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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, 1999
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
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FIRST ALLIANCE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0721183
- ------------------------------- ---------------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
17305 VON KARMAN AVENUE, IRVINE, CALIFORNIA 92614
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(Address of principal executive offices 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 29, 1999, the registrant had outstanding, net of treasury
shares, 18,139,488 shares of Class A Common Stock.
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<TABLE>
FIRST ALLIANCE CORPORATION
INDEX
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition (Unaudited) as of
September 30, 1999 and December 31, 1998 ......................................... 1
Consolidated Statements of Income (Unaudited) for the quarters
and nine months ended September 30, 1999 and 1998................................. 2
Consolidated Statements of Comprehensive Income (Unaudited)
for the quarters and nine months ended September 30, 1999 and 1998................ 3
Consolidated Statements of Cash Flows (Unaudited) for the quarters
and nine months ended September 30, 1999 and 1998................................. 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.............................................................. 20
Item 3. Defaults Upon Senior Securities.................................................... 20
Item 4. Submission of Matters to a Vote of Security Holders................................ 20
Item 5. Other Information.................................................................. 20
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits................................................................ 21
b. Reports on Form 8-K..................................................... 22
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS)
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents............................................................... $ 10,982 $ 18,052
Restricted cash......................................................................... 2,467 1,281
Receivable from trusts.................................................................. 3,314 4,652
Loans held for sale..................................................................... 30,677 24,421
Loans receivable held for investment.................................................... 1,086 57,667
Residual interests in securities - at fair value........................................ 46,408 48,720
Mortgage servicing rights............................................................... 8,893 10,033
Property, net........................................................................... 8,568 9,733
Goodwill 3,098
Prepaid expenses and other assets....................................................... 2,048 3,044
------------- -------------
Total assets......................................................................... $ 117,541 $ 177,603
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse financing facility............................................................ $ 19,241 $ 17,539
Secured term loan facility - related party.............................................. 64,720
Other borrowings........................................................................ 6,545
Accounts payable and accrued liabilities................................................ 8,777 5,757
Deferred taxes/income taxes payable..................................................... 4,932 8,441
Notes payable........................................................................... 4,649 14
------------- -------------
Total liabilities.................................................................... $ 37,599 $ 103,016
------------- -------------
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; 50,000,000 shares authorized; shares issued
and outstanding: 22,186,288 at September 30, 1999 and at December 31, 1998........... 223 223
Additional paid in capital.............................................................. 65,813 65,298
Retained earnings....................................................................... 65,411 61,326
Treasury stock - at cost: 4,046,800 shares at September 30, 1999 and at
December 31, 1998.................................................................... (51,582) (51,582)
Accumulated other comprehensive income.................................................. 77 (678)
------------- -------------
Total stockholders' equity........................................................... 79,942 74,587
------------- -------------
Total liabilities and stockholders' equity......................................... $ 117,541 $ 177,603
============= =============
</TABLE>
See notes to consolidated financial statements.
1
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<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------- ---------------------------
1999 1998 1999 1998
----------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Loan origination and sale................................. $ 15,173 $ 15,149 $ 40,132 $ 41,420
Interest.................................................. 2,745 5,120 10,915 16,487
Loan servicing and other fees............................. 635 2,291 3,578 5,833
----------- ------------ ------------ ------------
Total revenue........................................... 18,553 22,560 54,625 63,740
----------- ------------ ------------ ------------
EXPENSE:
Compensation and benefits................................. 6,434 6,072 17,165 17,835
Advertising............................................... 1,609 2,947 5,380 7,048
Professional services and other fees ..................... 673 1,194 2,042 3,237
Facilities and insurance.................................. 1,655 1,194 3,621 3,336
Supplies.................................................. 550 544 1,363 2,090
Depreciation and amortization............................. 663 503 1,617 1,401
Interest.................................................. 2,265 2,207 9,141 5,839
Legal..................................................... 1,474 969 5,186 1,844
Travel and training....................................... 434 339 1,096 1,134
Other..................................................... 355 379 1,204 841
----------- ------------ ------------ ------------
Total expense........................................... 16,112 16,348 47,815 44,605
----------- ------------ ------------ ------------
INCOME BEFORE INCOME TAX PROVISION........................... 2,441 6,212 6,810 19,135
INCOME TAX PROVISION......................................... 976 2,379 2,725 7,259
----------- ------------ ------------ ------------
NET INCOME................................................... $ 1,465 $ 3,833 $ 4,085 $ 11,876
=========== ============ ============ ============
NET INCOME PER SHARE:
Basic..................................................... $ .08 $ .21 $ .23 $ .60
=========== ============ ============ ============
Diluted................................................... $ .08 $ .21 $ .22 $ .60
=========== ============ ============ ============
WEIGHTED AVERAGE NUMBER OF COMMON
Basic..................................................... 18,139,488 18,534,938 18,139,488 19,798,208
Diluted................................................... 18,139,488 18,536,091 18,156,453 19,833,306
</TABLE>
See notes to consolidated financial statements.
