Rianda as Vice
President and General Counsel of the Company.
Effective October 26, 1998 Richard Taylor resigned as General Counsel and
Corporate Secretary of the Company.
Effective October 26, 1998 the Company appointed Susan Linder as Corporate
Secretary of the Company.
<PAGE> 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
--- ----------------------
3.1 Certificate of Incorporation of the Company (Incorporated by
reference to Exhibit 3.1 to the Company's Registration Statement on Form
S-1, Commission File No. 333-3633)
3.2 Bylaws of the Company (Incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-1, Commission File
No. 333-3633)
4.1 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1 to
the Company's Registration Statement on Form S-1, Commission File No.
333-3633)
4.1.1 Form of Incentive Stock Option Agreement for use with 1996 Stock
Incentive Plan (Incorporated by reference to Exhibit 4.1.1 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1996, Commission File No. 0-28706)
4.1.2 Form of Non-qualified Stock Option Agreement for use with 1996 Stock
Incentive Plan (Incorporated by reference to Exhibit 4.1.2 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1996, Commission File No. 0-28706)
10.1 Warehouse Financing Facility dated October 29, 1993 (Incorporated
by reference to Exhibit 10.1 to the Company's Registration Statement on
Form S-1, Commission File No. 333-3633)
10.2 Form of Pooling and Servicing Agreement (Incorporated by reference
to Exhibit 10.2 to the Company's Registration Statement on Form S-1,
Commission File No. 333-3633)
10.3 Corporate Headquarters Lease (Incorporated by reference to Exhibit
10.3 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.4 S Distribution Notes (Incorporated by reference to Exhibit 10.4 to the
Company's Registration Statement on Form S-1, Commission File
No. 333-3633)
10.5 Mason Employment Agreement (Incorporated by reference to Exhibit
10.5 to the Company's Registration Statement on Form S1, Commission
File No. 333-3633)
10.5.1 Mason Loan (Incorporated by reference to Exhibit 10.5.1 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1996,
Commission File No. 0-28706)
10.6 Form of Directors' and Officers' Indemnity Agreement (Incorporated by
reference to Exhibit 10.7 to the Company's Registration Statement on
Form S-1, Commission File No. 333-3633)
10.7 Master Repurchase Agreement dated as of October 31, 1997 between
Nationscapital Mortgage Corporation and the Company (Incorporated by
reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997, Commission File No. 0-28706)
10.8 Master Repurchase Agreement dated as of October 31, 1997 between Coast
Security Mortgage Inc. and the Company (Incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, Commission File No. 0-28706)
10.9 Chisick Employment Agreement (Incorporated by reference to Exhibit
10.10 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.10 Reimbursement Agreement (Incorporated by reference to Exhibit 10.11
to the Company's Registration Statement on Form S-1, Commission File
No. 333-3633)
10.11 Warehouse Financing Facility dated September 5, 1996 (Incorporated by
reference to Exhibit 10.12 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1996, Commission File No.
0-28706)
10.12 Interim Warehouse and Security Agreement dated as of February 15, 1997
between Nationscapital Mortgage Corporation and the Company
(Incorporated by reference to Exhibit 10.12 to the Company's Quarterly
Report on Form 10-Q for the period ended March 31, 1997, Commission File
No. 0-28706)
10.13 Interim Warehouse and Security Agreement dated as of February 15, 1997
between Coast Security Mortgage Inc. and the Company (Incorporated by
reference to Exhibit 10.13 to the Company's Quarterly Report on Form
10-Q for the period ended March 31, 1997, Commission File No. 0-28706)
21
<PAGE> 24
10.14 Smith Loan (Incorporated by reference to Exhibit 10.14 to the Company's
Quarterly Report on Form 10-Q for the period ended March 31, 1997,
Commission File No. 0-28706)
10.15 Building Purchase and Sale Agreement between Amresco Residential
Mortgage Corporation and the Company (Incorporated by reference to
Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the
period ended September 30, 1997, Commission File No. 0-28706)
10.16 Warehouse Credit Facility Agreement dated August 18, 1997 between
Prudential Securities Credit Corporation and the Company (Incorporated
by reference to Exhibit 10.16 to the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1997, Commission File No.
0-28706)
10.17 Master Repurchase Agreement dated as of October 27, 1997 between First
Union National Bank and the Company (Incorporated by reference to
Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, Commission File No. 0-28706)
10.18 Amendment to Warehouse Credit Facility Agreement dated August 18,
1997 between Prudential Securities Credit Corporation and the Company.
(Incorporated by reference to Exhibit 10.18 to the Company's quarterly
report on Form 10-Q for the period ended March 31, 1998, Commission
File No. 0-28706)
27 Financial Data Schedule *
- -----------------
* Filed herewith.
(b) Reports on Form 8-K:
None
22
<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST ALLIANCE CORPORATION
REGISTRANT
Date: November 16, 1998 /s/ BRIAN CHISICK
------------------------------- -------------------------------------
Brian Chisick
President and Chief Executive Officer
Date: November 16, 1998 /s/ FRANCISCO NEBOT
------------------------------- -------------------------------------
Francisco Nebot
Executive Vice President
Chief Financial Officer
23
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