2
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<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
NET INCOME................................................... $ 1,465 $ 3,833 $ 4,085 $ 11,876
OTHER COMPREHENSIVE INCOME, NET OF TAX:
Foreign currency translation adjustment net of income
taxes of $249 and $11 and $1,089 and $38 for the
quarters and nine months ended September 30, 1999
and 1998, respectively.................................. (373) 18 (1,633) 63
Less: Reclassification adjustment for foreign currency
transaction loss, net of income taxes of $1,592 for the
quarter and nine months ended September 30, 1999........ 2,388 2,388
---------- ---------- ---------- ----------
COMPREHENSIVE INCOME......................................... $ 3,480 $ 3,851 $ 4,840 $ 11,939
========== ========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
3
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<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................................... $ 1,465 $ 3,833 $ 4,085 $ 11,876
Adjustments to reconcile net income to net cash provided by
operating activities:
Capitalized residual interests and mortgage servicing rights.. (5,711) (4,539) (13,406) (13,742)
Accretion of residual interests in securities................. (1,015) (1,833) (3,141) (6,790)
Collection of residual interests in securities................ 5,142 4,598 15,164 15,653
Amortization of mortgage servicing rights..................... 1,529 1,277 4,835 3,994
Amortization of debt issuance costs........................... 679 2,037
Amortization of goodwill...................................... 78 78
Depreciation and amortization of property..................... 585 503 1,539 1,401
Deferred stock compensation................................... 42
Accretion of discounts on loans receivable.................... (16) (38)
Recognition of deferred fees on loans receivable held for 3 (794)
Provision for loan losses..................................... 70 383
Foreign currency transaction gain............................. (136) (171)
Loss (gain) on sale of property............................... (28) 38 5
Gain on sale of United Kingdom loan portfolio................. (1,263) (1,263)
Changes in assets and liabilities, net of effects from
Restricted cash............................................... (502) (445) (1,186) (1,071)
Receivable from trusts........................................ 295 265 1,262 (1,725)
Loans held for sale........................................... (14,644) (10,729) (6,943) (23,664)
Prepaid expenses and other assets............................. (369) 816 33 1,869
Accounts payable and accrued liabilities...................... (1,269) (4,891) 2,519 999
Deferred taxes/income taxes payable........................... 391 2,074 (4,000) 4,939
------------- ------------- ------------- -------------
Net cash provided by (used in) operating activities......... (14,564) (9,223) 1,240 (6,423)
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments (advances) on warehouse financing receivable.......... (3,281) 2,591
Capital expenditures............................................. (109) (309) (165) (3,289)
Proceeds from sale of property................................... 40 62 50
Collections on loans receivable held for investment.............. 160 291 13,500 601
Proceeds from sale of United Kingdom loan portfolio.............. 44,039 44,039
Payments for acquisition of Coast Security Mortgage, less cash (2,641) (2,641)
------------- ------------- ------------- -------------
Net cash provided by (used in) investing activities......... 41,489 (3,299) 54,795 (47)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) on warehouse financing facilities.... 10,697 21,026 (12,054) 24,765
Repayment of secured term loan facility from sale of United
loan portfolio................................................ (50,964) (50,964)
Repayments to other borrowings................................... (6,545)
Purchase of treasury stock....................................... (11,759) (31,038)
Proceeds from issuance of stock.................................. 521
Net borrowings (repayments) on notes payable..................... (35) 3,635 (10)
------------- ------------- ------------- -------------
Net cash provided by (used in) financing activities......... (40,302) 9,267 (65,928) (5,762)
------------- ------------- ------------- -------------
Effect of exchange rate changes on cash.......................... 2,398 23 2,823 41
------------- ------------- ------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (10,979) (3,232) (7,070) (12,191)
CASH AND CASH EQUIVALENTS, beginning of period................... 21,961 5,073 18,052 14,032
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS, end of period......................... $ 10,982 $ 1,841 $ 10,982 $ 1,841
============= ============= ============= =============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
<TABLE>
FIRST ALLIANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(DOLLARS IN THOUSANDS)
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
SUPPLEMENTAL INFORMATION:
Interest paid.................................................... $ 4,773 $ 2,123 $ 8,282 $ 5,760
========== ========== ========== ==========
Income taxes paid................................................ $ 514 $ 117 $ 6,653 $ 2,172
========== ========== ========== ==========
SUPPLEMENTAL INFORMATION ON NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Transfer of loans held for sale to loans receivable held for
Investment.................................................... $ 468 $ - $ 687 $ -
========== ========== ========== ==========
Transfer of loans held for investment to real estate owned....... $ - $ - $ 55 $ -
========== ========== ========== ==========
Stock warrants issued as debt issuance costs..................... $ - $ - $ 515 $ -
========== ========== ========== ==========
Notes payable issued in connection with Coast Security
Mortgage acquisition.......................................... $ 1,000 $ - $ 1,000 $ -
========== ========== ========== ==========
COMPONENTS OF EFFECT OF EXCHANGE RATE
CHANGES ON CASH:
Receivable from trusts........................................ $ 3
Loans held for sale........................................... $ (1,080) $ (1,521)
Loans receivable held for investment.......................... $ (906) 1,576
Property...................................................... 4 (5) 2 (11)
Prepaid expenses and other assets............................. (11) (5) 11 (11)
Warehouse financing facilities................................ 966 1,382
Accounts payable and accrued liabilities...................... 41 14 (15) 17
Deferred taxes/income taxes payable........................... 1,255 (21) 491 (49)
Foreign currency transaction gain............................. 136 171
Accumulated other comprehensive income........................ 2,015 18 755 63
---------- ---------- ---------- ----------
Net effect of exchange rate changes on cash............... $ 2,398 $ 23 $ 2,823 $ 41
========== ========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
FIRST ALLIANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
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, 1999 are not necessarily
indicative of the results of operations to be expected for the year ending
December 31, 1999.
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, 1998, together with the MD&A for such
period.
HEDGING ACTIVITIES
Between the time of loan funding and loan sale or securitization, the
Company has exposure to interest rate risk relating to its fixed rate loans.
This is a result of the loans having an interest rate which is fixed based on
the prevailing rates at the time of funding, whereas a fluctuation in rates may
occur at the time of loan sale or securitization. If market interest rates were
to rise between the funding and loan sale or securitization, the fixed rate
loans would, in turn, decrease in value. The Company mitigates the risk
associated with fixed rate mortgage 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 recognized in earnings. A loss of $106,000 and a gain of
$986,000 were recognized on hedging activities for the quarter and nine months
ended September 30, 1999, respectively, as compared to losses of $1,250,000 and
$1,266,000 for the corresponding periods in 1998. The notional amount of forward
sales of United States Treasury Securities was $7 million at September 30, 1999.
ACQUISITION
In July 1999, the Company acquired Coast Security Mortgage Corporation
("Coast"), a retail mortgage company that originated approximately $100 million
of sub-prime first mortgages in each of the last two years. Coast was previously
owned by, among others, Mark Chisick and Brad Chisick, each of whom are sons of
Brian Chisick, FACO's chairman and chief executive officer. The purchase price
of $4 million was finalized subject to customary indemnification, monetary
holdbacks and an independent third party evaluation regarding the merits,
pricing and terms of the transaction. The acquisition of Coast was accounted for
using the purchase method. Accordingly, the Company recorded approximately $3.2
million in goodwill, which is currently being amortized over 10 years. The
Company currently maintains eight offices (two of which are located in
California, and one of which is located in each of Colorado, Illinois, Ohio,
Oregon, Pennsylvania and Utah) with respect to the acquisition of Coast.
6
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UNITED KINGDOM LOAN SALE
In July 1999, the Company sold its portfolio of United Kingdom loans. The
sale of such assets was an opportunity presented to the Company in a manner that
allowed the Company to completely exit its United Kingdom operations. The
proceeds from the mortgage sale were used to repay the related secured term loan
facility. The Company recorded a gain on sale, net of deferred fees and foreign
currency loss, of approximately $1.3 million. Consequently, the Company does not
bear any material foreign currency risk exposure.
STOCK REPURCHASE PROGRAM
In April 1997, the Board of Directors approved a share repurchase program
under which the Company is authorized to purchase up to 7.5 million shares of
its Class A Common Stock. Of the 7.5 million shares authorized as of September
30, 1999, the Company had repurchased approximately 4.0 million shares; however,
did not repurchase any shares during the fourth quarter of 1998 and the first
nine months of 1999. The Company has resumed the share repurchase program during
the fourth quarter of 1999 and had repurchased 115,000 shares as of November 10,
1999.
NET INCOME PER SHARE
A reconciliation of the numerator and denominator used in basic and
diluted net income per share is as follows for the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income (dollars in thousands): ..........................$ 1,465 $ 3,833 $ 4,085 $ 11,876
============= ============= ============= =============
Weighted average number of common shares:
Basic...................................................... 18,139,488 18,534,938 18,139,488 19,798,208
Effect of dilutive securities - stock options.............. 1,153 16,965 35,098
------------- ------------- ------------- -------------
Diluted.................................................... 18,139,488 18,536,091 18,156,453 19,833,306
============= ============= ============= =============
Net income per share:
Basic $ .08 $ .21 $ .23 $ .60
Effect of dilutive securities - stock options.............. - - (.01) -
------------- ------------- ------------- -------------
Diluted....................................................$ .08 $ .21 $ .22 $ .60
============= ============= ============= =============
</TABLE>
SUBSEQUENT EVENTS
In October 1999, the Company extended its $150 million warehouse financing
facility to December 2000, which was due to expire in December 1999. As partial
consideration for this facility, the Company agreed to grant the warehouse
lender stock warrants to purchase an aggregate of 900,000 shares. This warehouse
financing facility, which is secured by loans originated or purchased by the
Company, bears interest at a rate ranging between 1.25% to 1.75% over one month
United States ("US") dollar denominated London Interbank Offered Rate ("LIBOR").
The Company has resumed activity with respect to its share repurchase
program during the fourth quarter of 1999 and had repurchased 115,000 shares as
of November 10, 1999.
During October 1999, the Company closed one of its retail branches located
in Ohio.
<PAGE>
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 secured 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. 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 offered the Company for its securitization, would likely have a
material adverse effect on the Company's results of operations and financial
condition.
In October 1999, the Company extended its $150 million warehouse financing
facility to December 2000, which was due to expire in December 1999 (see
"Subsequent Events"). This facility contains certain affirmative and negative
covenants with which the Company was in compliance as of September 30, 1999. In
March 1999, the Company entered into an additional $20 million warehouse
financing facility, which expired in September 1999 and was not renewed.
Although management expects that the Company will be able to maintain its
financing agreement, there can be no assurance that the Company will be able to
do so. If the Company is not successful in maintaining or replacing the existing
financing agreement, the Company may be forced to curtail its loan production
activity, which may lead to significantly reduced loan sales and
securitizations, thereby having a material adverse effect on the Company's
results of operations and financial condition.
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. Revenue from loan origination fees has historically
allowed the Company to generate positive operating cash flow. There can be no
assurance, however, that the Company's operating cash flows will continue to be
positive in the future.
The Company's average loan-to-value ("LTV") for loan originations and
purchases has historically ranged between 60% and 68%. Consequently, the
Company's product has been susceptible to heavy solicitation for refinancing.
This has resulted in average constant prepayment rates ("CPRs") experienced by
the Company to be greater than that of the industry, which in turn has
negatively affected mortgage servicing rights and the recognition of income on
residual interest. Continued increase in CPRs may have a material adverse effect
on the Company financial condition, result of operations, and cash flows.
In February 1997, the Company entered into an affinity real estate secured
credit card agreement with Fidelity Federal Bank, a Federal Savings Bank
("Fidelity"). Under the terms of this agreement, Fidelity would fund the
affinity credit card balance and would pay the Company for its solicitation
services, customer services and collection efforts. In connection with this
arrangement, the Company is required to maintain a restricted cash balance,
equivalent to charge-offs experienced by the Company in the preceding twelve
months. The agreement also stipulates that following termination of the program
by Fidelity, the Company is obligated to purchase the outstanding balance on the
credit cards. In June 1999, Fidelity notified the Company of its intent to
terminate the program by February 2000. Accordingly, the Company is currently
pursuing the sale of its credit card portfolio in an effort to meet its
obligation in February 2000, and has discontinued the issuance of new credit
cards. There is, however, no assurance that the Company will either be
successful in selling the credit card portfolio, which currently has an
available credit line of approximately $27 million and an outstanding balance of
approximately $20 million, by the obligation date or be able to have the
appropriate capital or financing in place to purchase these assets.
In September 1998, the Company was informed by the United States
Department of Justice ("DOJ") 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
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 (see
"Recent Developments"). The DOJ has agreed to limit its initial inquiry to
pricing disparities, and is currently reviewing data provided by the Company.
The Company is also party to various legal proceedings arising out of the
ordinary course of its business. 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 (see Part
II, Item 1., "Legal Proceedings," below).
8
<PAGE>
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, FASB issued Statement of Financial Accounting Standard
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
which is effective for annual and interim periods beginning after June 15, 2000.
This statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. The Company has not yet completed its
analysis of the effect this standard will have on the Company's financial
condition, results of operations or 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 became 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 adoption
of this standard did not have a material effect on the Company's financial
reporting.
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, 1999, is comprised
of 32 active offices in the United States (ten of which are located in
California, four of which are located in New York, three of which are located in
New Jersey, two of which are located in Illinois, Maryland, Ohio and
Pennsylvania, and one of which is located in each of Arizona, Colorado, Florida,
Minnesota, Oregon, Utah and Washington. Additionally, the Company maintains
eight offices (two of which are located in California, and one of which is
located in each of Colorado, Illinois, Ohio, Oregon, Pennsylvania and Utah) with
respect to its newly acquired subsidiary, Coast Security Mortgage (see "Recent
Developments"). The Company also 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. Revenue from loan origination fees has historically
allowed the Company to generate positive operating cash flow.
As a fundamental part of its business and financing strategy, the Company
securitizes the majority of its loans. In a typical securitization, the Company
sells loans to a special purpose entity, established for the limited purpose of
buying the assets from the Company and transferring the assets to a trust. The
trust issues interest-bearing securities, which are collateralized by the
underlying mortgages. The proceeds from the sale of the securities are used to
purchase the assets from the Company. In addition to the cash proceeds received
in connection with the securitization, the Company also retains a residual
interest in the trust. A significant portion of the Company's income is
associated with securitization activity.
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 the residual interests and their allocated cost is
recorded as gain on securitization and is included in loan origination and sale
revenue.
9
<PAGE>
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. In order to arrive
at the value of the residual interest, the Company estimates the excess future
cash flows by taking into consideration, among other factors, certain
assumptions regarding prepayment speeds and credit losses. Furthermore, such
cash flows are discounted at a rate which the Company believes is an appropriate
risk-adjusted market rate of return. Assumptions regarding future prepayment
speeds and credit losses are subject to volatility that could materially affect
results of operations. If actual prepayments and credit losses were to
significantly exceed the assumptions used and hence the excess cash flows, the
carrying value of the residual interest would need to be reduced through a
charge to earnings. Conversely, if actual prepayment and credit losses were less
than the assumptions used, the carrying value of residual interest and earnings
would be increased.
RECENT DEVELOPMENTS
In July 1999, the Company acquired Coast, a retail mortgage company that
originated approximately $100 million of sub-prime first mortgages in each of
the last two years. Coast was previously owned by, among others, Mark Chisick
and Brad Chisick, each of whom are sons of Brian Chisick, FACO's chairman and
chief executive officer. The purchase price of $4 million was finalized subject
to customary indemnification, monetary holdbacks and an independent third party
evaluation regarding the merits, pricing and terms of the transaction. The
acquisition of Coast was accounted for using the purchase method. Accordingly,
the Company recorded approximately $3.2 million in goodwill, which is currently
being amortized over 10 years. The Company currently maintains eight offices
(two of which are located in California, and one of which is located in each of
Colorado, Illinois, Ohio, Oregon, Pennsylvania and Utah) with respect to the
acquisition of Coast.
In July 1999, the Company sold its portfolio of United Kingdom loans. The
sale of such assets was an opportunity presented to the Company in a manner that
allowed the Company to completely exit its United Kingdom operations. The
proceeds from the mortgage sale were used to repay the related secured term loan
facility. The Company recorded a gain on sale, net of deferred fees and foreign
currency loss, of approximately $1.3 million. Consequently, the Company does not
bear any material foreign currency risk exposure.
In November 1998, the Attorney General of Minnesota filed an action on
behalf of the State against the Company in Ramsey County District Court. The
suit alleged violations of the Minnesota Uniform Deceptive Trade Practices Act,
the Consumer Fraud Act, Truth in Lending Act and related federal regulations.
The action was settled in September 1999. The settlement agreement does not
constitute an admission by the Company of the allegations made by the Attorney
General or any violation of any state or federal law; however, it involves cash
payments to a limited number of customers and provides for additional terms and
disclosures. The Company entered into this agreement without admitting any
wrongdoing and for settlement purposes only. Management does not believe that
the terms of the settlement will have a material adverse effect on the Company's
results of operations and financial condition.
During the current quarter of 1999, the Company opened two retail
branches, one of which is located in each of California and Pennsylvania.
However, during the same period, the Company closed three of its retail
branches, one of which is located in each of Georgia, Virginia and Ohio.
Accordingly, the Company has recorded a lease obligation reserve related to
these non-operating retail branches during the current quarter (see "Subsequent
Events").
10
<PAGE>
LOAN ORIGINATIONS AND PURCHASES
The following table summarizes loan origination and purchase activity for
the periods indicated:
<TABLE>
<CAPTION>
AT OR FOR THE QUARTERS AT OR FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loan originations and purchases:
Retail originations.................................... $ 124,229 $ 118,082 $ 311,051 $ 338,850
Coast Security Mortgage................................ 28,085 28,085
Loans by mail.......................................... 7,292 - 8,688 -
Wholesale purchases.................................... 1,174 15,955 9,632 63,833
------------ ------------ ------------ ------------
Total................................................ $ 160,780 $ 134,037 $ 357,456 $ 402,683
============ ============ ============ ============
Number of active branches as of the end of the period:
United States:
California........................................... 12 8
Other states......................................... 28 23
United Kingdom......................................... 3
------------ ------------
Total................................................ 40 34
============ ============
Weighted average initial interest rate.................... 8.8% 9.3% 9.0% 9.4%
Weighted average initial combined loan-to-value ratio..... 68.2% 67.2% 66.5% 64.9%
Average loan size......................................... $ 114 $ 101 $ 105 $ 92
</TABLE>
Originations and purchases increased 20% for the quarter and decreased 11%
for the nine months ended September 30, 1999 as compared to the corresponding
periods in the prior year. While origination volume increased, wholesale
purchases decreased for the quarter and nine months ended September 30, 1999.
The increase in origination volume is primarily attributable to higher retail
originations, additional volume generated from Coast Security Mortgage, a
subsidiary purchased during the third quarter, and the Company's Loans by Mail
program, which was developed in the current year. The decrease in wholesale
purchases is primarily due to the discontinuation of the Company's wholesale low
LTV purchase program during the second quarter of 1998.
LOAN SALES
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Securitizations.............................................. $ 120,001 $ 100,000 $ 324,987 $ 310,002
Domestic whole loan sales.................................... 20,827 46,009 46,237 110,912
United Kingdom whole loan sales.............................. 47,028 47,028
------------ ------------ ------------ ------------
Total................................................... $ 187,856 $ 146,009 $ 418,252 $ 420,914
============ ============ ============ =============
</TABLE>
Loan sales increased 29% for the quarter ended September 30, 1999 as
compared to the corresponding prior year quarter, primarily due to the sale of
the Company's United Kingdom loan portfolio. Excluding the sale of the United
Kingdom loan portfolio, loan sales decreased 12% for the nine months ended
September 30, 1999 as compared to the corresponding prior year period, primarily
due to a corresponding decrease in loan originations and purchases volume during
1999 as compared to 1998.
11
<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 QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
REVENUE:
Loan origination and sale:
Gain on sale of loans................................ 15.8% 12.2% 17.4% 12.2%
Net loan origination and other fees.................. 66.0 55.0 56.0 52.8
Interest .............................................. 14.8 22.7 20.0 25.9
Loan servicing and other fees.......................... 3.4 10.1 6.6 9.1
---------- ---------- ---------- ----------
Total revenue........................................ 100.0 100.0 100.0 100.0
---------- ---------- ---------- ----------
EXPENSE:
Compensation and benefits.............................. 34.7 26.9 31.4 28.0
Advertising............................................ 8.7 13.1 9.8 11.1
Professional services and other fees .................. 3.6 5.3 3.7 5.1
Facilities and insurance............................... 8.9 5.3 6.6 5.2
Supplies............................................... 3.0 2.4 2.5 3.3
Depreciation and amortization.......................... 3.6 2.2 3.0 2.2
Interest............................................... 12.2 9.8 16.7 9.2
Legal.................................................. 7.9 4.3 9.5 2.9
Travel and training.................................... 2.3 1.5 2.0 1.8
Other.................................................. 1.9 1.7 2.3 1.2
---------- ---------- ---------- ----------
Total expense........................................ 86.8 72.5 87.5 70.0
---------- ---------- ---------- ----------
Income before income tax provision........................ 13.2 27.5 12.5 30.0
Income tax provision...................................... 5.3 10.5 5.0 11.4
---------- ---------- ---------- ----------
Net income................................................ 7.9% 17.0% 7.5% 18.6%
========== ========== ========== ==========
</TABLE>
RESULTS OF OPERATIONS
REVENUE
The following table sets forth the components of the Company's revenue for
the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Loan origination and sale:
Gain on sale of loans (1).................................. $ 2,937 $ 2,745 $ 9,515 $ 7,786
Net loan origination and other fees........................ 12,236 12,404 30,617 33,634
Interest..................................................... 2,745 5,120 10,915 16,487
Loan servicing and other..................................... 635 2,291 3,578 5,833
----------- ----------- ----------- -----------
Total revenue........................................... $ 18,553 $ 22,560 $ 54,625 $ 63,740
=========== =========== =========== ===========
</TABLE>
(1) Excludes net loan origination and other fees.
12
<PAGE>
Total revenues decreased 18% or $4.0 million and 14% or $9.1 million for
the quarter and nine months ended September 30, 1999, respectively, as compared
to the corresponding periods in 1998.
Although gain on sale of loans and net loan origination and other fees
revenue remained consistent for the quarter ended September 1999 as compared to
the corresponding prior year period, it decreased by $1.3 million for the nine
months ended September 30, 1999 as compared to the corresponding period in 1998.
Excluding the $4.5 million negative adjustment related to residual
interest which was recognized during the second quarter of 1998, gain on sale of
loans increased $0.2 million and decreased $2.8 million for the quarter and nine
months ended September 30, 1999. The increase in gain on sale during the current
quarter and the decrease for the nine months ended September 30, 1999 is
primarily related to a decrease in gain on sale from domestic whole loan sales
and securitizations, offset by the gain recognized on the sale of the United
Kingdom loan portfolio during the current quarter.
Gain on sale from domestic whole loan sales decreased $0.8 million and
$1.8 million for the quarter and nine months ended September 30, 1999,
respectively, primarily due to lower domestic whole loan sales and lower
premiums available in the secondary market. Domestic whole loan sales decreased
to $46 million for the current year as compared to $111 million in the prior
year.
Gain on sale from securitizations decreased $0.2 million and $2.2 million
for the quarter and nine months ended September 30, 1999, respectively. This
decrease is primarily related to a decrease in the value of residual interest
and mortgage servicing rights and higher securitization costs, all of which was
partially offset by less premiums paid on wholesale purchases and increased
hedging gains.
The value of residual interest and mortgage servicing rights decreased by
$1.4 million and $7.4 million for the quarter and nine months ended September
30, 1999, respectively, as compared to the corresponding prior year periods.
Residual interest and mortgage servicing rights as a percent of loans
securitized decreased to 2.6% and 3.5% for the quarter and nine months ended
September 30, 1999, respectively, from 4.5% and 5.9% for the corresponding prior
year periods. The decrease in the value of residual interest and mortgage
servicing rights was primarily related to lower spreads on the securitizations
coupled with a required upfront overcollateralization. Additionally, the Company
increased its weighted average CPR assumptions to 34% and 35% for the quarter
and nine months ended September 30, 1999, respectively, from 32% and 30% for the
corresponding prior year periods. Furthermore, costs related to the
securitization increased by $0.3 million and $0.6 million for the quarter and
nine months ended September 30, 1999, respectively. The decrease in the value of
residual interest, mortgage servicing rights and increased securitization costs
was partially offset by a $0.4 million and $3.5 million reduction in premiums
paid on wholesale purchases, coupled with a reduction in hedging losses of $1.1
million and $2.3 million during the quarter and nine months ended September 30,
1999, respectively, when compared to the corresponding prior year periods.
The decrease in gain on sale from domestic whole loan sales and
securitization was negated by a $1.3 million gain recognized during the current
quarter on the Company's sale of its United Kingdom loan portfolio, which was
consummated in July 1999.
Net loan origination and other fees decreased $0.2 million or 1% and $3.0
million or 9% for the quarter and nine months ended September 30, 1999,
respectively, when compared to the corresponding prior year periods. This
decrease is primarily due to a decrease in weighted average origination fees,
partially offset by higher retail loan sales experienced during the current
year. Weighted average origination fees decreased to 10.4% and 10.9% for the
quarter and nine months ended September 30, 1999, respectively, as compared to
13.4% and 13.7% for the corresponding prior year periods.
Interest revenue decreased $2.4 million or 46% and $5.6 million or 34% for
the quarter and nine months ended September 30, 1999, respectively, as compared
to the corresponding prior year periods. This decrease was primarily related to
decreases in interest revenue derived from residual interest, loans held for
sale, the Company's United Kingdom loan portfolio and other investments.
Interest revenue related to residual interest decreased $0.8 million and $3.7
million for the quarter and nine months ended September 30, 1999, respectively,
as compared to the corresponding prior year periods, primarily due to greater
than expected prepayment rates experienced during the current year. Interest
revenue related to loans held for sale decreased by $0.1 million and $1.3
million for the quarter and nine months ended September 30, 1999, respectively,
as compared to the corresponding prior year periods, due to lower average
balances of loans outstanding during the current year. Interest revenue related
to the Company's United Kingdom loan portfolio decreased $1.3 million and $0.3
million for the quarter and nine months ended September 30, 1999, respectively,
as compared to the corresponding prior year periods, as a result of the sale of
the loan portfolio in July 1999. Furthermore, interest revenue related to other
investments decreased $0.2 million and $0.3 million for the quarter and nine
months ended September 30, 1999, respectively, as compared to the corresponding
prior year periods, primarily due to the warehouse financing receivable which
existed in 1998.
13
<PAGE>
Loan servicing and other fees decreased $1.7 million or 72% and $2.3
million or 39% for the quarter and nine months ended September 30, 1999,
respectively, as compared to the corresponding prior year periods. The decrease
is primarily due to (1) a decrease in fees related to prepayment penalties and
other loan servicing fees, (2) a decrease in net credit card income, (3) an
increase in the amortization of mortgage servicing rights, and (4) an increase
in reserve for servicing advances. Prepayment penalties and other loan servicing
fees decreased $0.8 million and $1.0 million for the quarter and nine months
ended September 30, 1999, respectively, as compared to the corresponding prior
year periods, primarily due to a decrease in loan payoffs experienced during the
quarter and decreased ancillary income earned on the Company's United Kingdom
loan portfolio, resulting from the related loan sale which occurred in July
1999. Net credit card income decreased $0.6 million and increased $0.1 million
for the quarter and nine months ended September 30, 1999, respectively, as
compared to the corresponding prior year periods, as a result of higher
charge-offs experienced during the year, partially offset by higher finance
charges due to an increase in average credit card balances during the current
year. Amortization of mortgage servicing rights increased $0.3 million and $0.8
million for the quarter and nine months ended September 30, 1999, respectively,
as compared to the corresponding prior year periods, due to an increase in CPRs
experienced during 1999. Furthermore, the Company recognized a $0.6 million
reserve for servicing advances during the current year.
EXPENSE
The following table sets forth the components of the Company's expense for
the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Compensation and benefits.................................... $ 6,434 $ 6,072 $ 17,165 $ 17,835
Advertising.................................................. 1,609 2,947 5,380 7,048
Professional services and other fees......................... 673 1,194 2,042 3,237
Facilities and insurance..................................... 1,655 1,194 3,621 3,336
Supplies..................................................... 550 544 1,363 2,090
Depreciation and amortization................................ 663 503 1,617 1,401
Interest..................................................... 2,265 2,207 9,141 5,839
Legal........................................................ 1,474 969 5,186 1,844
Travel and training.......................................... 434 339 1,096 1,134
Other........................................................ 355 379 1,204 841
----------- ----------- ----------- -----------
Total expense.............................................. $ 16,112 $ 16,348 $ 47,815 $ 44,605
=========== =========== =========== ===========
</TABLE>
Total expense decreased 1% or $0.2 million and increased 7% or $3.2
million for the quarter and nine months ended September 30, 1999, respectively,
as compared with the corresponding periods in 1998.
Although compensation and benefits increased $0.4 million or 6%, it
decreased by $0.7 million or 4% during the quarter and nine months ended
September 30, 1999, respectively, as compared to the corresponding prior year
periods. The increase in expenses during the quarter is related to the
acquisition of Coast Security Mortgage and the development of the Company's
E-Commerce and Loans by Mail divisions.
Advertising, professional services and supplies decreased $1.9 million or
40% and $3.6 million or 29% during the quarter and nine months ended September
30, 1999, respectively, as compared to the corresponding prior year periods.
This decrease in expenses is primarily due to the discontinuation of the
Company's credit card and United Kingdom operations in December 1998 and the
Company's overall cost reduction strategy, partially offset by an increase in
expenses related to the acquisition of Coast Security Mortgage and the
development of the Company's E-Commerce and Loans by Mail divisions.
14
<PAGE>
Facilities and insurance increased $0.5 million or 39% and $0.3 million or
9% during the quarter and nine months ended September 30, 1999, respectively, as
compared to the corresponding prior year periods. The increase is due to an
increase in the Company's lease obligation reserve related to non-operating
branches (see "Recent Developments").
The increase in legal expenses of $0.5 million and $3.3 million during the
quarter and nine months ended September 30, 1999, respectively, as compared to
the corresponding prior year periods, is related to ongoing legal matters (see
Part II, Item 1. "Legal Proceedings").
Interest expense increased $0.1 million and $3.3 million for the quarter
and nine months ended September 30, 1999, respectively, as compared to the
corresponding prior year periods. The increase in interest expense is due to (1)
an increase in debt issuance costs, (2) an increase in cost of funds related to
the United States denominated secured term loan facility, (3) an increase in the
average balance of the credit card portfolio; (4) partially offset by a decrease
in the average balance of the domestic warehouse financing facility. Debt
issuance costs increased by $0.7 million and $2.0 million during the quarter and
nine months ended September 30, 1999, respectively, as compared with the
corresponding prior year periods. Additionally, for the nine months ended
September 30, 1999, the Company incurred an approximately $1.2 million increase
in cost of funds related to its United States denominated secured term loan
facility resulting from foreign currency devaluation. However, during the
quarter ended September 30, 1999, cost of funds related to the United States
denominated secured term loan facility decreased $0.7 million as a result of its
payoff in conjunction with the sale of the United Kingdom loan portfolio. Cost
of funds related to the credit card portfolio increased $0.1 million and $0.9
million for the quarter and nine months ended September 30, 1999, respectively,
due to an increase in the average balance of the credit cards serviced. The
increase in debt issuance cost, foreign currency loss and cost of funds related
to the United Kingdom and credit card portfolios was partially offset by a
decrease in interest from the domestic warehouse financing facility of
approximately $0.2 million and $0.8 million, during the quarter and nine months
ended September 30, 1999, respectively, resulting from a decrease in the average
balance of loans financed.
INCOME TAXES
The Company's estimated tax rate for the quarters ended September 30, 1999
and 1998 was 40.0% and 38.3%, respectively. The increase in the Company's
estimated tax rate is primarily due to a change in geographical concentration of
the Company's business.
15
<PAGE>
SERVICING
The following tables provide data on loan delinquency, real estate owned
("REO") and net losses for the Company's combined United States and United
Kingdom servicing portfolio:
<TABLE>
<CAPTION>
AS OF
--------------------------------------------------------------------------------
SEPTEMBER 30, 1999 DECEMBER 31, 1998 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..................... $ 864,948 $ 865,663 $ 857,484
========== =========== ===========
30-59 days delinquent................... 5,512 0.6% $ 11,565 1.3% $ 8,528 1.0%
60-89 days delinquent................... 4,740 0.6 7,794 0.9 4,404 0.5
90 days or more delinquent.............. 19,612 2.3 22,464 2.6 23,612 2.8
---------- ----------- ----------- ----------- ----------- -----------
Total delinquencies.................. $ 29,864 3.5% $ 41,823 4.8% $ 36,544 4.3%
========== =========== =========== =========== =========== ===========
REO (1) ............................... $ 965 0.1% $ 2,063 0.2% $ 1,921 0.2%
========== =========== =========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
FOR THE QUARTERS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Average servicing portfolio (2)........................... $ 862,274 $ 854,757 $ 863,595 $ 840,284
Net losses (3)............................................ $ 352 $ 273 $ 1,105 $ 673
Percentage of average servicing portfolio - annualized.... 0.16% 0.13% 0.17% 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 period.
(3) Net losses means actual net losses realized with respect to the disposition
of REO.
LIQUIDITY AND CAPITAL RESOURCES
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.
The loan origination and processing fees charged to a 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.
In October 1999, the Company extended its $150 million warehouse financing
facility to December 2000, which was due to expire in December 1999 (see
"Subsequent Events"). This warehouse financing facility, which is secured by
loans originated or purchased by the Company, bears interest at a rate ranging
between 1.25% and 1.75% over one month US dollar denominated LIBOR. This
facility contains certain affirmative and negative covenants with which the
Company was in compliance as of September 30, 1999. In March 1999, the Company
entered into an additional $20 million warehouse financing facility, which
expired in September 1999 and was not renewed.
16
<PAGE>
Although management expects that the Company will be able to maintain its
financing agreement, there can be no assurance that the Company will be able to
do so. If the Company is not successful in maintaining or replacing the existing
financing agreement, 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 February 1997, the Company entered into an affinity real estate secured
credit card agreement with Fidelity. Under the terms of this agreement, Fidelity
would fund the affinity credit card balance and would pay the Company for its
solicitation services, customer services and collection efforts. In connection
with this agreement, the Company is required to maintain a restricted cash
balance, equivalent to charge-offs experienced by the Company in the preceding
twelve months. The agreement also stipulates that following termination of the
program by Fidelity, the Company is obligated to purchase the outstanding
balance on the credit cards. In June 1999, Fidelity notified the Company of its
intent to terminate the program by February 2000. Accordingly, the Company is
currently pursuing the sale of its credit card portfolio in an effort to meet
its obligation in February 2000, and has discontinued the issuance of new credit
cards. However, there is no assurance that the Company will either be successful
in selling the credit card portfolio, which currently has an available credit
line of approximately $27 million and an outstanding balance of approximately
$20 million, by the obligation date or be able to have the appropriate capital
or financing in place to purchase these assets.
During the current quarter, the Company's spread on its securitization
decreased due to less favorable market conditions experienced during the current
quarter, which led investors to demand higher yields. Consequently, the Company
was required to provide upfront overcollateralization in the form of cash
equaling $2.6 million.
As of September 30, 1999, the Company had commitments to fund loans of
$6.8 million. Historically, approximately 55% of such commitments have
ultimately been funded. Capital expenditures totaled $109,000 and $165,000 for
the quarter and nine months ended September 30, 1999, as compared to $309,000
and $3.3 million for the corresponding prior year periods. The decrease in
capital expenditures during the current year was partially due to the Company's
overall cost reduction strategy. In addition, during the nine months ended
September 30, 1998, the Company incurred a non-recurring $1.4 million of
improvements related to its telemarketing facility in Irvine, California.
In April 1997, the Board of Directors approved a share repurchase program
under which the Company is authorized to purchase up to 7.5 million shares of
its Class A Common Stock. Of the 7.5 million shares authorized as of September
30, 1999, the Company had repurchased approximately 4.0 million shares; however,
did not repurchase any shares during the fourth quarter of 1998 and the first
nine months of 1999. The Company has resumed the share repurchase program during
the fourth quarter of 1999 and had repurchased 115,000 shares as of November 10,
1999.
YEAR 2000 ISSUE
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 loan transactions,
service its loan portfolio or engage in other normal business activities. 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. All steps of the plan have been
completed and, thus far, the Company has been required to replace or renovate
only a small amount of its older computer equipment to comply with the Year 2000
issue. Since the majority of the Company's computer software and hardware was
purchased or developed recently and was designed to be Year 2000 compliant, the
Company's cost of addressing the Year 2000 issue has not been material, nor does
the Company expect any remaining costs to be material.
17
<PAGE>
The Company has initiated formal communication with its significant
outside vendors to determine the extent to which the Company may be vulnerable
to Year 2000-related risks in the event that those parties fail to properly
address their own Year 2000 issues. 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.
Consequently, a contingency plan for outside vendors has been completed for
dealing with the most reasonably likely worst case scenario.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In July 1999, the Company sold its portfolio of United Kingdom loans.
Proceeds from the sale were used to repay the related secured term loan
facility.
No other material changes with regard to market risk from the preceding
fiscal year were noted.
18
<PAGE>
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
those who purchased the stock during the stated class period by failing to
disclose known material adverse conditions in making certain public statements
about the Company's growth prospects. The state action is currently in the
discovery stage. On May 26, 1999, an action based on substantially similar facts
and allegations was filed in the United States District Court for the Central
District of California. The plaintiffs in these class action suits are seeking
an unspecified amount of damages. The Company has filed a motion to dismiss,
which is being set for hearing. Both the state and federal actions are in the
preliminary stages, and the Company believes that the allegations are without
merit.
In September 1998, the Company was informed by the DOJ 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 joint 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 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 (see "Recent Developments"). The DOJ has agreed to limit
its initial inquiry to pricing disparities, and is currently reviewing data
provided by the Company.
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, seeking an injunction against the
Company from charging rates, points and other terms which significantly deviate
from industry-wide standards or which are otherwise unconscionable or unlawful.
The remedies sought by the Attorney General include injunctive relief;
restitution for all consumers; civil penalties; and the costs of investigating
and prosecuting the action, including attorneys' fees. A preliminary injunction
was granted, limiting the points the Company can charge to a total of five. In
addition, the Company must advise the Attorney General before any foreclosure
actions are filed in the Commonwealth. The Company filed a motion to vacate the
injunction, which was denied without prejudice. The case is currently in the
discovery stage.
In December 1998, the Attorney General of the State of Illinois filed an
action on behalf of the State against the Company in the Cook County Circuit
Court. The suit alleges violations of the Illinois Consumer Fraud Act, Deceptive
Trade Practices Act and Illinois Interest Act. The Attorney General seeks
injunctive relief, restitution, civil penalties, rescission, revocation of
business licenses, attorneys' fees and costs. The Company's motion to dismiss
the complaint was granted as to three of the four claims.
In December 1998, the American Association of Retired Persons ("AARP")
filed an action against the Company and against Brian and Sarah Chisick in the
Superior Court of California, in the County of Santa Clara. The suit alleges
unfair, unlawful, fraudulent and deceptive business practices and conspiracy.
The AARP is seeking injunctive relief, restitution, revocation of licenses,
attorneys' fees and costs. The case is currently in its discovery stage.
The Company is also a party to various legal proceedings arising out of the
ordinary course of its business including a number of lawsuits alleging
misleading lending practices, some of which have been filed either as class
actions or under private attorney general statutes. Given the preliminary state
of these proceedings, the Company cannot determine the probability or reasonably
estimate any potential loss, if any, related to the ultimate outcome of the
cases.
19
<PAGE>
ITEM 2. CHANGES IN SECURITIES
In April 1999, the Company's Board of Directors authorized the issuance of
an additional 1,000,000 shares pursuant to its 1996 Stock Incentive Plan,
subject to the approval of the stockholders at the Annual Shareholders Meeting
to be held in April 2000.
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
Not Applicable.
20
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
--- ----------------------
2.1 Stock Purchase Agreement by and among Coast Security Mortgage, Inc.
and the shareholders thereof and First Alliance Corporation, dated as
of July 2, 1999 (Incorporated by reference to Form 8-K filed on July
19, 1999)
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 10.6 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 10.7 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
10.9 to the Company's Registration Statement on Form S-1, Commission
File No. 333-3633)
10.10 Reimbursement Agreement (Incorporated by reference to Exhibit 10.10 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 10.11 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)
21
<PAGE>
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)
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)
10.16 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)
10.19 Master Repurchase Agreement dated as of December 30, 1998 between
Lehman Commercial Paper Inc. and the Company (Incorporated by
reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, Commission File No. 0-28706)
10.20 Deed of Trust Note dated as of February 19, 1999 between the Ohio
National Life Insurance Company and the Company (Incorporated by
reference to Exhibit 10.20 to the Company's Quarterly Report on Form
10-Q for the period ended March 31, 1999, Commission File No. 0-28706)
27 Financial Data Schedule *
- ----------------
* Filed herewith.
(b) Reports on Form 8-K:
A current report on Form 8-K was filed July 19, 1999 by First
Alliance Corporation. Under Item 5, "Other Events," First Alliance
reported the consummation of the Coast Security Mortgage
acquisition.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and 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 12, 1999 /s/ BRIAN CHISICK
---------------------- ----------------------------------------
Brian Chisick
President and Chief Executive Officer
Date: November 12, 1999 /s/ FRANCISCO NEBOT
---------------------- -------------------------------
Francisco Nebot
Executive Vice President
Principal Financial Officer
23
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